Auditor's Report

Dear Readers,

Auditor's Report is an integral part of the financial statements. In this report, the auditor will tell you whether the financial statements are prepared in accordance with the GAAP (Generally Acceptable Accounting Principles).

In some recent lawsuits, auditors are held responsible for the accuracy of the financial statements. From the point of view of auditors, their job is not to make sure that the financial statements are 100% error free (which is impossible)!

The management of a company is ultimately responsible for the preparation of the company's financial statements. The logic is very simple: "The management should be the one who understands the company's operation most thoroughly. They use the financial statements to communicate the company's financial information with its stakeholders like shareholders, creditors, labour unions, etc.

On the other hand, auditors are responsible for auditing the financial statements prepared by the management and express an independent opinion. When the financial statements are prepared fair, the auditor will issue an "Unqualified (or clean)" opinion. When the financial statements are not prepared in accordance with the GAAP, the auditor will issue a "Qualified" opinion.

When doing an audit, the auditor will assume that the management will record and prepare the financial information with good faith unless the auditor find some evidence that the assumption is not reasonable.

If the management of a company really wants to hide something (expenses, lawsuits, liabilities, etc.) or create something (fake revenue, etc.), it will be very difficult to discover. If the auditor cannot trust the management, the auditor will often choose to resign in order to protect its professional image.

Auditor's resignation often has negative impact on a company's stock price because auditors do not resign without a reason. Often, they will use excuses like "cannot agree on audit fees", "cannot agree on some minor issues", "tight scheduling", etc. As an investor, you MUST find out the real reason before you decide whether to keep the company's shares. My personal preference will be to sell the shares first (just in case) and buy them back in the future if the company can prove that nothing is wrong! A recent example is a HK Company 389, the management had a big argument with the auditor before its trading was suspended and its management was arrested!

Sometimes, a company will change auditor to increase investors' confidence. For example, a local company which wants to increase its credibility may hire "Big 4" auditing firms instead of small local firms. It is a common belief (keep in mind that belief NOT = 100% true) "Big 4" auditing firms have higher standards and therefore, should result in a more fair audit opinion.

As a general rule, changing from a local firm to a "Big 4" firm is usually seen as a positive sign. Changing from a "Big 4" firm to a local firm is often seen as a negative sign.

Next time, remember to check the auditor's report and hopefully, the opinion is a clean one. Otherwise, you should know what to do, right?

Investment Division, FQ Coaching Limited

Disclaimer: This discussion is for provided for educational purpose only. Readers should do their own independent analysis before making their investment decisions. If you are interested in learning how to invest properly, please visit www.fqcoaching.com, we will offer different investment courses from time to time.