Example Opinion Scenarios: Comprehensive Insights for CPA Candidates
Explore illustrative auditor's report scenarios, detailing clean opinions with emphasis-of-matter, qualified opinions, disclaimers, and adverse opinions. Understand key triggers, materiality thresholds, and proper language usage aligned with AU-C Section 705 and PCAOB AS 3101/3105.
C.2 Example Opinion Scenarios
In the journey toward mastering audit reports, it is essential to understand how different opinion scenarios arise and how each report reflects an auditor’s judgment of an entity’s financial statements. This section showcases four main outcomes under Generally Accepted Auditing Standards (GAAS) and Public Company Accounting Oversight Board (PCAOB) standards:
- Clean (Unmodified) Opinion with an Emphasis-of-Matter Paragraph
- Qualified Opinion
- Disclaimer of Opinion
- Adverse Opinion
We will also review fundamental terminology and reference the relevant professional standards governing modifications to an auditor’s opinion, including AU-C Section 705 “Modifications to the Opinion in the Independent Auditor’s Report” (AICPA) and PCAOB Auditing Standards 3101 and 3105 (for issuers).
Overview of Modified Opinions
To help visualize the decision framework that auditors follow when deciding which opinion to issue, consider the decision tree below. It outlines how an auditor moves from unmodified or “clean” opinions to modifications (Qualified, Adverse, or Disclaimer) based on the nature and extent of misstatements or scope limitations:
flowchart TB
A((Start)) --> B{Material Misstatement<br>or Scope Limitation?}
B -- No --> C[Unmodified Opinion<br>(Possible Emphasis-of-Matter)]
B -- Yes --> D{Material <br>or Material & Pervasive?}
D -- Material but Not Pervasive --> E[Qualified Opinion]
D -- Material & Pervasive --> F{Misstatement or Scope Limitation?}
F -- Misstatement --> G[Adverse Opinion]
F -- Scope Limitation --> H[Disclaimer of Opinion]
• “Material” refers to the significance of the error or omission.
• “Pervasive” means the effects of the misstatement or limitation are so widespread that they impact multiple financial statement elements or fundamentally undermine reliance on the statements.
1. Clean (Unmodified) Opinion with Emphasis-of-Matter Paragraph
1.1 When and Why It Arises
An unmodified (clean) opinion states that the financial statements present fairly, in all material respects, the financial position and results of the entity’s operations according to the applicable financial reporting framework (e.g., U.S. GAAP). However, auditors sometimes add an Emphasis-of-Matter (EoM) paragraph to highlight a specific issue without modifying their overall opinion.
Common reasons for issuing an unmodified opinion with an EoM paragraph include:
• Significant subsequent events (for instance, a natural disaster occurring after the financial year-end but disclosed properly).
• Changes in accounting principles that materially affect comparability but have been appropriately disclosed.
• Unusual important transactions, uncertainties, or contingencies that the auditor wishes to emphasize.
1.2 Illustrative Example
Below is an illustrative (condensed) excerpt from an independent auditor’s report with an EoM paragraph related to a change in accounting principle:
INDEPENDENT AUDITOR’S REPORT
We have audited the accompanying financial statements of XYZ Corporation, which comprise… [standard unmodified opinion introduction and basis for opinion sections]…
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of XYZ Corporation as of December 31, 20XX, and the results of its operations and its cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America.
Emphasis of Matter
As discussed in Note X to the financial statements, during 20XX, the Company adopted Accounting Standards Update (ASU) 20XX-XX, which represents a change from the method previously used. Our opinion is not modified with respect to this matter.
[Signature of the auditor]
[Auditor’s address]
[Date of the audit report]
1.3 Practical Considerations
• Ensure the EoM paragraph is placed immediately after the Opinion section.
• Clearly reference the note in the financial statements describing the event or change in principle.
• State that the auditor’s opinion is not modified with respect to the matter discussed.
2. Qualified Opinion
2.1 When and Why It Arises
A qualified opinion is issued when one of the following occurs:
• A material misstatement is present in a specific account or disclosure, but it is not pervasive—often described as “except for” the described matter, the financial statements are presented fairly.
• The auditor was unable to obtain sufficient appropriate audit evidence for one element or area, but this limitation does not affect the entirety of the financial statements.
If the misstatement or scope limitation is isolated to a particular section or does not overshadow the overall fairness of the financial statements, a qualified opinion may be appropriate.
2.2 Language and Format
Under GAAS (AU-C Section 705) and PCAOB standards (AS 3101/3105), the wording of a qualified opinion typically includes the phrase “except for the effects of the matter described in the Basis for Qualified Opinion section, the financial statements present fairly…”
2.3 Illustrative Example (Material Misstatement)
INDEPENDENT AUDITOR’S REPORT
Basis for Qualified Opinion
We conducted our audit in accordance with GAAS… [include standard language about responsibilities]. However, the Company has recorded its inventory at cost, which Management has not adjusted for net realizable value. Management’s calculation and supporting documentation indicate that approximately $1 million in inventory losses have not been accounted for in the accompanying financial statements.
