Using Disclaimers in Audit Reports
Discerning Between Shades of Opinion

By Robert R. Davis

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Under Generally Accepted Auditing Standards (GAAS), the fourth standard of reporting requires that an auditor, at the conclusion of an audit, either express an opinion regarding the financial statements, taken as a whole, or issue a disclaimer of opinion. Professional standards (AU section 508.10) provide for the following audit opinions: unqualified opinions; explanatory language added to the auditor’s standard (unqualified) report; qualified opinions; adverse opinions; and a disclaimer of opinion.

Statement on Auditing Procedure (SAP) 23, Recommendation Made To Clarify Accountant’s Representations When Opinion Is Not Expressed, adopted in 1949, was the precursor of the current language in a disclaimer of opinion, which declares that the auditor is not expressing an opinion on the financial statement. A disclaimer of opinion is appropriate in the following circumstances:

  • Lack of independence (SAS 26);
  • Scope limitations (inability to obtain sufficient competent evidential matter) (SAS 58);
  • When the auditor concludes that there is substantial doubt about the entity’s ability to survive (going-concern) (SAS 59); and
  • Matters involving uncertainties (SAS 79).

The decision to issue a disclaimer of opinion follows an assessment by the auditor that other opinions are not warranted under the circumstances. The quandary in arriving at this decision is that the underlying conditions (except for independence) may also support the issuance of another modified audit report or even an unqualified opinion—for example, scope limitations. Professional guidance (AU section 508.25) suggests that significant scope restrictions normally result in a disclaimer of opinion. At the same time, the auditor must also consider the nature and magnitude of the potential effects of the items, their materiality, and the number of financial statement accounts involved. These factors, accompanied by the difficult evaluation of whether the auditor has examined sufficient competent evidential matter, must be resolved to support the appropriate opinion: qualified, disclaimer, or unqualified.


Another situation that may warrant the issuance of a disclaimer is uncertainties, which include contingencies. The auditor may be faced with a deficiency of evidential matter regarding the probable outcome of an event at the time of the audit. The auditor is expected to exercise judgment regarding the sufficiency of evidential matter that is, or should be, available to verify management’s estimate of the effect of future events upon the financial statements or the adequacy of the financial statement disclosures (AU section 508.30). A scope limitation arises if the auditor cannot obtain the necessary evidential matter relating to the uncertainty, and the consideration of the appropriate opinion follows the reasoning discussed previously.

A 1972 monograph by Douglas R. Carmichael, who is now chief auditor at the PCAOB, “The Auditor’s Reporting Obligation, The Meaning and Implementation of the Fourth Standard of Reporting, Auditing Research Monograph 1,” represents the only definitive study that reviewed the historical development of the disclaimer of opinion along with proposed criteria for its application. Carmichael strongly suggested that, in then-present reporting practice, auditors generally did not issue a disclaimer of opinion for an isolated uncertainty, even of very large relative magnitude, unless the issue imperiled the continued existence of the company. In a recent exchange of e-mails with Carmichael related to the foregoing statement, he replied that: “The discussion in the monograph is outdated. The audit reporting requirements no longer require any modification of the report for an uncertainty other than one that results in substantial doubt about ability to continue as a going concern. … Also, it does not reflect my current thinking. Accounting standards and business developments, e.g., derivatives, have introduced a range of uncertainty that is not adequately dealt with in current auditing standards.”

A financially distressed entity may cause the auditor to evaluate whether there is substantial doubt about the entity’s ability to exist as a going concern for a reasonable period. Carmichael identifies this situation as a pervasive uncertainty. If, after evaluating a series of factors, the auditor has reservations about the entity’s ability to survive beyond a year from the balance sheet date, the auditor normally issues an unqualified opinion with an explanatory paragraph expressing that substantial doubt (AU section 341.12; Footnote 4 to AU section 341.12 allows the auditor to decline expressing an opinion). The justification for a disclaimer rests on the nature and pervasiveness of this type of uncertainty (see AU section 508.29). Unfortunately, the rationale that motivates the auditor to issue a disclaimer versus an unqualified opinion remains elusive.

