Quality of earnings vs audit

A quality of earnings report and an audit both involve close examination of a company’s financial records, and the two are genuinely easy to confuse, but they are built for different purposes and produce different things. A quality of earnings report, usually shortened to QoE, is a transaction-specific diligence exercise. An audit is a periodic assurance engagement performed to recognized professional standards. Neither substitutes for the other, and a QoE in particular carries no auditor’s opinion at all.

Quality of earnings

A QoE is commissioned specifically because a transaction is happening — most often by the buyer during due diligence, though a seller sometimes commissions one proactively to get ahead of the buyer’s questions. It works through the target’s historical financial results to normalize reported earnings: identifying one-time items, related-party transactions, owner add-backs, revenue recognition issues and working-capital trends that a simple read of the financial statements would miss, and producing an adjusted view of what the business’s earnings actually look like on a sustainable, go-forward basis. It is not performed to auditing standards, does not result in an opinion, and is addressed to and for the benefit of whoever commissioned it — not a general-purpose document meant for anyone else to rely on.

• Commissioned specifically for a pending transaction, not on a recurring reporting cycle
• Normalizes earnings and surfaces adjustments a standard financial statement would not show
• Carries no auditor’s opinion and is not performed to recognized auditing standards
• Addressed to, and for the benefit of, the specific party who commissioned it

Audit

An audit is an assurance engagement performed by a licensed public accounting firm under recognized auditing standards, resulting in an independent opinion on whether the financial statements present fairly, in all material respects, the company’s financial position under the applicable accounting framework. Audits happen on a recurring cycle — typically annual — as part of a company’s normal financial reporting and governance, or because a lender, investor or regulator requires one, not specifically because a sale is underway. Many small, privately held Canadian businesses have never been audited at all, relying instead on lower levels of assurance such as a review or compilation engagement, which is one reason a buyer’s QoE process can feel far more intensive than anything the seller’s own financial statements have ever been through.

• Performed to recognized auditing standards and results in a documented opinion
• Runs on a recurring cycle as part of normal financial reporting, not solely because of a sale
• Many small private businesses have review or compiled statements, not audited ones
• A general-purpose document, not built around one specific transaction

How to tell them apart

The clearest test is the opinion: an audit ends in a formal, signed opinion about whether the statements present fairly; a QoE ends in a set of findings and adjustments with no opinion attached at all. A buyer who treats a seller’s audited financial statements as though they already answer every diligence question is missing the point of a QoE just as much as a seller who assumes a QoE gives their numbers the same credibility an audit would. In practice, the two can be complementary — existing audited or reviewed statements are useful source material for a QoE, but they do not replace the transaction-specific normalization work a QoE is built to do, and a QoE does not retroactively make unaudited financials into audited ones.