Qualified Opinion
In our opinion, except for the effects of the matter discussed in the Basis for Qualified Opinion section, the financial statements referred to above present fairly, in all material respects, the financial position of ABC Corporation…
[Signature of the auditor]
[Auditor’s address]
[Date of the audit report]
2.4 Practical Considerations
• Clearly describe the specific issue leading to the qualification in the “Basis for Qualified Opinion” section.
• Use “except for” language to isolate the problematic area.
• Include an estimate or quantification of the misstatement whenever possible.
3. Disclaimer of Opinion
3.1 When and Why It Arises
A disclaimer of opinion is issued when the auditor cannot form an opinion due to severe scope limitations. In other words, the auditor was unable to obtain sufficient evidence to support an opinion. Situations leading to disclaimers may include:
• The client’s records are missing or significantly incomplete, making verification impossible.
• Restrictions imposed by management or circumstances preventing essential audit procedures.
• Pervasive uncertainty that makes forming a conclusion impossible (not merely because management used an unusual accounting principle, but because the auditor cannot verify critical supporting data).
3.2 Illustrative Example
INDEPENDENT AUDITOR’S REPORT
Disclaimer of Opinion
We were engaged to audit the accompanying financial statements of DEF Company as of and for the year ended December 31, 20XX. We could not obtain sufficient appropriate audit evidence regarding the Company’s revenue transactions because management did not provide access to relevant customer invoices and sales contracts.
Because of the significance of the matter described in the Basis for Disclaimer of Opinion section, we were not able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion. Accordingly, we do not express an opinion on these financial statements.
Basis for Disclaimer of Opinion
We conducted our engagement in accordance with GAAS… [continue standard required disclaimers and language].
[Signature of the auditor]
[Auditor’s address]
[Date of the audit report]
3.3 Practical Considerations
• Use the heading “Disclaimer of Opinion” instead of “Opinion.”
• Avoid describing the results of any procedures because the overall inability to gather critical evidence renders all results inconclusive.
• Though the reasons are typically explained immediately after the disclaimer, the overall tone should convey that the auditor cannot opine—rather than “the statements are wrong,” it communicates “we cannot determine whether the statements are correct.”
4. Adverse Opinion
4.1 When and Why It Arises
An adverse opinion is the most critical type of modified opinion. It states that the financial statements do not present fairly the financial position or results of the entity due to a material misstatement that is also pervasive. Typical triggers:
• The entity’s use of fundamentally incorrect accounting policies that affect multiple items in the financial statements.
• Multiple material misstatements or significant non-compliance with GAAP rendering the financial statements misleading overall.
4.2 Illustrative Example
INDEPENDENT AUDITOR’S REPORT
Adverse Opinion
We have audited the accompanying financial statements of GHI Corporation. In our opinion, because of the significance of the matters discussed in the Basis for Adverse Opinion section, the financial statements do not present fairly the financial position of GHI Corporation as of December 31, 20XX, or the results of its operations and its cash flows for the year then ended, in accordance with accounting principles generally accepted in the United States of America.
Basis for Adverse Opinion
Management has failed to consolidate a wholly-owned subsidiary in accordance with U.S. GAAP. Additionally, a material portion of intangible assets is overstated due to the omission of required impairment testing. As a result, the financial statements are materially misstated, and the misstatement is pervasive to assets, liabilities, and net income.
[Signature of the auditor]
[Auditor’s address]
[Date of the audit report]
4.3 Practical Considerations
• Clearly articulate the reasons for the adverse opinion in the “Basis for Adverse Opinion” section.
• Provide insight into how the misstatement is pervasive, impacting multiple statements or fundamentally undermining the reliability of the financial statements.
5. Key Terminology Reference
Below are select terms that guide auditors in choosing the appropriate opinion type:
• Except for: Language used in a qualified opinion to isolate the specific area of misstatement or limitation.
• Material and Pervasive: Level of seriousness and breadth of a misstatement or limitation. If both conditions are met, an adverse or disclaimer of opinion is warranted depending on whether the issue is a misstatement or lack of evidence.
• Scope Limitation: A limitation on the auditor’s ability to gather sufficient appropriate evidence. This might be due to physical constraints, unavailability of documents, or restrictions by management.
6. References and Further Reading
• AU-C Section 705: “Modifications to the Opinion in the Independent Auditor’s Report.”
• PCAOB AS 3101: “The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion.”
• PCAOB AS 3105: “Departures from Unqualified Opinions and Other Reporting Circumstances.”
• AICPA Professional Standards: For the full text of authoritative guidance.
• GAAS Hierarchy: Outlines how GAAS is structured, which standards are binding, and which are interpretative.
Advanced Auditor Opinion Scenario Quiz for CPA Candidates
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