What does an audit involve?

An audit involves the auditor looking through a company’s accounts, deciding if they contain any material misstatements (i.e. frauds and errors that are significant enough to have a large impact on the company’s finances) and then publishing a report on their findings. 

Auditors are supposed to make judgements on a few different things. One is what the risk associated with any material misstatements they found is, as in how likely they are to cause big problems for the company and its stakeholders. Another is how well the company is doing its accounting. Are the books structured and presented in a good way? Are they including the right things and using appropriate accounting policies? Are the disclosures and estimates being provided by the directors reasonable? Basically, the idea is that the auditor will be able to ultimately decide whether a company’s accounts provide a ‘fair and true’ snapshot of the business’ finances and how it is operating.

Auditors also check to see if they agree with the way company directors are calculating what is called going concern. That basically means that at this point in time a company has enough resources to keep operating indefinitely, i.e. it’s not going to go bust.  

If everything looks hunky-dory on the fair and true front, the audit report will express what is known as an unmodified opinion. That’s just the auditor equivalent of two thumbs up. If the auditor thinks there are some material misstatements kicking around in there, or that the accounts didn’t contain enough information for the auditor to be confident there weren’t any material misstatements, then the report will be a modified opinion. 

This second category can be broken down further. Auditors issue a qualified opinion when there are or could be some material misstatements but not ones that are pervasive i.e. not ones that are likely to cause any real damage to the business. They issue an adverse opinion if the misstatements are material and pervasive. (This could be either because one really bad thing is happening or because there are so many smaller problems that all together they will add up to something bad.) 

Finally, there’s the option to disclaim an opinion. This means either (1) that the accounts didn’t contain an appropriate level of evidence, and any misstatements the auditors missed as a consequence of that could be material and pervasive, or (2) there was appropriate evidence but the auditor still felt it wasn’t possible for them to state an opinion on the fairness and trueness of the books, essentially because there were too many other uncertainties and unknowns. But this last one is a pretty rare outcome for an audit report.