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December 9, 2015

The enhanced auditor report ‘sea change’ – delivering relevancy through transparency

With bold objectives of delivering enhanced transparency to investors and stimulating better communication between auditors and audit committees, new standards introduced by the International Auditing and Assurance Standards Board (IAASB) represent the biggest shake-up in auditor reporting in decades.

Innovation is not a word usually associated with auditors, however, early indications from the UK experience, where the enhanced auditor’s report was introduced in 2013, are that auditors are embracing the change and investors are welcoming the fresh approach. New Zealand, Australia, Singapore and other jurisdictions in the Asia-Pacific region are also moving, in fact the IAASB says 111 jurisdictions are introducing the new auditor’s report from periods ending 15 December 2016. While listed entities will be the most impacted by the new requirements, in some jurisdictions, such as New Zealand, they’ll also apply to certain non-listed entities over time.

The extent of the changes should not be underestimated. As IAASB Chairman Arnold Schilder says they are "radical, a ‘step-change’" which will make the auditor’s work "more transparent and relevant to users." No matter where you operate, now is the time for businesses, their boards and audit committees to get to grips with the new standards and the brave new world of enhanced auditor’s reports.

The new rules encourage a move away from sometimes meaningless boilerplate language, which is of questionable value to investors, toward enhanced and expansive communication between the auditor and board or audit committee of an entity – and ultimately investors.

At the heart of the reforms is a requirement for the inclusion of ‘key audit matters’ (KAM) in the auditor’s reports. Inclusion of KAM discussions will require the exercising of significant professional judgment and expertise. Currently, unless there’s bad news to report, most auditors’ reports on financial statements provide little information specific to their clients. By bad news, I mean if there is a material misstatement in the financial statements, which hasn’t been corrected or the auditors is unable to obtain the necessary evidence.

Other enhancements include requirements to disclose any material uncertainty or "close calls" relating to going concerns, placement of the audit opinion first and the engagement partner’s name on the report, as well as further information on auditor’s responsibilities and independence.

Requiring enhanced auditor’s reports should provide greater transparency and will open a dialogue between the parties that will be beneficial to the entity concerned, as well as investors. There is a risk, particularly where matters of contention exist, that it will also introduce or engender a degree of tension between the entity and auditor. Auditors are caught between the investors’ desire for genuine insights and the reality that they can’t disclose anything that hasn’t been disclosed in financial statements. That said, the profession has committed itself to improving communication with the investor community through these bold new proposals.

The inclusion of key audit matters in the auditor’s report is a positive development, as the process of communication necessary to identify the KAM and agree the description in the auditor’s report with the audit committee is a worthwhile process in and of itself. Certainly boards and their audit committees will need to be engaged early in the process so that disclosures in the financial statements adequately reflect the auditor’s KAM.

If it works as intended, KAM will give an insight into the thinking and discussion that feeds into the audit and some insight into the influence which the auditor has had on the financial statements issued. Acceptance in the UK is encouraging, with the Financial Reporting Council’s Nick Land saying that "it is already clear that the requirements are not giving rise to excessive boilerplate or legalistic audit reports. In many cases, the auditor’s reports seem quite frank and open…"

For the first time, through these new rules, we’re giving investors a window into the issues that keep auditors awake at night. It’s about addressing the crisis of relevance auditors are facing in 21st century capital markets and providing audit professionals with an opportunity to display their professional judgment and expertise – and even innovation.

This has to be a good thing for investors, as well as also improving the public perception of auditors as independent arbiters of company accounts.

Alex Malley is chief executive of CPA Australia

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