#cfa-level-1 #reading-22-financial-statement-analysis-intro
Financial statements presented in companies’ annual reports are generally required to be audited (examined) by an independent accounting firm in accordance with specified auditing standards. The independent auditor then provides a written opinion on the financial statements. This opinion is referred to as the audit report. Audit reports take slightly different forms in different jurisdictions, but the basic components, including a specific statement of the auditor’s opinion, are similar. Audits of financial statements may be required by contractual arrangement, law, or regulation.
International standards for auditing have been developed by the International Auditing and Assurance Standards Board of the International Federation of Accountants. These standards have been adopted by many countries and are referenced in audit reports issued in those countries. Other countries, such as the United States, specify their own auditing standards. With the enactment of the Sarbanes–Oxley Act of 2002 in the United States, auditing standards for public companies are promulgated by the Public Company Accounting Oversight Board.
Under international standards for auditing (ISAs), the objectives of an auditor in conducting an audit of financial statements are
To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework; and
To report on the financial statements, and communicate as required by the ISAs, in accordance with the auditor’s findings.8
Publicly traded companies may also have requirements set by regulators or stock exchanges, such as appointing an independent audit committee within its board of directors to oversee the audit process. The audit process provides a basis for the independent auditor to express an audit opinion on whether the information presented in the audited financial statements present fairly the financial position, performance, and cash flows of the company in accordance with a specified set of accounting standards. Because audits are designed and conducted using audit sampling techniques and financial statement line items may be based on estimates and assumptions, independent auditors cannot express an opinion that provides absolute assurance about the accuracy or precision of the financial statements. Instead, the independent audit report provides reasonable assurance that the financial statements are fairly presented, meaning that there is a high probability that the audited financial statements are free from materialerror, fraud, or illegal acts that have a direct effect on the financial statements.
The standard independent audit report for a publicly traded company normally has several paragraphs under both the international and US auditing standards. The first or “introductory” paragraph describes the financial statements that were audited and the responsibilities of both management and the independent auditor. The second or “scope” paragraph describes the nature of the audit process and provides the basis for the auditor’s expression about reasonable assurance on the fairness of the financial statements. The third or “opinion” paragraph expresses the auditor’s opinion on the fairness of the audited financial statements.
An unqualified audit opinion states that the financial statements give a “true and fair view” (international) or are “fairly presented” (international and US) in accordance with applicable accounting standards. This is often referred to as a “clean” opinion and is the one that analysts would like to see in a financial report. There are several other types of opinions. A qualified audit opinion is one in which there is some scope limitation or exception to accounting standards. Exceptions are described in the audit report with additional explanatory paragraphs so that the analyst can determine the importance of the exception. An adverse audit opinion is issued when an auditor determines that the financial statements materially depart from accounting standards and are not fairly presented. An adverse opinion makes analysis of the financial statements easy: Do not bother analyzing these statements, because the company’s financial statements cannot be relied on. Finally, a disclaimer of opinion occurs when, for some reason, such as a scope limitation, the auditors are unable to issue an opinion. Exhibit 10 presents the independent auditor’s report for Volkswagen. Note that Volkswagen received an unqualified or clean audit opinion from PricewaterhouseCoopers for the company’s fiscal year ended 31 December 2009.
Exhibit 10. Volkswagen’s Independent Audit ReportOn completion of our audit, we issued the following unqualified auditors’ report dated February 17, 2010. This report was originally prepared in German. In case of ambiguities the German version takes precedence:
We have audited the consolidated financial statements prepared by VOLKSWAGEN AKTIENGESELLSCHAFT, Wolfsburg, comprising the income statement and statement of comprehensive income, the balance sheet, the statement of changes in equity, the cash flow statement and the notes to the consolidated financial statements, together with the group management report, which is combined with the management report of the Company for the business year from January 1 to December 31, 2009. The preparation of the consolidated financial statements and the combined management report in accordance with the IFRSs, as adopted by the EU, and the additional requirements of German commercial law pursuant to § (article) 315a Abs. (paragraph) 1 HGB (“Handelsgesetzbuch”: German Commercial Code) are the responsibility of the Company’s Board of Management. Our responsibility is to express an opinion on the consolidated financial statements and on the combined management report based on our audit.
We conducted our audit of the consolidated financial statements in accordance with § 317 HGB and German generally accepted standards for the audit of financial statements promulgated by the Institut der Wirtschaftsprüfer (Institute of Public Auditors in Germany) (IDW). Those standards require that we plan and perform the audit such that misstatements materially affecting the presentation of the net assets, financial position and results of operations in the consolidated financial statements in accordance with the applicable financial reporting framework and in the combined management report are detected with reasonable assurance. Knowledge of the business activities and the economic and legal environment of the Group and expectations as to possible misstatements are taken into account in the determination of audit procedures. The effectiveness of the accounting-related internal control system and the evidence supporting the disclosures in the consolidated financial statements and the combined management report are examined primarily on a test basis within the framework of the audit. The audit includes assessing the annual financial statements of those entities included in consolidation, the determination of the entities to be included in consolidation, the accounting and consolidation principles used and significant estimates made by the Company’s Board of Management, as well as evaluating the overall presentation of the consolidated financial statements and the combined management report. We believe that our audit provides a reasonable basis for our opinion.
Our audit has not led to any reservations.
In our opinion, based on the findings of our audit, the consolidated financial statements comply with the IFRSs as adopted by the EU and the additional requirements of German commercial law pursuant to Article 315a paragraph 1 HGB and give a true and fair view of the net assets, financial position and results of operations of the Group in accordance with these requirements. The combined management report is consistent with the consolidated financial statements and as a whole provides a suitable view of the Group’s position and suitably presents the opportunities and risks of future development.
Hanover, February 17, 2010
PricewaterhouseCoopers
Aktiengesellschaft
Wirtschaftsprüfungsgesellschaft
Harald Kayser
Wirtschaftsprüfer
ppa. Martin Schröder
Wirtschaftsprüfer
Source: Volkswagen’s Annual Report 2009.
In the United States, under the Sarbanes–Oxley Act, the auditors must also express an opinion on the company’s internal control systems. This information may be provided in a separate opinion or incorporated as a paragraph in the opinion related to the financial statements. The internal control system is the company’s internal system that is designed, among other things, to ensure that the company’s process for generating financial reports is sound. Although management has always been responsible for maintaining effective internal control, the Sarbanes–Oxley Act greatly increases management’s responsibility for demonstrating that the company’s internal controls are effective. Management of publicly traded companies in the United States are now required by securities regulators to explicitly accept responsibility for the effectiveness of internal control, evaluate the effectiveness of internal control using suitable control criteria, support the evaluation with sufficient competent evidence, and provide a report on internal control.
Although these reports and attestations provide some assurances to analysts, they are not infallible. The analyst must always use a degree of healthy skepticism when analyzing financial statements.