Should auditor’s reports include commentary on key items?
The International Auditing and Assurance Standards Board is working to focus on the essentials in a project addressing the content and structure of auditor’s reports.October 4, 2012
by Ken Tysiac
The International Auditing and Assurance Standards Board (IAASB) has a major project under way addressing the content and structure of the auditor’s report in order to improve the quality of information provided and its presentation.
Last month, the IAASB held the first of three global round-table events with stakeholders to discuss changes outlined in its Invitation to Comment. Comments are due Oct. 8 and can be submitted on the IAASB’s website.
Following the first round-table discussion, which was held in New York, IAASB Chairman Arnold Schilder, Deputy Chair Dan Montgomery, and Technical Director James Gunn discussed issues related to the auditor’s report project. Here are excerpts from the discussion:
Tysiac: There seems to be agreement at the round table that auditor reporting really needs to change, and yet not a whole lot of agreement about what the changes need to be. Can you talk about how you handle that when you get all the comments back?
Schilder: You cannot expect that something that has been there for decades, the short-form auditor’s report, will change overnight, because it’s established practice. Auditors know how to deal with that, and so does their audience, whether it’s preparers on one hand or those charged with governance, including audit committees. So this is really a major project for change, and we do indeed think that the status quo is not an option. But we are not surprised that in such a major project which is appealing to everybody, influencing everybody’s practice, that you can’t have a simple consensus overnight.
Tysiac: There has been some question about subjectivity versus objectivity in the auditor’s report. Some say the report should purely be objective, but you have said that subjectivity can be construed as judgment, and if you don’t have judgment, the value of the report decreases. Can you explain?
Schilder: The comments started as, “We would like objective auditors’ comments, meaning based on facts and not personal views of an auditor.” Which is fine. But that’s not the discussion. The discussion is that nowadays there is far more judgmental information in financial statements. So where management had to make an assessment or had to make choices from a number of options or within ranges—assumptions underlying a goodwill evaluation or evaluation of financial instruments, for example—that’s not just one concrete number. Management has to think about it. They have to discuss the assumptions they will apply in coming to their evaluations and where in a range of options they will make their choice. That, by definition, is a judgmental process.
Tysiac: There also have been discussions about this being a holistic process, where accounting standard setters, regulators, preparers, audit committees, and even investors need to help make things better. Can you talk about that?
Montgomery: Obviously, accounting standard setters might have a role to play if there is concern about certain types of disclosures and whether the information is appropriate or needs to be expanded. Perhaps the accounting standard setters need to have a look at the existing accounting framework to see if it needs to be enhanced in some way. In certain jurisdictions, regulators also have a role to play in terms of the information that’s provided by entities to users … what’s provided, how it’s provided, to see whether that part of the process also may need to be changed. So there may be a need for a holistic look at the entire financial reporting process and see what role each of the parties may be able to play to make sure that the concerns that have been raised by users are in fact being addressed.
Gunn: Change provides opportunity. There’s a burden that gets associated with change, and I think everyone will have to help carry that burden. But it’s important that the burden doesn’t fall disproportionately on some individual’s or group’s shoulders. There are other participants in the regulatory, standards-setter, preparer, and investor communities that also have important roles to play in enabling change.
Tysiac: There was talk that the auditor’s report could grow to 20 or 30 pages in light of these changes. Is that realistic in your opinion? Your sample report was four pages long.
Schilder: The background of that comment was, “What happens if auditors are required to provide additional commentary?” They might be reluctant to not comment on anything that might be of importance. And you never know about the future. So an auditor might say, “I have a minor thing, but you never know if it will be important in the future. Let me write that down as well.” That might result in 20 or 30 pages because it would become of a defensive nature. That’s not what we would like to stimulate. That’s why in this invitation to comment we are focused on essentials, what is of key importance to users. Now that, of course, is a difficult decision involving some subjectivity. But nevertheless, maybe some two to 10 comments would make sense.
Tysiac: Do you have a thought on the legal liability question? There seems to be a fear that auditors will leave themselves open to legal jeopardy if they don’t make as many comments as other auditors.
Montgomery: It’s an issue that needs to be explored as a part of this process. Clearly there are certain environments such as the U.S. that the litigiousness is such that it could be a consideration in terms of a potential impediment or implication of any change in auditor reporting. I think it’s a legitimate issue that needs to be addressed further.
Schilder: It’s not just a U.S. concern. In Europe, auditors would be concerned about what might happen if you stick out your neck and make more comments. It could be raised that people would claim that in some cases certain additional information has been provided whereas, in other cases, it has not. Could an auditor be blamed because his colleague has provided more? What about the quality of the comments or the quality of the analyses? ... We understand the concern and sensitivity. But nevertheless, on the other hand, you could argue that litigation risk might somewhat decrease because there is now an open floor for all of us to share more comments with an outside audience, still focusing on what is essential and most relevant.
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Ken Tysiac is a Journal of Accountancy senior editor.