Plain speaking! – Field-testing the new auditor’s report in Holland

28 Apr 2014

Call it the tragedy of the auditor: thousands of audit hours reduced down to one standard piece of text – an auditor’s report on a large bank that barely differs from one on a regional manufacturing company. The majority of the auditor’s work is hidden from the stakeholders – the very people he’s doing it for.

But all that is about to change with the International Auditing and Assurance Standards Board (IAASB) proposals for enhancing the auditor’s report. PwC in the Netherlands have taken those proposals and written new-style auditor’s reports with some of their clients – reports that are now being used in Annual General Meetings. . World Watch interviewed Territory Assurance Leader Michael de Ridder and Partner, Peter Eimers to find out more.

New style reports weren’t required in the Netherlands. What led you to experiment with implementing the new, more informative audit reports in some of your listed company audits this year?

Michael de Ridder: First, the current auditor’s report no longer meets today’s expectations of transparency. A simple ‘true and fair’ is not good enough – it gives little comfort to the users of financial statements and provides no insight for the wider public. When my car is serviced, I want to know what work the mechanic has done! It gives me a greater degree of comfort and also gives the mechanic a greater degree of credit in his work. Relevant reports on financial statements from a relevant profession – that’s what is at stake here.

Peter Eimers: Really, the message is that auditors need to start talking the language of financial statement users. A lot of people think that some countries going it alone is going to jeopardise the comparability of auditor’s reports – but we think that’s inevitable at this stage. Someone has to go first! As a country we have a tradition of acting as a frontrunner. The new report is a logical step in an ongoing process – and so when shareholder groups and politicians encouraged the profession in the Netherlands to be bold and try the new reports in practice, we were happy to embrace that challenge and pilot the proposals.

How did your clients react? Did you have any difficulty convincing them to be part of the experiment?

PE: The vast majority of executive and non-executive directors are supporting these developments. We did a dry run of field testing in the Autumn of 2013, and, following that, certain clients were even encouraging us to use the new style reports. Some, of course, were not keen on anticipating the standard – they are continuing to work within the established framework. And that kind of caution is fine too – in fact in some cases we have found it to be instructive.

Have you had any reaction from investors and other stakeholders to the new reports?

PE: We haven’t yet had many annual general meetings, but the feedback we are getting anecdotally from investors and wider stakeholders is very encouraging. On the whole, they’re keen on the transparency that the new reports are offering – that is, while there hasn’t yet been in-depth discussion on specific approaches, there is already considerable interest in the general outcome. What’s particularly interesting is that there are questions being asked of those entities that didn’t work to produce the new style report.

What did you find to be the most challenging part of drafting the new reports?

MdR: One of the things that we found difficult was just gearing up for producing the new style reports. We had to do a first draft of all of them, and then many of them were changed, because the way we wanted to write it didn’t coincide with the kind of things the actual users of financial statements would want to read. We also had to make sure that we were being really entity specific – so we always had this challenge in our minds: if you erased the name of the company from the report, would the reader still be able to tell which industry the entity operated in, what kind of company they were and maybe even exactly who they are? We called it the Tipp-Ex challenge!

You decided to go beyond the proposed IAASB requirements to include a description of materiality and group scoping judgements in some of the reports – as in the UK. Have you had any feedback on those disclosures?

PE: I think that a lot of people wanted those materiality and scoping aspects included in the report, because they saw what the Financial Reporting Council was doing in the UK and they decided that it was a very desirable enhancement. In the event, we didn’t get much feedback on it, but what we did find was that the auditors – our teams – were more scared of writing about it than companies were scared of providing the information or submitting to those judgements.

You’re just heading into the season when Annual General Meetings are being held. Have the new reports influenced the questions and dialogue in those meetings?

PE: As I said before, we haven’t had many meetings yet. There are some questions being asked of those companies that didn’t dive into the deep end and get the new reports done. But we know that shareholders and management are referring to our reports. Questions and discussions in shareholder meetings have been more specific and to-the-point. So the feedback so far is good!

What would you say was the most surprising finding in the pilot?

MdR: We’re pleased that the new-style reports allow us to be really entity-specific and give the companies that we report on a highly relevant communication. But the most significant finding is that we’ve discovered that we as auditors really need to change our mindset. If we’re more proactive and more courageous, we can produce reports that are highly appreciated by society. Stakeholders will undoubtedly take the next step of getting the debate started as to who should be primarily responsible for disseminating entity specific information and where the extent of the auditor’s transparency ends and that of the entity being audited begins. There are engrossing issues that merit a broad-based debate.

What are your plans for auditor reporting now?

PE: It is expected that all audit opinions issued on the financial statements of listed entities will have to be in the new style next year and in the near future this may also widen to other areas that have broader societal impact. Obviously this is going to be a huge coaching challenge for us.

MdR: One of the things we would say about moving forward is that everybody – not just the auditor – needs to get involved, and encourage one another. Boards have to have the courage to share information that is critical to the understanding of their business; directors and audit committees need to provide more information and insight in their reports; standard setters and regulators need to ensure that the roles of the various parties involved remain untainted, maybe by tailoring their standards and supervision and stakeholders should be clear about what information they want for their decision-making processes, so that reports can continue to be refined.