Our July 2013 issue focused on accountability. There cannot be a more relevant backdrop to the recent global developments taking place in enhancing the role of audit and the auditor’s reporting model.
A concern we have often heard but has remained unaddressed over the decades is the ‘expectation gap’ between the role of an auditor as expected or perceived by the users of the financial statements and what the real role of an auditor is under the applicable laws and regulations. The primary reason for this gap is the lack of communicative value of the auditor’s report. Investors have often indicated that auditors, in the audit process, obtain and review critical information relating to the company, areas of significant impact on the company’s financial position and exercise of management judgement around these areas. These insights do not make it through to the auditor’s report creating a gap between the information that is available to the auditors and their appointers. Consequently, the primary purpose of the audit report has remained limited to opining on whether the financial statements pass or fail the ‘true and fair’ presentation test.
To address these concerns, regulators around the world have worked together and are proposing changes in what is seen as an overhaul of the auditor reporting model.
On 25th July 2013, the International Auditing and Assurance Standards Board (IAASB) issued an exposure draft (the ED) of Reporting on Audited Financial Statements: Proposed New and Revised International Standards on Auditing (ISAs). The ED revises a number of existing ISAs and proposes a new ISA. The new ISA (ISA 701) Communicating Key Audit Matters in the Independent Auditor’s Report introduces requirements to include ‘key audit matters’ (KAMs) in the auditor’s report of listed entities. KAMs are those matters that the auditor considers of most significance in the audit of the entity’s current period financial statements.
Other changes to the auditor’s report are proposed by revising other ISAs including ISA 700 Forming an Opinion and Reporting on Financial Statements.
In summary, key changes in the auditor’s report proposed are as follows:
• Reporting Key Audit Matters
• A new section on the auditor’s opinion on the management’s assessment and appropriateness of the use of going concern basis and whether the auditor has identified a material uncertainty casting significant doubt on the entity’s ability to continue as a going concern
• A statement of auditor’s independence and compliance with other ethical responsibilities under the applicable law and regulations
• An improved description of the auditor’s responsibilities
• Reporting on the auditor’s responsibilities relating to other information
• Engagement partner’s name in the auditor’s report of listed entities.
While the IAASB was working on these proposals, the regulator on the other side of the North Atlantic Ocean wasn’t far behind. Within a matter of few days, on 13 August 2013, the Public Company Accounting Oversight Board (PCAOB) issued its own new auditing standard The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion with related amendments for public comment. The objective of this new PCAOB standard is, in essence, the same as that of the IAASB’s, i.e., to make the auditor reporting model more informative and relevant to investors and other financial statement users.
In addition to the existing pass/fail opinion, key proposals of the new PCAOB auditing standard in the auditors’ report are as follows:
• Reporting Critical Audit Matters (CAMs) identified and addressed by the auditor during the audit of the current period’s financial statements.
• Enhance the current reporting language by including the phrase ‘whether due to error or fraud’ in the context of whether the financial statements are free of material misstatements
• A specific statement on the auditor tenure (i.e. the year since the auditor has been serving the company consecutively)
• A specific statement on the auditor independence and compliance with the United States federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission (“SEC”) and the PCAOB
• Communication related to other information in accordance with the new PCAOB auditing standard proposed concurrently—The Auditor’s Responsibilities Regarding Other Information in Certain Documents Containing Audited Financial Statements and the Related Auditor’s Report
Although the IAASB’s and the PCAOB’s proposals refer to the key reporting matters differently—key audit matters vs. critical audit matters—the guidance around how these matters will be determined by an auditor is similar. These are both identified as significant risks or areas involving significant auditor judgment; areas that posed significant difficulty in obtaining sufficient appropriate audit evidence or forming an opinion on the financial statements; and those that required an auditor to significantly change the planned audit approach. Under both sets of standards, these are matters of such importance that they are communicated by the auditors with those charged with governance, e.g. the audit committee.
In addition to the IAASB and the PCAOB proposals, the European Commission is also working on similar projects that will change the auditor reporting model through new/revised accounting and audit directives. The changes proposed by the IAASB and the PCAOB are expected to be effective from fiscal periods beginning on or after 15th December 2015. However, different countries may adopt a different timeline in implementing these changes in their version of the ISAs. For example, even ahead of the IAASB’s proposals, in June 2013, the Financial Reporting Council already revised ISA 700 (UK & Ireland) The Independent Auditor’s Report on Financial Statements and is effective from the periods commencing on or after 1st October 2012 for the companies reporting against the UK Corporate Governance Code. Some of the changes in the ISA 700 (UK & Ireland) are over and above those proposed by the IAASB. For example, the ISA (UK & Ireland) also requires the auditor to report on how the concept of materiality was applied in planning and performing an audit.
The way ahead
These changes seem distant and are still at the proposal stage. It should be borne in mind though that these are based on extensive outreach activities conducted by the international regulators and have closely followed each other’s projects. Therefore, these are quite likely to make their way through to the final standards.
As regards the impact on audit reporting in India is concerned, the global developments may put forward an interesting challenge to the regulators and standard-setters in India. Currently, paragraphs 4 and 5 of the Companies (Auditor’s Report) Order, 2003 already require reporting on specific items but these may not align with the definition of a key/ critical audit matter referred to in the IAASB and the PCAOB proposals. Also, there are proposals that do not currently exist in an auditor’s report under the Indian Companies Act. Accordingly, it will have to be seen whether Indian audit reports get even longer by bringing on board these additional sections to make it more consistent with the global reporting model or get a bit more concise by replacing/ removing some of the items reported on currently.
