The independent auditor’s report on the financial statement is a familiar part of the information that listed companies are required to make available to investors and the public. However, despite their importance to confidence in financial reporting, few people read audit opinions. With the occasional exception of a “going concern” qualification, audit opinions are pass/fail reports, phrased in standardized language, and they are usually all the same.
For most listed companies, that is about to change. In the wake of the global financial crisis, many investors demanded that, in addition to the pass/fail report, auditors provide insight into the risks and challenges associated with the audit and the company’s financial reporting. Of course, in order to accomplish these goals, audit reports would have to be individually drafted, and each would have to be unique.
In the past several years, the concept of expanded auditor reporting has been accepted by regulators and standards setters;
In January 2015, the International Auditing and Assurance Standards Board (IAASB) issued new standards requiring the auditor’s report for a listed company to include a discussion of key audit matters or KAMs. KAMs are the areas of greatest significance to the audit — the matters that required significant auditor attention and were discussed with the audit committee. In much of the world outside of the United States, listed company audits are required to be performed in accordance with IAASB standards. IAASB KAM disclosure is effective for audits of periods ending after December 15, 2016.
In April 2014, the European Union adopted a requirement that the auditor’s report for a company listed in the EU include a description of the most significant risks of material misstatement and how the auditor responded to those risks. Member states are expected to implement this requirement for audits beginning in mid-2017.
In 2013, the Public Company Accounting Oversight Board (PCAOB) proposed to require audit reports for companies registered with the US Securities and Exchange Commission to include a discussion of critical audit matters or CAMs. CAMs are matters addressed in the audit that involved the most difficult, subjective, or complex judgments or posed the most difficulty in obtaining audit evidence. The PCAOB has announced that it intends to issue a revised auditor reporting proposal in the third quarter of 2015.
In 2013, the UK’s Financial Reporting Council adopted a requirement that auditor reports for UK listed companies include a description of the risks that had the greatest effect on overall audit strategy, an explanation of how the concept of materiality applied to the audit, and an overview of how risk and materiality affected audit scope. This requirement took effect in late 2013, and numerous audit reports implementing it have been issued.
Expanded auditor reporting will affect not just auditors but listed companies as well. As companies prepare for the enhanced communications role that their auditor will be playing, they should be alert to several issues:
Don’t let the auditor be the source of new information. Management, not the auditor, should control disclosure about the company and its financial reporting. If the auditor is going to discuss a matter in the audit report, the company should make sure that it has made its own disclosures regarding the issue.
No surprises. The company should expect that matters the auditor intends to disclose as reporting risks or auditing challenges will have been discussed in advance with management and the audit committee. To the extent that the auditor’s disclosures may seem to raise questions about the company’s financial reporting, the company should anticipate those questions and be prepared to justify its position.
- Comparability matters. Investors are likely to expect companies in the same industry to have generally similar auditing and financial reporting challenges. Management should monitor the auditor opinions of its competitors. If those reports present different, or fewer, risks and challenges than those identified by the company’s auditor, management and the audit committee should explore the reasons for the differences and whether those differences suggest the need to strengthen the company’s reporting practices.