Types of Audit Opinions: Unmodified, Qualified, Adverse and Disclaimer Under AU-C 700, 705 and 706

The auditor's opinion is the end product of the audit. In a US audit of a nonissuer, there are four possible opinions: unmodified, qualified, adverse and a disclaimer of opinion. The choice depends on two questions: is there a material misstatement or an inability to obtain enough evidence, and if so, is the effect pervasive?

The requirements sit in three AU-C sections, all reshaped by SAS No. 134 (effective for audits of financial statements for periods ending on or after December 15, 2021):

• AU-C 700, Forming an Opinion and Reporting on Financial Statements: the unmodified opinion and the structure of the report.
• AU-C 705, Modifications to the Opinion in the Independent Auditor's Report: qualified, adverse and disclaimer.
• AU-C 706, Emphasis-of-Matter Paragraphs and Other-Matter Paragraphs in the Independent Auditor's Report.

This guide paraphrases these standards.

The structure of the auditor's report after SAS 134

SAS 134 moved the opinion to the top of the report. A typical unmodified report for a nonissuer now has these sections, in this order:

1. Title that includes the word "independent."
2. Addressee.
3. Opinion: identifies the entity and the statements audited and states the opinion.
4. Basis for Opinion: states that the audit was conducted under GAAS, refers to the auditor's responsibilities section, states that the auditor is independent and has met other ethical responsibilities, and states whether the auditor believes the evidence obtained is sufficient and appropriate.
5. Going concern section, if substantial doubt exists (see below).
6. Key audit matters, only if the auditor is engaged to communicate them under AU-C 701.
7. Emphasis-of-matter or other-matter paragraphs, if any.
8. Responsibilities of Management for the Financial Statements, including management's evaluation of going concern when the framework requires it.
9. Auditor's Responsibilities for the Audit of the Financial Statements.
10. Other reporting responsibilities, such as supplementary information, when applicable.
11. Signature, city and state, and date.

How the opinion is chosen

AU-C 705 frames the decision around two factors.

Factor 1: the nature of the matter

• The financial statements are materially misstated, or
• The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement (often called a scope limitation).

Factor 2: pervasiveness

Effects are pervasive when, in the auditor's judgment, they:

• are not confined to specific elements, accounts or items of the financial statements, or
• if confined, represent or could represent a substantial proportion of the financial statements, or
• in relation to disclosures, are fundamental to users' understanding of the financial statements.

The decision table

Materiality is set under AU-C 320, and the evaluation of uncorrected misstatements happens under AU-C 450. Both feed the opinion decision.

Unmodified opinion

An unmodified opinion states that the financial statements present fairly, in all material respects, in accordance with the applicable financial reporting framework. It is given when the auditor concludes, based on sufficient appropriate evidence, that the financial statements as a whole are free from material misstatement.

An unmodified opinion can still include a going concern section, an emphasis-of-matter paragraph or an other-matter paragraph. None of these modifies the opinion.

The term "unmodified" replaced "unqualified" in US nonissuer standards when the clarified standards took effect. Some people still say "clean opinion" or "unqualified opinion" informally.

Qualified opinion

A qualified opinion says that, except for the effects of the matter described, the financial statements present fairly. It is used when:

• misstatements, individually or in aggregate, are material but not pervasive, or
• the auditor cannot obtain sufficient appropriate evidence, and the possible effects of undetected misstatements could be material but not pervasive.

The opinion section is headed "Qualified Opinion," and the basis section is headed "Basis for Qualified Opinion." The basis section describes the matter and, where practicable, quantifies its financial effects. If the matter relates to an omitted disclosure, the auditor includes the omitted information if practicable.

Common examples

• inventory not observed at year-end and no satisfactory alternative procedures, where inventory is material but not pervasive
• a departure from GAAP in a single area, such as failing to record a material impairment
• an inadequate disclosure that is material but not pervasive

Adverse opinion

An adverse opinion says that, because of the significance of the matter described, the financial statements do not present fairly. It is used when misstatements are both material and pervasive.

The sections are headed "Adverse Opinion" and "Basis for Adverse Opinion." An example is an entity that prepares statements on a basis that departs from the framework in a fundamental way and declines to change it.

Disclaimer of opinion

A disclaimer states that the auditor does not express an opinion because of the significance of the matter described. It is used when the auditor cannot obtain sufficient appropriate evidence and concludes that the possible effects of undetected misstatements could be both material and pervasive.

AU-C 705 also allows a disclaimer in rare circumstances involving multiple uncertainties, even where evidence about each one has been obtained, if the potential interaction of the uncertainties makes it impossible to form an opinion.

A disclaimer changes several parts of the report. The opinion section is headed "Disclaimer of Opinion," the basis section is headed "Basis for Disclaimer of Opinion," and the auditor's responsibilities section is amended. The report does not include the statement that the evidence obtained is sufficient and appropriate, and limits the description of the auditor's responsibilities.

