What it is:
How it works (Example):
For example, let's assume that Company XYZ hires an auditor to audit its financial statements and internal controls for the year 2010. The auditor pores over the books but does not review every single journal entry for the year. The auditor " checks" accounts and performs various tests to verify balances, transactions, and procedures. The auditor interviews managers and staff regarding certain items, and the auditor inspects backup paperwork supporting various journal entries.
After the auditor has completed the audit, it issues a negative assurance as a separate letter, which is then attached to the company's financial statements. The negative assurance tells shareholders that the auditor could not find any evidence of material misstatements in the financials.
In the real world, negative assurances occur most often when one auditor is asked to review another auditor's work for a company. Underwriters usually require a negative assurance as a condition of closing a registered offering of securities.
Why it Matters:
A negative assurance is actually a very good thing. It is important to note, however, that a negative assurance does not mean that the audited company has not committed fraud or violated accounting rules. It simply means that the auditor could not find any evidence of those things during the audit. Negative assurances also help establish a defense to claims that investors might bring under Rule 10b-5 of the Securities Exchange Act of 1934.