Speaking up: Auditors to disclose areas of concern
Once confidential views on key audit matters will be revealed
When accounting giant KPMG audited the 2013 annual accounts of Rolls-Royce Holdings it did something that hadn't been revealed publicly by auditors before.
Looking over the accounts for the company's civil aerospace business, KMPG commented in their report on the areas that represented the greatest risk to the audit and the procedures they used to manage those risks. This included areas such as measurement of profit, identification of revenues and valuation of assets, among others.
In another part of the report, KPMG considered how the Rolls-Royce accountants had valued some financial options in its Daimler subsidiary and concluded: "We found that the resulting estimate was acceptable but mildly optimistic, resulting in a somewhat lower liability being recorded than might otherwise have been the case."?
To the layman, such statements may appear unremarkable or even bland, but within the world of auditing they were revolutionary.
For the first time, KPMG had exposed some of what goes on in an audit to the public view, in accordance with new audit rules that are progressively being introduced around the world, with the UK starting their process of changing auditor reporting in 2013.
"The new rules are really opening up what would previously have been behind closed doors, and that will now be in the public domain in the auditor's opinion, which goes with the published financial statements in the annual report," says Elizabeth Carson, a professor in the school of accounting at UNSW Business School.
The way KMPG conducted the audit on Rolls-Royce may not have been any different to the way the firm had conducted countless audits of public companies in the past, but the way they reported the results is the biggest change in auditing for decades and is expected to make audit reports more useful and informative.
'Auditors will disclose the areas that they are spending the most time on in the audit process. We’ve never seen auditors say those sorts of things publicly before'
ELIZABETH CARSON
New disclosure
Every publicly listed company in Australia is required to have its annual financial accounts audited each year. The auditor's responsibility is to express an opinion on whether management has fairly presented the information in the financial statements.
The auditor is required to form a view on whether the information presented in the financial report, taken as a whole, reflects the financial position of the organisation at a given date.
In the process of doing an audit, the auditors will typically discuss what are called key audit matters with the company's financial staff and its board. These are judgment calls made by the company accountants over future revenue and profits and the carrying value of assets, for instance.
Until now, these discussions have been hidden from public view, but when the new rules are introduced in Australia from 2016, they will be included in the publicly available report. This has been designed to enhance the transparency of the audit and improve the communication between auditors and investors, and increase the perceived value of the audit.
It's a big change from previous audit reports, which simply provided the auditors' opinion as to whether the financial statements were true and fair.
"Auditors know a whole lot more about the organisation than that, so what we will see going forward is that auditors will disclose the areas that they are spending the most time on in the audit process. We've never seen auditors say those sorts of things publicly before," Carson says.
Significant judgments
Analysts and investors are the most excited about the changes because it will identify the areas in the financial statements where the greatest judgments are being made by management and these are areas on which investors may want to increase their focus.
The audit profession has come under increased public scrutiny in the past decade or so, with the public asking why auditors didn't pick up the fraud and cover-ups that allowed failed energy trader Enron to deceive investors for so long before it collapsed, and questions over the role of auditors in the more recent global financial crisis.
Carson doesn't expect the new audit reporting standards will impact on corporate collapses, which will inevitably occur, but says they will give some pointers.
"The changes to audit reporting aren't necessarily going to identify weaknesses in business models – that's not the point of the audit. But it will identify areas where significant judgments are being made and, if there's a change in those assumptions, the outcomes could be quite different. These really pinpoint the areas of risk in the financial statements," Carson says.
'There’ll be some tough conversations with management and boards around sensitive topics'
MERRAN KELSALL
Expectation gap
Part of the reason so much public anger was directed at auditors over corporate collapses was because of what's known as "the expectation gap". It arises when users of company accounts such as investors and creditors interpret the auditors' report that the financial statements are fairly presented as a comment on the overall health of the company.
Liz Stamford, audit and insolvency leader at Chartered Accountants Australia and New Zealand, says the new standards should help to address this because they will give the public a better understanding of what the auditor actually does.
In their reports, auditors will essentially say things such as: "For this particular matter that we thought was important for our audit, here's an example of some of the work that we did," says Stamford.
"People are actually able to see and understand what an auditor does because it's more specific and it's related to the company that they're looking at, the financial statements that they're looking at," she adds.
The changes come into effect for accounts for the year ending 15 December, 2016. Merran Kelsall, chair and CEO of the Australian Auditing and Assurance Standards Board, says that after extensive consultation, the profession is preparing for the changes.
Nonetheless, the reform will throw up some difficulties for auditors, not least that they will be required to use their judgment as to what to put in and what to leave out of an audit report, sometimes to the displeasure of the company involved.
"Some of the concerns would be: what do you do about really sensitive matters?" says Kelsall.
"Say there's been a significant breakdown in internal control and the auditor had to do a whole lot more work and is then satisfied. If that is something that wasn't disclosed in the financial statements, then does it represent a key audit matter that should be disclosed?" she asks.
"So there'll be some tough conversations with management and boards around sensitive topics."
Additional caution
The auditor has long been required to check the directors' assessment that their company remains a "going concern" and reporting on this will also require judgment on the auditor's part.
"If there's been a close call or a near miss, there's a change in the standard where the auditor has to look at whether disclosure is appropriate," Kelsall says.
However it could introduce an additional degree of caution into how the auditors write their reports, says Carson.
"Auditors may be a bit more careful, because once it's reported to the audit committee, the obligation may arise for it to be disclosed in the audit report. I think there's a minor concern about whether auditors will continue to be frank but the reality is, it is the role of auditors to provide an independent perspective on the financial statements and they'll continue to do that," she says.
Carson and her colleagues are keen to investigate whether the reporting changes improve the quality of the underlying audit and what risks auditors identify and reveal in the new reports.
"Such an analysis will help us understand whether these initiatives have succeeded in their objectives to improve confidence in audited financial statements," Carson says.