Risk & Economy » Audit » Holding to a high standard: innovation in audit

Innovation is exciting, right? The word triggers images of a future filled with flying cars and robot servants servicing our every whim. However, most innovation happens, in the words of TS Eliot, ‘not with a bang but a whimper’. There was no great plan for mobile phones to become the all-encompassing multimedia devices they are today; it just ended up that way via a series of staggers. Consequently, other parts of the establishment have had to move to accommodate this change, including libraries, record shops, TV stations and more. The benefits are widespread, but it wasn’t deliberate and nobody saw it coming.

It’s the same in audit: there’s been a very significant innovation to audit recently, but its impact is only just being understood. It’s the requirement for auditors of listed companies to include in their audit reports a section that describes certain ‘key audit matters’.

There’s been a very significant innovation to audit recently, but its impact is only just being understood.

In the UK, key audit matters have been required since 2013. The International Auditing and Assurance Standards Board’s (IAASB) version of key audit matters, from which the UK standards were borrowed, were adopted in many other countries from December 2016. The most notable exception so far is the USA, whose audit standard setter (the PCAOB) has introduced its own version of this standard to take effect over the next few years.

The IAASB standard defines key audit matters as “those matters that, in the auditor’s professional judgement, were of most significance in the audit of the financial statements of the current period… selected from matters communicated with those charged with governance”. The auditor is required to disclose the key audit matter, together with the reasons why it was considered to be a key audit matter and how the issue was addressed in the audit. A key audit matter is not a qualification or other modification. The main justification for the standard is to provide greater transparency for investors about the audit.

The main justification for the standard is to provide greater transparency for investors about the audit.

ACCA has recently published a global study of the implementation of the new IAASB standard across nine countries, looking at over 560 separate audit reports. This quantitative analysis was further supported by roundtables in selected countries. In addition, ACCA partnered with local bodies to produce separate detailed reports on the implementation of key audit matters in Singapore and Malaysia.

Three effects

The report is clear: key audit matters do provide useful information for investors. But ACCA’s report found three additional effects which make key audit matters a truly innovative idea.

Firstly, a disclosure of key audit matters provides a focus to the discussions between the audit committee and auditor. As a result, there’s a boost to corporate governance as a result of the disclosures.

Secondly, because of the increased attention to the contents of the audit report as well as the deepened audit committee discussion, auditors are incentivised to think harder about the riskiest parts of the audit. And there’s an added benefit in that auditors may even reduce work in less risky areas of the audit in order to spend even more time on riskier areas. As a result, key audit matters stimulate improvements in audit quality.

Finally, once an issue has been raised as a key audit matter, it’s inevitable that investors will want to read the sections in the accounts that relate to that item. As a result, preparers tend to double-check disclosures in the annual report and accounts to ensure that they’re as good as they can be before publication. So key audit matters encourage better financial reporting.

These three effects – improvements to corporate governance, audit quality and corporate reporting – combine to produce a small but meaningful impact on the overall financial reporting supply chain. And, with just the right amount of regulation, there’s the potential for even more innovation, as experience of the UK’s early-adoption of these standards shows.

Beyond the standard audit

With the encouragement of the regulator, audit firms went beyond the requirements of the standard to give additional disclosures within the audit report. For example, as well as describing how the key audit matter was addressed, some firms experimented with explaining their audit findings. This provided an added richness to the disclosures. It’s important that such innovation is allowed to flourish and isn’t snuffed out by an overly zealous focus on the precise requirements of the standard.

From the finance director’s point of view, the key factors to a successful audit are preparation and communication. Discuss with your auditors early what areas are likely to be included as key audit matters this year. Find out what additional information they’re likely to need during their audit and think about how the disclosures in the accounts could be strengthened to provide more useful information to investors.

From the finance director’s point of view, the key factors to a successful audit are preparation and communication.

It’s clear that key audit matters are an incredible innovation and demonstrate clearly the value of audit. But the benefits don’t belong to the audit alone, and finance directors should be looking to how to make the most of these benefits when preparing their accounts.

Andrew is head of audit and assurance at ACCA’s Professional Insights team.