During the time covered by this study, the Auditing Standards Board (ASB) issued SAS 58 (AU section 508.21), which eliminated the use of the “subject to” audit opinion in audit reports issued on or after January 1, 1989. One intended purpose of the “subject to” opinion (considered to be a qualified opinion) was to put the reader on notice that the financial statements may require adjustment in the future because of material uncertainties. The auditor’s inability to obtain evidentiary matter justified the use of this opinion. Litigation, going-concern issues, discontinued-operations questions, and tax disputes were conditions that usually supported “subject to” opinions. In 1978, the Commission on Auditors’ Responsibilities (CAR) recommended eliminating this opinion, declaring that it was confusing to users. CAR encouraged auditors to focus on the adequacy of uncertainty disclosures in attempting to provide users with protection against information risk. The frequency of disclaimers remained unaffected after the elimination of the “subject to” opinion.


The LexisNexis database was used to identify companies that received a disclaimer of opinion from 1976 through 2001. This database includes the following: SEC filings; the Disclosure Online Database–U.S. Public Company Profiles; and National Automated Accounting Research System (NAARS)–Annual Reports. In addition, five companies illustrated in Accounting Trends & Techniques are included, starting with the 1966 reporting year. The NAARS database from 1972 through 1984 contains over 48,000 corporate annual reports; no disclaimers were discovered in this database before 1976. Overall, 338 companies received a combined 521 disclaimers. For a company to be included in this study, the actual opinion had to be available for examination; unaudited statements were excluded.


Exhibit 1 lists the disclaimer events by year. Numbers in brackets represent nonfinancial entities, that is, companies outside of Standard Industrial Classification (SIC) code 6000, which encompasses financial institutions, financial service companies, real estate firms, and insurance companies. Segregating these companies attempts to eliminate distortions in the analysis by recognizing the impact of the savings and loan crisis of the 1980s.

With these companies removed, the numbers of issued disclaimers for nonfinancial entities over the time span examined have not changed significantly over the years examined. From 1976 through 2001, the average number of disclaimers was approximately 20 (13 nonfinancial entities). During 1980 to 2001, most of the period covered by this study, the number of companies listed on the New York Stock Exchange increased from 1,570 to 2,798. The elimination of the “subject to” opinion had no perceptible impact on the number of disclaimers rendered. Therefore, the issuance of a disclaimer of opinion was an atypical event.

One effect of the issuance of a disclaimer is audit report delay (ARD), defined as the number of days between the company’s fiscal year-end and the date of the audit report. The average ARD for all companies was 115 days (127 days for nonfinancial entities). The inherently serious nature of going-concern issues apparently increases ARD. In contrast, a 1993 research study, “Audit Structure and Other Determinants of Audit Report Lag,” by E. Michael Bamber, Linda Smith Bamber, and Michael P. Schoderbek (Auditing: A Journal of Practice & Theory, 12: 1-23), calculated 40 days as the mean ARD for companies that received either a clean or a qualified opinion.

Exhibit 2 and Exhibit 3 list the general comments or reasons that appeared in the auditors’ reports, along with their frequency. Most audit reports identified multiple reasons for the disclaimer. Therefore, approximately 35% of the reports in Exhibit 2 and 34% of the reports in Exhibit 3 reflected a single reason for the disclaimer.

Exhibit 2 shows that most reasons for a disclaimer are related to going-concern issues. Operating losses was the most frequent and important reason why companies received a disclaimer. Included under this caption are recurring losses from operations (mentioned 123 times), along with a loss in the current year. The reference to recurring losses is not surprising, because this phrase is specifically mentioned in AU section 341.06 as a “negative trend” that supports substantial doubt about the company’s survival. Among the other negative trends that the auditor should consider are working capital deficiencies (65), along with negative cash flows from operating activities (8). These three “negative trend” reasons contributed to the multiple reasons for disclaimers; in every instance except one, these reasons appear in combination with other explanations for the disclaimer. Together, they accounted for approximately one-third of all explanations.

