Qualified for an opinion or qualified opinion?

In one of the classes on financial reporting and analysis, my professor once asked us, “In a company’s annual report, what is the difference between an unqualified Opinion and a Qualified Opinion?”

Our first reaction was that unqualified sounds like an unverified or unreliable opinion, and qualified sounds like a certified or verified opinion. Our interpretation was far from correct.

When you study a company’s annual report, you will see a section named Independent Auditor’s Report right before the financial statements. 

The first segment of this section is usually called “Opinion.” Opinion is good. Just opinion means unqualified opinion. But it becomes a problem if any other word is mentioned before Opinion.

An auditor can give three types of unfavorable opinions:

• Qualified Opinion

An auditor mentions a “Qualified Opinion” when it is unable to find evidence or the necessary information for a particular item in the financial statements.

Sterling & Wilson Solar’s FY21 annual report contains a Qualified Opinion. At the time, the promoters were the Shapoorji Pallonji Group. Now, the company is Sterling & Wilson Renewable Energy, and it is jointly promoted by Reliance Industries and the Shapoorji Pallonji Group.

What was the issue? Sterling & Wilson was supposed to receive a loan repayment from its promoters. The promoters had been delaying the repayment, and the authorities and shareholders had raised concerns. The auditor, BSR & Co LLP, was unable to ascertain the full impact of such non-compliance. That is why it signed off on the report with a qualified opinion.

Note that in a qualified opinion, apart from the issue with specific items, the auditor signs off the rest of the financial statements as correctly represented.

• Disclaimer of Opinion

Sometimes, the promoters, management or some external entity might refuse or be unable to share critical information or evidence to support the presented financial statements. This impairs the auditor’s ability to form or express an opinion. In such cases, the auditor signs off on the report with a Disclaimer of Opinion.

Eveready Industries’ FY20 annual report contained a Disclaimer of Opinion by its auditor, Singhi & Co. Eveready Industries is the popular maker of Eveready Batteries.

Eveready had given loans to related companies but had not received repayments. It had also given guarantees for external loans taken by related companies, which they had failed to repay on time.

The auditor could not fully ascertain the loss allowance from those inter-corporate dealings and could not certify that financial statements provided a true picture of the business. Therefore, it gave a Disclaimer of Opinion.

Anyway, the management at Eveready has changed since then, and the Burmans of Dabur are now promoters in Eveready.

• Adverse Opinion

It is the worst of them all.

The FY20 annual report of McLeod Russel India contains an Adverse Opinion by its auditor, Lodha & Co. The auditor stated in the report that the financial statements do not comply with the Indian Accounting Standards and also do not give information as required by the Companies Act 2013.

The auditor explained at length the basis for the Adverse Opinion.

But let’s conclude that an Adverse Opinion is when the auditor finds material misstatements or outright disagrees with the presented financial statements and information provided by the management.

In summary, a company’s quality of reporting is good if its annual report contains just an Opinion from the auditor. It is bad if the auditor mentions either Qualified Opinion, Disclaimer of Opinion, or Adverse Opinion.

• A qualified opinion is when a minor issue exists, but the rest of the statements can be taken at face value.
• A disclaimer of opinion is when critical information or evidence is not available.
• An adverse opinion is when the auditor disagrees with the entirety of the presented financial statements.

Note that the sample annual reports are from 2020 and 2021. You may look at these old reports for conceptual understanding, but please don’t hold those old reports against those companies today. Always do your own independent research and reach a decision.