Withdrawal as an alternative

If the scope limitation is imposed by management after the engagement is accepted and its effect could be pervasive, the auditor considers withdrawing from the engagement where practicable and possible under law. If withdrawal is not possible, the auditor disclaims.

Emphasis-of-matter paragraphs

What they do

An emphasis-of-matter paragraph refers to a matter that is appropriately presented or disclosed in the financial statements and that, in the auditor's judgment, is of such importance that it is fundamental to users' understanding of the statements.

Requirements

Under AU-C 706, the paragraph:

• is in a separate section with an appropriate heading that includes "Emphasis of Matter"
• refers clearly to the matter and to where the relevant disclosures can be found
• states that the auditor's opinion is not modified with respect to the matter

The auditor cannot use an emphasis-of-matter paragraph to fix an inadequate disclosure. If the disclosure is inadequate, that is a misstatement and the opinion is modified instead.

When they are used

Some AU-C sections require emphasis-of-matter paragraphs in specific situations. For example, AU-C 800 requires one when the financial statements are prepared under a special purpose framework, such as the cash basis or the tax basis, to alert users to the basis of accounting. AU-C 708 requires one when there is a change in accounting principle that has a material effect on the financial statements. Others are at the auditor's discretion, such as:

• a major catastrophe after year-end that has a significant effect on the entity
• significant related-party transactions
• an uncertainty about the outcome of significant litigation

Reserve emphasis paragraphs for matters that are fundamental to users' understanding.

Other-matter paragraphs

What they do

An other-matter paragraph refers to a matter not presented or disclosed in the financial statements that, in the auditor's judgment, is relevant to users' understanding of the audit, the auditor's responsibilities or the auditor's report.

Requirements

The paragraph is in a separate section with the heading "Other Matter" or similar. It may not include information the auditor is prohibited from providing, and it may not include information management is required to provide.

When they are used

• the prior-period statements were audited by a predecessor auditor whose report is not reissued
• the prior-period statements were not audited, or were reviewed or compiled
• the report is restricted in use

Going concern is its own section

Under SAS 134, when substantial doubt about the entity's ability to continue as a going concern exists after considering management's plans, the report includes a separate section titled "Substantial Doubt About the Entity's Ability to Continue as a Going Concern." It is not called an emphasis-of-matter paragraph, though it serves a similar purpose. The opinion is unmodified if the disclosures are adequate. See going concern assessment under AU-C 570 for the full process.

Key audit matters

Key audit matters (KAMs) are the matters of most significance in the audit. For nonissuer audits, AU-C 701 applies only when the auditor is engaged to communicate them. They are not required by default. KAMs cannot be used in place of a modified opinion, and when the auditor disclaims, KAMs are not communicated.

Documenting the opinion decision

Under AU-C 230, the file should support the opinion. For a modified opinion, document:

1. the matter giving rise to the modification
2. the amount or possible amount, compared with materiality
3. the pervasiveness evaluation and its reasoning
4. communications with those charged with governance about the circumstances and proposed wording of the modification, which AU-C 705 requires before the report is issued
5. the drafting of the report, including the basis paragraph

For emphasis-of-matter and other-matter paragraphs, document why the matter met the criteria.

FAQ

What are the four types of audit opinions?

Unmodified, qualified, adverse and disclaimer of opinion. The first is a clean opinion; the other three are modified opinions under AU-C 705.

What is the difference between a qualified and an adverse opinion?

Both arise from material misstatement. A qualified opinion applies when the effect is material but not pervasive. An adverse opinion applies when the effect is material and pervasive.

Does an emphasis-of-matter paragraph modify the opinion?

No. AU-C 706 requires the paragraph to state that the opinion is not modified with respect to the matter emphasized.

When is a disclaimer of opinion issued?

When the auditor cannot obtain sufficient appropriate evidence and the possible effects of undetected misstatements could be material and pervasive. It can also apply in rare cases with multiple uncertainties.

Are key audit matters required in private company audit reports?

No. For nonissuer audits, AU-C 701 applies only when the auditor is engaged to communicate key audit matters.

Sources

• AICPA, AU-C Section 700, Forming an Opinion and Reporting on Financial Statements (as amended by SAS No. 134, effective for periods ending on or after December 15, 2021)
• AICPA, AU-C Section 705, Modifications to the Opinion in the Independent Auditor's Report
• AICPA, AU-C Section 706, Emphasis-of-Matter Paragraphs and Other-Matter Paragraphs in the Independent Auditor's Report
• AICPA, AU-C Section 570, The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern; AU-C Section 701, Communicating Key Audit Matters in the Independent Auditor's Report
• AICPA, AU-C Section 708, Consistency of Financial Statements; AU-C Section 800, Special Considerations: Audits of Financial Statements Prepared in Accordance With Special Purpose Frameworks
• AICPA, AU-C Section 320; AU-C Section 450; AU-C Section 230

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AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error