The high rank of legal issues (second-highest) in this study is interesting. Although litigation is probably the most familiar example of a material contingency, at present, outstanding litigation only rarely modifies the auditors’ report. (The tobacco companies received unqualified opinions despite the threat of gigantic legal settlements.) The instances in this study (156) suggest that, in the auditors’ judgment, the financial cloud cast by the presence of litigation was so material that users would be better served by a disclaimer rather than the traditional footnote disclosure of the uncertainty (or a “subject to” opinion). Approximately half of these events occurred after the January 1, 1989, abolition of the “subject to” opinion. Therefore, it is not clear whether the auditor felt more comfortable in downgrading the opinion from a qualified opinion (subject to) to a disclaimer, or whether circumstances dictated that a disclaimer was the only option.

One classification that is not part of the going-concern considerations is the fourth-most-cited reason, “documentation issues.” Within this category, statements in the auditors’ report ranged from “management unable to provide certain representations” to “no longer able to rely on management's representations,” along with the usual confirmation problems and references to falsified shipping documents. These comments ranked prominently in the auditors’ report and usually were so significant that they were solely responsible for the disclaimer. The language used for “incomplete and inadequate records” (14th-most-cited) was unambiguous and left no doubt as to its importance in the decision to issue a disclaimer. Inventory observation issues (16th-most-cited) are listed separately for analysis because of their uniqueness, although they also could be included under “documentation issues.” When both incomplete accounting records and inventory matters are combined with documentation issues, the frequency of these “scope limitation” issues would elevate the category’s ranking to second place for all companies and reinforce the proposition that evidentiary matters play a significant role in decisions that affect the issuance of a disclaimer. Interestingly, scope limitation conditions were responsible for more “single reason” audit reports (63) than all other reasons combined (55) for the nonfinancial companies in Exhibit 3.

A review of Exhibit 3 (nonfinancial companies) shows that the major difference between Exhibits 2 and 3 is the explanatory comment: “Institutional capital substantially below regulatory guidelines.” The reason was cited only one time for a nonfinancial company. Once again, going-concern issues dominate the justifications for the disclaimers. Various auditing issues or scope limitations continue to be the only other important reason that auditors cite when issuing a disclaimer. Overall, if the scope limitation factors are combined (i.e., auditing procedures, incomplete records, and inventory issues), they account for only approximately 15% of all disclaimers issued over this time span. Therefore, the circumstances that have overwhelmingly contributed to the issuance of a disclaimer of opinion are going-concern problems.

Implications and Options

Over the 30 years studied, the evidence clearly demonstrates that the issuance of a denial of opinion is a rare event, and disclaimers represent a minuscule percentage of all opinions expressed. Going-concern issues were the dominant source (85%) of the disclaimers. Material scope limitations imposed by the client, along with litigation issues, were the only other notable grounds for a disclaimer. These circumstances suggest that the limited use of disclaimers was based not only on materiality considerations but also on the impact that they would have on the usefulness of the statements.

The small number of disclaimers issued may reflect the reluctance of auditors to use this extreme option at the expense of jeopardizing the entire utility of the published financial statements. If part of the examination was restricted, the user may be entitled to some assurance about the remainder of the financial amounts, which is provided by a qualified (except for) opinion. The now defunct “subject to” opinion was criticized as a self-fulfilling prophesy with respect to the impact it had upon companies’ ability to acquire additional funding. One may question the efficacy of a disclaimer associated with companies facing bankruptcy.

There appear to be no established financial measures that influence an auditor to issue a disclaimer versus an unqualified opinion with an explanatory paragraph that would express substantial doubt. One could argue that if the company is facing serious financial difficulties, perhaps not issuing financial statements may communicate a stronger warning than issuing a disclaimer. But given regulatory and marketplace realities, financial statement users may get a better sense of the magnitude of the uncertainties if the auditors’ disclaimers note that the entities’ compliance with GAAP may be inappropriate because of the severity of financial problems. The use of this phraseology is preferable and more beneficial for users than the traditional “no opinion.”

Robert R. Davis, PhD, is an associate professor of accounting at Canisius College, Buffalo, N.Y.




















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