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New auditor’s report: A clear way forward?

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10th Jun 2013
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There is not a month goes by where you don’t read the words “audit” and “reform” together in the same sentence in some publication or another, says Steve Collings.

Attempts by regulatory bodies to overhaul the audit regime to make the audit gain more credibility is going to be a huge task given the lambasting that auditors have received over recent years and the way in which the audit profession, as a whole, has been slammed by various critics.

Audit firms themselves have come in for some fierce criticism from their own regulators for failing to adhere to ethical standards or failing to demonstrate professional scepticism (the ways in which auditors can evidence scepticism will feature in an upcoming article for AccountingWEB). Of more concern is the fact that the Financial Reporting Council (FRC) has recently reported that the number of audits that contain “serious flaws” has increased from last year.

Aside from attempts to overhaul the audit regime, the FRC has issued an amended ISA (UK and Ireland) 700 The Auditor’s Report on Financial Statements.

Auditors’ reports have also been on the receiving end of some sharp criticism from interested parties. Technical jargon has been at the forefront of these criticisms because it has been alleged that users cannot understand what the auditor’s report is actually saying. Some commentators have also criticised the auditor’s report as simply being nothing more than largely describing who is responsible for what when it comes to the financial statements rather than giving any meaningful substance about the financial statements themselves and the audit itself.

The arguments for an overhauled audit report carry much weight. Indeed I, myself, have been questioned from clients as to what the audit report is actually talking about. In some cases, practitioners have also said that it’s only the opinion paragraph that is actually looked at by clients because the rest of the report is “painful” to read and clients are lost after the first paragraph.

In recognition of this, the FRC has decided that the audit report needs more substance to it and for audits of financial statements for periods commencing on or after 1 October 2012, there will be more information needed in the audit report. It is to be noted that these new requirements only extend to those entities that are required to apply the UK Corporate Governance Code.

The revised ISA (UK and Ireland) 700 now requires:

  • A description of the assessed risks of material misstatement that have been identified by the auditor that had the greatest effect on:
  • the overall strategy
  • resource allocation
  • the direction of the audit engagement team’s efforts
  • How the auditor has applied the concepts of materiality in planning and performing the audit
  • A summary of the audit scope and an explanation of how the scope was responsive to the assessed risks of material misstatement and the auditor’s application of the concept of materiality as disclosed in the audit report

Assessed risks of material misstatement

Risk is one of the main features of any audit and the levels of risk essentially dictate the procedures that the auditor will apply to reduce risk to an acceptable level. Having read the proposal by the FRC in detail, the first question that sprung to mind was at what point does the line get drawn where risk and associated disclosures are concerned? The revised ISA (UK and Ireland) 700 requires the auditor to describe the assessed risks of material misstatement that had the greatest effect on the audit strategy, resource allocation and how the audit was directed but given the fact that we live in a very litigious world, will auditors be required to disclose all the risks associated with the audit?

Various commentators are recommending disclosing all risks associated with the audit and they are recommending such an approach to err on the side of caution. The application and other explanatory material in the revised ISA (UK and Ireland) 700 at paragraph A13A states that it is left to the auditor’s judgement to decipher which, if any, of the significant and other risks, require disclosure in the auditor’s report. In addition, where the auditor significantly revises their risk assessment, the auditor must consider the need to disclose this fact, as well as the circumstances giving rise to the changed assessment, in their report.

Materiality

The requirement in the new ISA (UK and Ireland) 700 is to include an explanation as to how the auditor has applied the concept of materiality in planning and performing the audit. This, at first glance, may appear to indicate that disclosure of the materiality levels are all that are needed to comply with this requirement. However, the Application and Other Explanatory Material at paragraph A13B is much more detailed and includes materiality that may also include:

  • Materiality level or levels for those classes of transactions, account balances or disclosures where such materiality levels are lower than materiality for the financial statements as a whole (as described in paragraph 10 of ISA (UK and Ireland) 320 Materiality in Planning and Performing an Audit
  • Performance materiality (as described in paragraph 11 of ISA (UK and Ireland) 320
  • Any significant revisions of materiality thresholds that were made as the audit progressed
  • The threshold used for reporting unadjusted differences to the audit committee
  • Significant qualitative considerations relating to the auditor’s evaluation of materiality

