Audit report: The report you know, but don’t read!

Most investors chase numbers—net profit, EPS, revenue growth, etc. But what if those numbers are hiding the complete picture?

We’re starting a series to help you, the investors, understand how financial numbers can be dressed up—and how you can protect your wealth by reading between the lines.

A great, yet often ignored, starting point? The auditor’s report. Audit reports often uncover what glossy financials don’t. While investors obsess over performance metrics, auditors flag issues that go unnoticed—especially by retail investors.

In this article, we break down how audit reports can reveal the real story behind the numbers, with real examples from listed Indian companies.

Why do audit reports deserve attention?

Most investors focus on headline earnings, ignoring the possibility that accounting manoeuvres could artificially inflate a company’s net profit that the audit report quietly exposes.

An auditor, in its audit report, addresses irregularities, red flags, or points that may necessitate stakeholders’ attention through various paragraphs, depending on their nature and severity.

Below are some key sections of an audit report that are relevant for investors to study

Auditor’s opinion

The Auditor’s Opinion provides the core judgement on whether financial statements present a true and fair view of a company's financial health. If the auditor issues an unmodified opinion, it means they found everything accurate, reliable, and fully compliant with accounting standards. However, an unmodified opinion should make an investor want to dig deeper.

There are 3 types:

• Qualified opinion: Financials are broadly fine, but there are some other areas that need closer attention
• Adverse opinion: Significant misstatements or inaccuracies.
• Disclaimer opinion: The auditor couldn't arrive at a conclusion due to incomplete or insufficient information.

Key audit matters (KAM)

KAM highlights the most significant areas of risk or judgement the auditor encountered. Even in an unmodified report, KAM can reveal where things were less certain. Example: Revenue recognition policies for long-term contracts, valuation of goodwill, or regulatory liabilities may appear as KAMs.

Emphasis of the matter

Though not a qualified opinion, this section draws investor attention to disclosures that are important for understanding the financials. Example: Ongoing tax litigations, related party transactions, or regulatory investigations often appear here.

Material uncertainty related to going concern

States whether there is any risk the company may not remain a going concern. This is crucial during downturns or litigation-heavy environments.

Let’s look at a real instance to understand the effect of audit disclosures.

The income statement: Does anything look out of place?

Here’s a snapshot of the reported numbers of a listed company from the capital goods, industrial products sector (₹ in lakhs):

Rounded off to the nearest integer.

At first glance, everything seems fine. The company turned around from losses to profits within two years. EPS grew 1,410% within a year from ₹1.3 to ₹19.64.

The issue: A qualified opinion with ₹556.51 lakhs adjusted from other equity

The auditor issued a qualified opinion—a red flag that should have every investor’s attention. Here's the excerpt that matters: “...the tax expense of ₹556.51 lakhs has been directly written off in other equity through retained earnings instead of charging it to the statement of profit and loss. Therefore, the profit after tax for the year is overstated by ₹556.51 lakhs.”

The company opted for a tax settlement under the Vivaad Se Vishwas Scheme. But instead of recording the ₹556.51 lakhs as a tax expense in the profit and loss statement—as required by Ind AS 12 (Income Taxes) and Ind AS 8 (Accounting Policies, Changes in Accounting Estimates and Errors)—they adjusted it directly through equity. This inflated the reported profits and could mislead investors.

The financial impact: From ₹19 EPS to ₹13

PAT numbers are rounded off to the nearest integer.

This isn’t just a technical accounting detail—it has real implications. Investors who rely on EPS to value stocks or benchmark performance would be operating on a distorted view of profitability.

Case 2: Construction sector

A listed company reported a non-current investment of over ₹1,200 crore in a wholly owned subsidiary, recorded at cost. However, the subsidiary’s net worth had significantly eroded as of year-end. Despite this, management claimed the investment was fully recoverable, relying on a valuation report from an independent valuer.

But here’s where it gets critical—the auditors weren’t convinced. They explicitly stated that they lacked sufficient audit evidence to support the management’s assumptions and estimates used in the valuation. As a result, they couldn’t confirm whether the carrying value needed adjustments.

This shows the possible cases of inflated asset values and masking underlying stress — something only visible if you read the audit report closely.

What should you do as an investor?

Financial statements may look clean, but the truth often lies in the audit report. In both cases discussed—whether it was a company adjusting tax expenses directly through equity or skipping impairment despite major erosion in a subsidiary’s value—auditors had raised clear concerns.

As investors, it’s critical to look beyond net profit and EPS. Qualified or adverse audit opinions are not just technical disclosures—they’re red flags. These red flags often point to inflated profits or overvalued assets that haven't yet flowed through the profit and loss account.

To make informed decisions, always read the audit opinion and key notes to accounts. If auditors are expressing doubts or disclaimers, it means the numbers may not tell the full story.

What are the consequences if you invested without knowing all this?

When such accounting treatments are not fairly presented and the investors believe in them, they factor in more growth and value the company at inflated multiples. Not just this, the inflated profits at a higher profit multiple make the company’s valuation unfairly expensive.

In cases where an erosion in investment has to be eventually corrected—as it must be—it impacts the financials directly. Such entries eventually reduce the company’s profitability in future periods. This can lead to:

• A drop in EPS and net profit,
• Erosion of book value and
• Eventually, a fall in share price.

In short, what is hidden today comes out tomorrow—and when it does, it’s often at the cost of unsuspecting shareholders.

Other red flags beyond profit overstatement

Here are other signs in audit reports and financial statements that investors should be cautious of:

• Frequent changes in accounting policies: Used to smoothen profits or avoid losses.
• Highly related party transactions: May indicate cash being cycled within group companies.
• Large contingent liabilities: Disclosed but not accounted for—could become real liabilities later.
• Negative operating cash flows: Even with strong profits, if the company consistently fails to generate cash, something’s wrong.
• Resignations of auditors or delays in audit signing: Often a sign of deeper issues.

It’s an independent lens into a company’s financial conduct. Unlike management commentary or investor presentations, it’s authored by professionals whose job is to ensure the financials comply with accounting standards.

A clean P&L doesn’t mean all is well. As we’ve seen in the example, ₹556.51 lakhs of tax expense routed through equity distorted the picture completely. Without reading the audit note, an investor may not have detected this red flag.

Conclusion: A second set of eyes

In capital markets, where perception often drives price, the audit report offers rare clarity. It highlights the gaps between appearance and reality—and empowers investors to make decisions based on the integrity of information, not just numbers.

So, the next time you review an annual report, don’t stop at EPS or PAT. Go further. Open the audit report. Read the notes. Scan the qualifications. Because sometimes, the most expensive mistake is trusting numbers without questioning them.