Auditors' report, directors' report and corporate governance

Why an audit is needed

In a company, ownership is separate from control. Shareholders cannot check the accounts themselves, and directors prepare accounts about their own performance. An external auditor, independent of the directors, is appointed by the shareholders (usually at the annual general meeting) to examine the financial statements and report to the shareholders.

The auditors' report

The auditor gives an opinion on whether the financial statements give a true and fair view and have been properly prepared in line with accounting standards and company law.

• Unmodified (clean) opinion: the statements are true and fair.
• Modified opinion: qualified (true and fair except for a specific matter), adverse (not true and fair), or a disclaimer (the auditor could not get enough evidence).

Importance: gives credibility to the accounts for shareholders, lenders, suppliers and tax authorities. Limits: it is an opinion based on testing samples, not a guarantee that every figure is correct or that there has been no fraud; the audit is paid for by the company.

The directors' report

Prepared by the directors and published with the accounts. It typically covers the company's principal activities, a review of the business and its future prospects, the dividends recommended, the names of the directors, and other matters required by law (such as political donations and employee matters in the UK). It gives shareholders information that the figures alone do not, but it is written by the directors, so it may present the company favourably; the auditor checks that it is consistent with the financial statements.

Corporate governance

Corporate governance is the system by which companies are directed and controlled. The auditor's part:

• independent check on the directors' stewardship of shareholders' money
• reporting to shareholders, not to the directors
• working with the audit committee (usually independent non-executive directors)
• staying independent, for example by limiting non-audit work for the same client and rotating audit partners.

Worked example

A shareholder says: 'The auditors signed a clean report, so the accounts must be 100% correct and there can be no fraud.' Evaluate this statement briefly.

1. For: a clean opinion means an independent expert believes the accounts are true and fair, which gives reasonable assurance.
2. Against: auditors test samples, so not every transaction is checked; the opinion is about material misstatement, not exact accuracy; detecting fraud is the directors' responsibility and a well-hidden fraud can be missed.
3. Conclusion: the report gives reasonable, not absolute, assurance.

Answer: The statement overstates the audit: it gives reasonable assurance that the accounts are true and fair, not a guarantee.

Check yourself

1. To whom does the external auditor of a company report?
   • The directors
   • The company's bank
   • The shareholders
   • The tax authorities
   Show answer

   The shareholders. The auditor is appointed by and reports to the shareholders.

2. What does the external auditor give an opinion on?
   • Whether the financial statements give a true and fair view
   • Whether the company will make a profit next year
   • Whether the share price is fair
   • Whether the directors' salaries are reasonable
   Show answer

   Whether the financial statements give a true and fair view. The opinion is on the truth and fairness of the financial statements.

3. An auditor says the accounts are true and fair except that inventory may be overstated. What kind of opinion is this?
   • Unmodified opinion
   • Adverse opinion
   • Qualified opinion
   • Disclaimer of opinion
   Show answer

   Qualified opinion. 'Except for' a specific matter is a qualified opinion.

4. Why are audits particularly important for public limited companies?
   • Shareholders manage the company day to day
   • Ownership is separated from control, so shareholders need independent assurance
   • Directors cannot prepare accounts
   • Audits fix the company's tax bill
   Show answer

   Ownership is separated from control, so shareholders need independent assurance. Shareholders rely on directors to run the company and report on it, so an independent check is needed.

5. Which item would you expect in the directors' report?
   • The auditor's opinion on the accounts
   • The tax authority's assessment
   • Shareholders' personal addresses
   • A review of the business and the dividend recommended
   Show answer

   A review of the business and the dividend recommended. The directors' report reviews the business and states the recommended dividend.

6. Give two limitations of an external audit.
   Show answer

   The auditor only tests a sample of transactions, so errors can be missed; it gives reasonable, not absolute, assurance and is not a guarantee against fraud; the auditor is paid by the company, which may threaten independence.. Audits rely on sampling and judgement, give reasonable assurance only, and the auditor is paid by the client.

7. Who usually sits on a company's audit committee?
   • The external auditors
   • The finance director alone
   • Major customers
   • Independent non-executive directors
   Show answer

   Independent non-executive directors. Audit committees are made up of independent non-executive directors who oversee financial reporting and the audit.

Practise with instant feedback Print this lesson

Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Accounting specification (XAC11/YAC11), Issue 2
• Pearson Edexcel IAL Accounting WAC12 Unit 2 mark scheme, June 2022

Last updated 8 November 2026. Spotted a mistake? Tell us.