Audit scope

The audit report now needs to include an explanation as to the audit scope, which also includes an explanation of how the scope was responsive to the assessed risks disclosed and the application of materiality. The Application and Other Explanatory Material at paragraph A13C does give an example of what may be included in the summary, such as:

  • The coverage of revenue, total assets and profit before tax
  • The coverage of revenue, total assets and profit before tax of reportable segments
  • The number of locations the auditor has visited as a proportion of the total number of locations and the rationale underlying any programme of visits
  • The effect of the group structure on the planned scope. For example, the group may consist of a large number of autonomous subsidiary companies or may consist of a number of non-autonomous divisions
  • The nature and extent of the group auditor’s involvement in the work of component auditors

Initial concerns

A concern that I, and indeed many other commentators and auditors have, is that will the auditor’s report end up with so much information in it that we end up with ‘information overload’ mainly due to the litigious world we work in? Where do auditors draw the line for disclosure? Will the auditor’s report end up being even more off-putting than it already is? Of course, the auditor’s report is in desperate need of overhaul to make it more meaningful and the intention of the revised ISA (UK and Ireland) 700 seems to be to allow the user of the auditor’s report to better understand the audit - which is not a bad thing. Some practitioners have suggested that an unqualified auditor’s report needs to be kept as short and succinct as possible without the need for additional information that may confuse users and I think this suggestion has the opportunity of carrying weight.   Notwithstanding the fact that the current version of ISA (UK and Ireland) 700 says that the objectives of the auditor are to form an opinion on the financial statements based on an evaluation of the conclusions drawn from the audit evidence obtained and to express clearly that opinion through a written report that also describes the basis for that opinion, the revised ISA (UK and Ireland) 700 now require this objective to be embellished even further with the potential for third parties to question auditors as to their work. 

Conclusion

Investors and other stakeholders may well find that information concerning risk, materiality and scope is useful and time will undoubtedly tell if that is the case. Any improvement to the current auditor’s report is welcome and hopefully the revised ISA (UK and Ireland) 700 will result in more transparent information being communicated through the auditor’s report; although there has to be a balance between transparency and the levels of information contained in the report.

Steve Collings is the audit and technical partner at LWA and the author of ‘Interpretation and Application of International Standards on Auditing’. He is also the author of ‘IFRS For Dummies’ and ‘AccountingWEB Guide to IFRS’ and was named ‘Accounting Technician of the Year’ at the 2011 British Accountancy Awards.

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Replies (10)

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By carnmores
10th Jun 2013 15:50

yet still

only the company itself can rely on it ?

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By arnold28
12th Jun 2013 11:14

Previous thread

Readers may also be interested in the other thread on this site discussing the issues.

https://www.accountingweb.co.uk/article/frc-changes-audit-report-standard/542759

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By David_Lewis
12th Jun 2013 12:35

Thanks

Steve

Thanks very much for the article.   Some difficult decisions ahead for auditors of listed companies, particularly where risks are commercially sensitive or even reputationally damaging to the client.   

However I don't think you can fault most of the logic (although the location information could be misleading if not put in context of both materiality and the underlying control systems).  Having said that, talking generally, there is a danger of information overload.

It will be interesting to see how this pans out, what happens if the auditor fails to disclose a risk that proves to be significant?   Even if it doesn't give rise to litigation, it could put the conduct of the audit (& the auditor) in the spotlight!!

I wonder if this change will encourage companies to look more closely at their internal controls/ risk management.   For example, I note (with some self interest) that there are a number of smaller (but not tiny) listed companies, that don't have an internal audit function. 

David Lewis

www.camroseconsulting.co.uk

 

 

 

 

 

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collings
By Steven Collings
12th Jun 2013 12:49

@David Lewis

Thank you for your comments.

