How to analyze the Audit Report of a company?

Every Indian company is statutorily required (Under Sec 139 of The Companies Act, 2013) to appoint an auditor and obtain Audit Report from the Certified practicing Auditors in the prescribed format. Thus, the Audit Report, with reference to Indian companies, has a well-defined format concerning its objectives, content, and form. In addition to statutory reports some of the large companies (having their paid-up capital more than Rs. 1 Crore or bank borrowing more than Rs.1 crore or having annual turnover more than Rs.10 Crore are also required to obtain Audit report under CARO (Company (Auditors Report) Order, 2016). Before we get into the analysis of an Audit Report of a company, let us understand what shall we expect from an Audit Report? A standard audit report carries seven key elements, each of which carries relevance for meaningful analysis of an audit report.

The scope of an Audit Report clearly states the scope of the Audit. It states the rules and methods followed in carrying out the Audit and adherence to the Generally Accepted Audit Standards. it also indicates the test methods adopted by the auditors in carrying out the audit of the financial statements of the company. it also clearly states key non-documentary evidence such as management explanations on which auditors have relied.  

Indian company audit report – key information

Some of the key information while reading an audit report is the Date of Report and Period under Audit. The date of the Report is a clear indication of the end date of the period during which auditors carried out the Audit. The auditors are supposed to take into consideration all the material events that occurred until the date of the audit report. The period under audit indicates that Auditor has expressed their opinion on the books of accounts and financial statements for that period. Any event having occurred outside of this period are not considered by the auditors.

Then comes one of the most critical sections of an Indian company audit report – opinion. It states if in the opinion of the auditors, the financial statements of the company present true and fair view of the financial affairs of the company. In case auditors find any event that does not completely render the financial statements untrue it is the standard practice to qualify their opinion. The Audit qualification is generally provided by way of Qualification notes. Each qualification notes results in the degree or extent of the element of truth or fairness of the information provided in financial statements. The severity of qualification is a matter of interpretation to be made by judging the materiality of qualification. Size of the company, nature of qualification, repetitive nature of event triggering qualification, the possibility of mitigation of qualificator events, management explanation, and quality of company management are key factors in interpreting the severity of qualifications.

Notes forming part of accounts posses another set of key information. These are like disclosure, clarification as well as qualification arising out of such disclosures and clarifications. Notes contain important information like whether company, has changed any accounting practice, has maintained their accounts in compliance with applicable accounting standards, undertaken any non-cash liabilities such as guarantees for self or any third parties, provided for all contingent liabilities, complied with regulatory requirements, paid taxes in time, entered into related party transactions at arm’s length so on and so forth.

Finally, Audit Report of a company also contains information about Auditors such as the name of the auditor and auditing firm as well as their registration numbers. Reading of audit reports of multiple ears also provides information about the history of changes in auditors and frequency and reasons for change, good standing of the singing auditors and so on. Reading and analyzing an Indian company audit report is science as well as an art. Instead of expecting a black and white opinion, which is generally very difficult for an auditor to form, one should expect to find an express or subtle hints about what to look into to identify potential risks, while evaluating a company’s financial and overall business standing.

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