It’s not exactly a Hollywood movie trailer, but new international requirements for an expanded audit report provide a teaser for what the United States should expect in the coming few years.
“This is well overdue,” says Joyce Joseph, an analyst and principal with Capital Accounting Advisory and Research. “Now in the aftermath of the financial crisis, this is an improvement in the nature and extent of communication by auditors, which will be quite beneficial to enable transparency and decision making, and potentially improve audit quality.”
The International Auditing and Assurance Standards Board recently finished its new standard calling on auditors to provide new information in audit reports that will give users of financial statements more insight into what auditors did, and what they found during the audit. The Public Company Accounting Oversight Board is considering a similar standard in the United States; it issued a preliminary proposal in 2013, and a fresh one is expected in the first half of this year, according to the board’s latest standard-setting agenda. The IAASB standard follows an even earlier standard adopted in the United Kingdom by the Financial Reporting Council.
Although the exact requirements are different, the British standard and the IAASB standard both direct auditors to provide some narrative insight into concerns or risks they addressed during the course of their audit work. Under the U.K. standard, auditors must provide an overview of the scope of the audit, showing how it addressed risk and materiality considerations, and auditors must explain how they applied the concept of materiality in planning and performing the audit.
Under the international standard, auditors are required to identify and discuss “key audit matters,” or KAMs—those issues that the auditor considered most significant, with an explanation of how they were addressed in the audit. In the United States, the PCAOB’s latest proposal would call on auditors to describe “critical audit matters” (CAMs, naturally) described as matters that involved the most difficult, subjective, or complex areas of judgment; those that posed the greatest difficult in obtaining audit evidence; or those that made it most difficult to arrive at an opinion.
“Now in the aftermath of the financial crisis, this is an improvement in the nature and extent of communication by auditors, which will be quite beneficial to enable transparency and decision making, and potentially improve audit quality.”
Joyce Joseph, Analyst, Capital Accounting Advisory and Research
Megan Zietsman, an audit and assurance partner with Deloitte & Touche, said the details of guidance might differ, but the principles are consistent. “It’s an attempt to increase the incremental value of the auditor’s report,” she says. “I don’t think the intended outcome is intended to be very different.”
The current U.S. proposal would require auditors to determine CAMs based on issues they discussed with the audit committee, plus issues that were summarized in engagement completion documentation and reviewed in the engagement quality review.
Feedback to the proposal has encouraged the PCAOB to narrow that guidance to focus on a smaller population of CAMs, says Sara Lord, a partner with McGladrey. “We don’t know yet if you will still get to the same place, but in theory, if you pull all these ideas together and evaluate what’s most important, you might come up with similar answers,” she says. “It’s just a question of how much work it takes to get there.”
Jan Herringer, director in the national assurance practice at BDO USA, agrees that ultimately there might be differences in how international and U.S. standards direct auditors on this point. That could lead to similar outcomes, but differences in how they are reached. “I think the wording about how auditors are supposed to determine CAMs could differ, so the documentation will be different,” she says.
KEY POINTS OF PROPOSALS
Below PwC provides details on the IAASB auditor’s repot standard.
Key audit matters (KAM)
KAM are the subject of a new standard, International Standard on Auditing (“ISA”) 701, Communicating Key Audit Matters in the Independent Auditor’s Report. ISA 701 sets out a decision framework for auditors using the communications with those charged with governance as a starting point. From the matters communicated with those charged with governance, the auditor determines those matters that required significant auditor attention. From there, the auditor determines which of these matters were of the most significance in the audit of the financial statements of the current period and are therefore KAM. ISA 701 allows for the possibility, in extremely rare circumstances, that the auditor not communicate a matter determined to be a KAM when the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication (e.g., consideration that such aspects include harm to the entity’s commercial negotiations or competitive position). This exception does not apply if the entity has publically disclosed information about the matter.
Although KAM are required only for audits of listed entities, ISA 701 also applies when an auditor otherwise decides to communicate KAM in the auditor’s report.
The description of a KAM in the auditor’s report is always required to include:
Why the matter was considered to be one of most significance in the audit
How the matter was addressed in the audit
A reference to the related financial statement disclosures, if any
ISA 570 (Revised), Going Concern, applies to audits of all entities and now includes:
A new requirement for the auditor to evaluate the adequacy of disclosures in “close call” situations
A new required description in all audit reports of both management’s and the auditor’s responsibilities related to going concern
If the entity’s going concern disclosures are adequate when there is a material uncertainty, a new separate section of the auditor’s report is required under the heading Material Uncertainty Related to Going Concern, drawing attention to those disclosures
If the entity’s going concern disclosures are inadequate, a modified opinion is required as the first section of the auditor’s report
Other enhancements to the auditor’s report for all audits include:
The Opinion section is required to be presented first, followed by the Basis for Opinion section, unless law or regulation prescribe otherwise
An affirmative statement about the auditor’s independence and the auditor’s fulfillment of relevant ethical responsibilities, with disclosure of the jurisdiction of origin of those requirements or reference to the International Ethics Standards Board for Accountants’ Code of Ethics for Professional Accountants
Enhanced description of both the responsibilities of the auditor and key features of an audit
A revised standard on other information is expected to be finalized soon and will require new and revised auditor reporting about other information for audits of all entities
Joe Carcello, executive director at the University of Tennessee’s corporate governance center, says he expects the next PCAOB proposal to remain consistent with the international standard on KAMs or CAMs. “If I had to guess, the PCAOB reproposal will be even closer to the IAASB’s standard” on that particular issue, he says.
Devil in the Details
Still, differences between the standards are assured. The international standard requires audit firms to name the engagement partner at the firm who was in charge of the audit. The PCAOB has attempted for years to push through a separate standard requiring audit firms to name the engagement partner, but has met heavy resistance from auditors who say it will increase their personal liability under U.S. filing rules. The latest indication from the PCAOB is that the board is working on a new idea to require auditors to provide a separate filing to the PCAOB naming engagement partners.
Matthew Waldron, director of financial reporting policy for the CFA Institute, says it doesn’t seem likely the PCAOB will require engagement partners to be named in audit reports. More probable: that the PCAOB will consider the timeliness and accessibility of information, if those details are required to be presented in some other way. “We are still strongly in favor of having [the name of the engagement partner] on the face of the audit report,” he says.
Another key difference will be the approach to going-concern warnings, Carcello says. The IAASB standard requires enhanced reporting that addresses the different responsibilities of management and auditors, a separate section when a material uncertainty exists and is disclosed, and new requirements meant to challenge the adequacy of disclosures in close-call situations. The PCAOB is in the early stages of reconsidering its approach to going-concern warnings as part of a separate project, after the Financial Accounting Standards Board adopted a new requirement for management to take the first step in alerting investors when questions about an entity’s viability arise.
Carcello says FASB’s standard has the effect of raising the threshold for when a going-concern warning is warranted. That gives companies a longer leash before disclosures would be required. “So if the auditing literature is aligned with the new FASB standard, the number of going-concern reports in the United States would probably go down,” he says. The PCAOB is expected to issue a consultation paper reflecting its earliest thinking on the subject in the first half of 2015.
The U.S. and international standards also could differ in any requirements that auditors consider information outside the financial statements as part of their audit work, Lord says. The U.S. proposal enhances the auditor’s responsibility by adding procedures and calling for more evaluation. The IAASB retains an approach more consistent with current practice, Lord says. U.S. auditors are hoping for more clarity in the next proposal. “We don’t know exactly yet what the PCAOB was intending,” she says.