What is an Adverse Opinion?

An adverse opinion is a statement made by an entity’s outside auditor, that the entity’s financial statements do not fairly represent its results, financial position, and cash flows. The opinion may also be issued if certain required disclosures do not accompany the financial statements, or if the entity has not prepared its financial statements in conformity with the provisions of the applicable accounting framework. The auditor states the reason for this type of opinion within the report. This is an unusual outcome, since the auditor is normally able to convince the client to alter its financial statements to achieve a higher degree of reporting fairness. When an adverse opinion is rendered, the client is typically unable to issue the financial statements to outsiders, such as creditors, lenders, and investors.

Impact of an Adverse Opinion

When a business receives an adverse audit opinion, this can have multiple negative effects, including the following:

If the business is publicly-held, the stock exchange on which its shares are listed may force it to de-list from the exchange. It may also result in the firing of a firm’s CFO and controller, since they are responsible for the financial statements.
If the business is publicly-held, the Securities and Exchange Commission may investigate it to see if there have been any accounting irregularities.
Investors who have relied on the company’s financial statements could take legal action against it, on the grounds that they have suffered losses.
The company will likely have a very difficult time raising funds from the investment community, since investors will be unwilling to rely on the firm’s financial statements. Giving the company money could be quite a risky endeavor for them.
The company will suffer a reputational hit, because outsiders will view the organization as having a poorly-run accounting department.

In short, there are so many reasons why a business will be harmed by an adverse opinion that management should go to great lengths to avoid it.

Example of an Adverse Opinion

Sample text for an adverse opinion is noted below:

We have audited the accompanying financial statements of XYZ Corporation, which comprise the balance sheet as of December 31, 20XX, and the related statements of income, retained earnings, and cash flows for the year then ended, and a summary of significant accounting policies and other explanatory information.

Adverse Opinion

In our opinion, because of the significance of the matters discussed in the Basis for Adverse Opinion section, the financial statements referred to above do not present fairly the financial position of XYZ Corporation as of December 31, 20XX, or the results of its operations or its cash flows for the year then ended, in conformity with generally accepted accounting principles (GAAP).

Basis for Adverse Opinion

As described in Note 4 to the financial statements, XYZ Corporation has not consolidated its wholly-owned subsidiary, ABC Company, in the financial statements as required by GAAP. Had ABC Company been consolidated, many elements in the financial statements would have been materially affected. The failure to consolidate has resulted in the omission of significant assets, liabilities, revenues, and expenses from XYZ Corporation's financial statements. This deviation from GAAP is considered to be both material and pervasive to the financial statements taken as a whole.

Additionally, as described in Note 8, XYZ Corporation has not properly accounted for certain inventory items. Specifically, the inventory has been recorded at estimated selling prices rather than historical cost, as required by GAAP. This has resulted in significant overstatements of inventory values and income.

For these reasons, we believe the financial statements do not accurately represent the financial condition of XYZ Corporation.