The FRC have to be commended on ANY improvements they make to the auditor's report.  There are many in the profession that are opposed to the revisions to ISA (UK & IRL) 700 and they are also critical of the current auditor's report format, hence a 'no win' situation.  Personally, I would not like to see an auditor's report spanning several pages in a firm's attempts to cover themselves as this would go against the FRC's objectives of trying to make the auditor's report more meaningful to users; hence there has got to be an element of reality where risks and scope are concerned. Certainly I would only expect to see 'material' risks rather than 'every' risk pertinent to a client (and would hope that's what regulatory bodies would expect as well).

Best wishes

Steve

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By Ayesha Bham
12th Jun 2013 12:56

Reporting
I recently attended a seminar where the speaker talked about this issue. She advised that every risk should be disclosed to be on the safe side! Needless to say the audience of around 100 accountants were horrified (although she didn't say that this revision was for listed companies only so thanks for the clarification Steve).
I agree the report is rubbish as it is and think the revisions actually do make sense provided QAD et al don't expect every possible risk - we are trying to reduce paper usage (!)

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7om
By Tom 7000
12th Jun 2013 13:25

chocolate teapot

 

Q: Who is required to apply the UK Corporate Governance Code ?

A: All companies with a Premium Listing of equity shares in the UK are required under the Listing Rules to report on how they have applied the Code in their annual report and accounts.

 

Q: Whats a premium listing? 

A Premium Listing is only available to equity shares issued by trading companies and closed and open-ended investment entities. Issuers with a Premium Listing are required to meet the UK’s super-equivalent rules which are higher than the EU minimum requirements. A Premium Listing means the company is expected to meet the UK’s highest standards of regulation and corporate governance – and as a consequence may enjoy a lower cost of capital through greater transparency and through building investor confidence. 

 

Q How many Auditors reading this do these rules apply to

A: None

 

...but stand up and be counted if you are signing off huge plcs accounts ;o)

 

Had me worried for a minute there

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Replying to Ken Howard:
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By twickers
16th Jun 2013 04:51

Corporate Governance

 

Trading company ?- you should also define.......and explain why rules do not apply to ALL

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By David_Lewis
12th Jun 2013 13:39

Reporting

I can't imagine that including every risk is what is envisaged,  it would water down the meaningfulness of the information and would probably require a statement that's longer than the accounts!!  

In reality, there will always be risks that wouldn't normally come under the auditor's radar eg: if a fraud arises through collusion.   It really wouldn't be feasible to note every conceivable risk.

 

 

 

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By nigelr
12th Jun 2013 18:05

Reporting

Every few years the same comment is made that the Audit Report is not fit for purpose and then we get a revised Standard which usually doubles the size of the Audit report. 

On each ocassion the revision does nothing to combat the fact that the public, investors and analysts have a different expectation as to what the audit report provides to that which the Auditor believes they are providing.  This used to be called the 'Expectation Gap'.

This current change will equally fail to provide any further clarrification or assurance.  In providing details of Risk and Materiality the users of the accounts will simply misinterpret the facts provided and not take account of the fact that it is all based upon the individual Auditors Opinion.  It is not a scientific calculation.  Accordingly the credit agencies and analytsts will compare one report to another for a business in the same sector and asess investment potential and credit limits based upon the difference saying that the items disclosed indicate the quality of the audit.

Giving more information is not the answer, it is simply more confusion.  What is required is that the users of the accounts become educated in understanding accounts and more importantly what an Audit is.

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By frankfx
12th Jun 2013 20:24

Audit Report trip advisor rating

Seems to be  that the needs of the user /reader of the audit report  has been neglected.

What readily digestible and comprehensible form of wording is required for the unsophsiticated shareholder or stakeholder.

Start from that point and we may end up with the desired outcome.

Wordage and verbage , amplified with explanations, is not the answer.

The Shareholder wants to be assured that he/she should have no concern  and can sleep easy.... or informed that there are 'issues' .... with a some scale of concern.

Perhaps a TRIP advisor rating system is all that is required 

We do not want something for the lawyers and insurance companies to get their teeth into- at the auditors expense.

Not forgetting  the windfall for the lecture circuit and training companies.

 

 

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