28 Nov 2013
DH: Since the financial crisis, there’s been a lot of scrutiny on all the players in the corporate reporting supply chain – including a focus on the auditor’s report. Investors and other stakeholders value the auditor’s report and they don’t want to lose the “binary pass/fail” audit opinion. But they want to hear more from auditors about the audit. The IAASB has responded to those pressures by proposing what will be the most fundamental changes to audit reports in decades – increasing transparency around key audit matters addressed in the audit, reaffirming independence, and making explicit their conclusions around going concern judgements.
DH: No. This isn’t about changing the scope of the audit; it’s about making the auditor’s report more informative by sharing greater insight from the audit. At every stage of the consultation, stakeholders have been pretty clear that the auditor’s report shouldn’t be an original source of information or an investment analysis – and that’s absolutely right. That would be a change in the role of audit and would blur the respective responsibilities of auditors, those charged with governance and management.
It’s the new section describing key audit matters that, in our view, is going to add the most value to users. There is no doubt that this will be a substantial change, yes. And there is a risk that this section could blur lines if it was used to fill gaps in management’s disclosures. But with a few tweaks to the proposed requirements, we don’t think that it will encroach on management’s responsibilities.
DH: The IAASB has included a principles-based requirement that defines the filter that the auditor uses to identify what’s key. We fully agree with that, but we think that the filter needs some refinement. We’ve done a lot of fieldwork in this area, and the message we’re getting from the practice is that the judgement framework needs to be more explicit. Engagement teams intuitively knew the types of matters they believe would be most relevant to users, but the proposals weren’t sufficient to guide their judgments, and that could lead to identifying matters they would not have considered a key audit matter if telling their story of the audit.
DH: In two ways – relevance and significance. First, the key audit matters should provide insight that’s relevant to the user’s understanding of the financial statements. In particular, why and how the audit addressed the more subjective areas in the financial statements – those that involved complex financial reporting estimates and significant management judgment. And then second, that the key audit matters should focus on the most significant things – what kept the auditor up at night, if you like!
DH: Keeping key audit matters focussed on the most significant matters will certainly help! But there’s also another consideration. We’ve already touched on the need to avoid the auditor’s report becoming an original source of information. We also believe it’s really important that we guard against reporting matters that risk unintended market consequences. We think this could happen if the auditor discussed, for example, suspected illegal acts, suspected fraud or close calls on going concern. Changing the “trigger point” by lowering the threshold of when such matters are reported and by whom could stimulate unintended and negative market reactions – particularly if there isn’t a level playing field. That would not be in the public interest. In our fuller response to the IAASB, we’ve offered some suggestions on how the proposals might avoid this.
DH: Yes – there are actually two extremes here: first, we’re prepared to support making transparent the conclusions the auditor already needs to form in the audit. So that’s whether the entity’s use of the going concern basis of accounting is appropriate and whether or not there are any material uncertainties. But we’ve been starting to hear feedback from stakeholders that this particular section of the IAASB’s proposals could just be perceived as being more boilerplate. At the other end of the spectrum, as I mentioned, we’re concerned about “close calls” on going concern – situations where we had to do a lot of work – but we were able to get satisfied that there isn’t a material uncertainty. Under the proposed standard, this could be considered a key audit matter, but that leads us back to the auditor’s report not being a source of original information. There’s also not a common understanding of when that particular disclosure would be appropriate and how it should be reported – even though it could trigger a significant market reaction. There is no doubt that many stakeholders believe that greater transparency around going concern judgments is needed. We fully agree with that. But what’s needed is a holistic and more integrated solution that considers enhanced financial reporting, corporate governance and audit responsibilities altogether. The optimal solution would be for the statements being made by the auditor to complement an explicit explanation by preparers of the rationale for their going concern conclusions.
DH: Well, the debate isn’t over and I guess first, we have a message for the standard-setters – please continue to aim for convergence! We are really pleased to see a high degree of consistency with the proposals from the various standard setters and regulators. But there are some differences. Substantively different models would be confusing to capital markets. The starting points vary across jurisdictions and convergence may take some time. But unintentional and unnecessary differences in approach can and should be avoided – again, our response goes over some practical solutions in more detail.