The audit reporting landscape – Time for a change
Background to the IAASB Project
Businesses have over the past few years become more complex and the economic crisis and defaults brought a wave of cynicism about the corporate world and their auditors. The current auditor’s report has gone largely unaltered for the past several years, while organizations and their audits have become increasingly more complex. In today’s complex business world, and particularly in light of lessons learned after the financial crisis and resultant corporate failures and defaults, stakeholders require a better understanding of the judgments that go into an opinion â€“ judgments that were most critical to the auditor in arriving at the opinion.
However, the auditor’s report, being the key deliverable addressing the output of the audit process, has up till now been a standard report with limited information which provides no indication of the complexities relating to the entity or the audit. Since, a substantial portion of all audit work is carried out, out-of-sight, investors and other financial statements users have demanded more transparency and insight into the audit process. It is a truism that stakeholders have always looked for more information from the auditors.
The International Auditing and Assurance Standards Board (IAASB) has therefore taken a step forward to address questions about the relevance and usefulness of the auditor’s standard report. This action deals with one of the many elements contributing to the long-standing and multifaceted “expectation gap” i.e., between what stakeholders and other financial statement users expect of independent auditors and what auditors deliver. With this initiative of IAASB, the auditor’s report has now been revolutionized. The IAASB has, after a five-year project, released new and amended International Standards on Auditing (ISAs) which many believe is a true game-changer for stakeholders and for the profession. The amended ISAs will transform the auditors report, and for listed entities, will include key information relating to the audit of the entity. The IAASB intends that the new and revised audit reporting standards should result in an audit report that increases the transparency of, and confidence in, the audit and the financial statements, which is in the public interest. Improved transparency improves trust and the IAASB believes that the transformation of the auditor’s report is critical to the perceived value of the financial statement audit and to the continued relevance of the auditing profession.
These new standards are expected to reinvigorate the audit and change the manner in which auditors communicate their work in the auditor’s report. This will inevitably impact other stakeholder groups, including the preparers of the financial statements (CFOs and their finance team), those charged with governance (TWCG), the investors and the regulators. More informative reports and dialogue will demonstrate more visibly the value and relevance of audit.
The changes that the IAASB is introducing to the auditors report revolves around three key aims: insight, transparency and improved readability.
Key Enhancements to the Auditor’s Report
1. Key Audit Matters (KAM) (applicable to audits of listed entities)
The most significant innovation in the new standards is the introduction of â€œkey audit mattersâ€ (ISA 701), a new section in the audit report to communicate KAM. KAM are those matters that, in the auditor’s judgment, were of most significance in the audit of the current period financial statements.
The requirement to communicate KAM is mandatory for audits of complete sets of general purpose financial statements of listed entities. This new section of the report will throw light on those matters that, in the auditors judgment, were of the most significance in the audit of the financial statements of the current period. This will not supplant the auditor’s opinion on the financial statements as a whole, which investors value, but it expands the report by requiring auditors to describe what the significant issues were, why they were considered significant, and how these were addressed.
While stakeholders have welcomed the new requirement of KAM, there are apprehensions about how this can be done meaningfully. Identifying KAM will be difficult, particularly where the matter is not a disclosed in the financial statements, and describing the KAM in crisp and understandable manner, while keeping it relevant, will be a challenge. This will no doubt continue to be an area for discussion as experience with the new reports evolves.
2. Going Concern (GC) (applicable to audits of all entities)
Both, management’s and auditor’s, responsibilities regarding going concern will be described in the new reports. A separate section under the heading â€œMaterial Uncertainty Related to Going Concernâ€ will be given when a material uncertainty exists.
When there is a material uncertainty about the entity’s ability to continue as a going concern, this will now be highlighted in a separate, clearly identified section of the report. Even when the auditor concludes that there is not a material uncertainty, one or more matters arising from the auditor’s work in arriving at that conclusion could be considered KAM. A revision to the going concern standard (ISA 570) also reminds auditors to evaluate whether the financial statements provide adequate disclosures when events or conditions have been identified that may cast significant doubt whether the organization has the ability to continue as a going concern, even if the auditor concludes that no material uncertainty exists.
3. Statement about the Auditor’s Independence and Fulfillment of Relevant Ethical Responsibilities.(applicable to audits of all entities)
To enhance transparency, an affirmative statement about the auditor’s independence and fulfillment of relevant ethical responsibilities, with disclosure of the jurisdiction of origin of those requirements or reference to the International Ethics Standards Board for Accountants’ Code of Ethics for Professional Accountants is a requirement now. The audit committee/ shareholders should annually or regularly evaluate whether the auditor is independent in terms of the relevant code(s) and the local regulations by monitoring non-audit services provided by the audit firms.
4. Disclosure of the Name of the Engagement Partner (applicable to audits of listed entities)
To increase transparency and to provide the engagement partner with a greater sense of personal responsibility and accountability, identifying the engagement partner’s name in audit reports of listed entities is a requirement now. This disclosure is necessary unless, in rare circumstances, such disclosure is reasonably expected to lead to a significant personal security threat.
5. Enhanced Description of the Responsibilities of the Auditor (applicable to audits of listed entities)
Disclosures relating to the description of the auditor’s responsibilities for the audit and key features of the audit have been enhanced and expanded now. This provides greater transparency of the audit process and enhanced understanding of the role of the auditor and the nature of the audit work.
6. Improving Readability by Changing the Order of Audit Report Sections
Under the new standards, the auditor’s report has been restructured to place audit and entity-specific information at the beginning of the report â€“ in particular the â€œOpinionâ€ section is required to be presented first, followed by the â€œBasis for Opinionâ€ section. Standardized wording in the report â€“ such as the descriptions of the auditor’s responsibilities and what is involved in an audit â€“ can be placed at the end of the report, or some might even decide to put it in an appendix or refer to a common website (such as that of a standard-setter or regulator).
Why the above affects UAE-based entities?
The IAASB project to improve auditor reporting is a key international development which has far-reaching implications globally. As the UAE adopts these standards issued by the IAASB, stakeholders in the UAE will also be impacted by the changes. The new and revised standards and the related conforming amendments are effective for audits of financial statements for periods ending on or after 15 December 2016. Early adoption is allowed.
Auditors have embraced the transformation â€“ producing insightful reports with tailored information and less jargon. Shareholder reaction has been very positive, referring to a â€˜sea changeâ€ in auditor reporting. This is a good start.
There are some daunting changes which will require careful navigation however as these will be as new to management, TWCG, audit committees and users as these will be to auditors. Thus, there are bound to be some challenges that will need to be overcome in conforming to the new reporting requirement. As auditors implement the new reporting requirements, there will be an element of uniqueness in each report. It is almost certain that the audit reports will vary in wording, tone and depth.
This will certainly impact the audit hours and deadlines as the reports will go through rigorous quality assurance processes and reviews which would need to be considered in establishing audit timelines.
The introduction of KAM is a significant enhancement that will change not only the auditor’s report format, but more broadly the quality of financial reporting by providing more information to to investors and to other key stakeholders. That said, it is important to emphasise here that it remains the responsibility of management, with the oversight of TCWG, to communicate relevant information to users about the entity and its financial performance, including providing adequate disclosures in accordance with the applicable financial reporting framework.
At PKF, we are committed to producing informative and insightful reports that reflect the spirit of these reforms.
(This article has been compiled by our director, Mr. Vinod Joshi, Audit Division, Dubai.)