CLASHES BETWEEN MANAGEMENT and auditors over assumptions made in annual financial statements will be thrown open to public scrutiny as part of fundamental changes being proposed to the auditor’s report.
Under proposals outlined by international accounting regulators, auditors are to be charged with commenting on subjective information, giving rise to the possibility of competing disclosures in company reports.
In June, the International Auditing and Assurance Standards Board (IAASB) published proposals aimed at improving the auditor’s report in annual financial statements, adding weight to initiatives launched by UK accounting watchdog the Financial Reporting Council and found in the European Commission’s plans to overhaul the audit market.
In addition to improving corporate reporting in a general sense, the various initiatives aim to force auditors to provide greater transparency about significant matters in the financial statements, as well as the conduct of the individual audit.
It is notable that the call for change came from institutional investors and financial analysts looking for help navigating complex financial statements and demanding more information on areas where auditors’ efforts were focused – particularly on subjective matters within the financial statements. There appears to have been little appetite among the companies themselves.
“It’s coming from the investor community,” says Hugh Morgan, technical director at Baker Tilly and responsible for drafting the firm’s response to the proposals. “We are happy the IAASB is leading the charge. They will do a sensible job – what they have come out with is very well thought through.”
At the heart of the suggestions is the need for transparency on matters specific to the audited financial statements and the audit performed. The IAASB has proposed adding a new section in which the auditor can call attention to matters important to the users’ understanding of the audited financial statements or the audit.
There are also suggested improvements to new statements about going concern and other information in documents containing audited financial statements; the description of the responsibilities of the auditor and key features of the audit itself; and enhancement to the report’s format.
But changes – ones that will see auditors commenting on management assumptions rather than signing off the accounts, and throw private conversations between audit committee and auditor open to public scrutiny – naturally raise a number of risks.
For instance, there may be confidentiality or liability implications to auditors when providing commentary with reference to matters not disclosed by management.
There is also a fear that provision of certain information could end up competing with management’s disclosures, thereby resulting in “duelling information” representing two versions of the truth.
According to Dan Montgomery, deputy chairman of the IAASB and chairman of its Auditor Reporting Task Force, this will be impossible to avoid. But most of the issues can be dealt with through communication between management, auditors and those charged with governance.
Richard Sexton, head of reputation and policy at PwC, says there should be a clear demarcation between the statements made by management and auditors.
“The auditors’ commentary is designed to draw attention to things discussed in the financial statement. It should point towards key disclosures,” Sexton says. “I don’t think it is a case of two versions of the truth.”
There is also a risk of increasing the expectation gap, as readers interpret the inclusion of auditor commentary as assurance on individual accounts or disclosures, while the fear of standardised wording and auditor statements reverting to boilerplate is never far away.
It is hoped this risk should be negated as auditors are commenting on client-specific issues, but many of these will still crop up – such as goodwill impairments, financial instruments and valuation of intangibles.
This is an issue that needs clarification, particularly on boilerplating, which the IAASB recognises – auditors would not be expected to create new language to add to the wording of the report.
“I don’t think all users’ view is the same,” says Montgomery. “Even if auditors might comment in the same way on the same type of matters, some have indicated they don’t believe that to be boilerplate. They perceive value in auditors commenting on these areas that users might find important.” ?