relWidely recognised as the most significant development in auditing in recent history, the new and revised auditor reporting standards are intended to enhance the communicative value and relevance of the auditor’s report, and may also improve audit quality and users’ perceptions of it
- Ins and outs of The New Auditor’s Report
- Key audit matters: questions and answers
- Auditor’s report and financial statement disclosures
- Audit committee reporting
- What’s going on with going concern?
- Effect on smaller entities
The International Standard on Auditing (ISA) 700 (Revised), Forming an Opinion and Reporting on Financial Statements is the overarching standard for auditor reporting. Nicolette Bester CA(SA) gives an overview of the key changes to the form and content of the auditor’s report
The ins and outs of the new format of the auditor’s report are illustrated in diagram 1, followed by commentary on the key changes that incorporates a South African perspective where applicable. The new format of the auditor’s report is effective for audits of financial statements for periods ending on or after 15 December 2016.
It should be noted that ISA 700 (Revised) is only prescriptive in terms of the sequence of the ‘Opinion’ and ‘Basis for Opinion’ sections of the auditor’s report. For the other sections, diagram 1 follows the illustrative auditor’s reports included throughout the suite of the new and revised auditor reporting standards.
OVERVIEW OF CONTENT ELEMENTS
The International Auditing and Assurance Standards Board (IAASB) has established a new requirement that the ‘Opinion’ section shall be presented first in the auditor’s report and incorporates:
- The matters previously contained in the introductory paragraph of the extant ISA 700, and
- The opinion on the financial statements as previously contained in the opinion paragraph of the extant ISA 700
Basis for Opinion
The ‘Opinion’ section shall be followed immediately by the ‘Basis for Opinion’ section that now has to be included in the auditor’s report, regardless of whether a modified opinion is expressed on the financial statements. This section contains the following key elements:
Conduct of the audit and audit evidence
This element states that the audit was conducted in accordance with International Standards on Auditing (ISAs), refers to the section of the auditor’s report that describes the auditor’s responsibilities under the ISAs, and states whether the auditor believes that the audit evidence obtained is sufficient and appropriate to provide a basis for the auditor’s opinion.
This element contains an affirmative statement about the auditor’s independence and fulfilment of relevant ethical responsibilities. In South Africa, registered auditors (RAs) are subject to the relevant ethical requirements of the Independent Regulatory Board for Auditors (IRBA) Code of Professional Conduct for Registered Auditors (IRBA Code) as well as, in the case of companies, the jurisdictional ethical requirements of the Companies Act 71 of 2008 relating to the audit of financial statements.
The statement included in the auditor’s report on independence and other ethical requirements in South Africa is expected to refer to the IRBA Code that is consistent with the International Ethics Standards
DIAGRAM 1 CONTENT ELEMENTS OF THE AUDITOR’S REPORT (Click to enlarge)
Board for Accountants (IESBA) Code of Ethics for Professional Accountants (Part A and B) together with the ethical requirements relevant to the audit of the financial statements in South Africa.
Modified auditor’s opinion
If the auditor has modified his/her opinion on the financial statements, the auditor is required to include within the ‘Basis for Opinion’ section, as previously required by the extant ISA 700, a description of the matter giving rise to the modification. The heading of this section will also be amended to accommodate the type of modification, such as ‘Basis for Qualified Opinion’.
Material Uncertainty Related to Going Concern
ISA 570 (Revised), Going Concern, requires that a separate section be included in the auditor’s report when the auditor concludes that a material uncertainty related to going concern exists and it has been adequately disclosed in the financial statements.
Emphasis of Matter and Other Matter
The concepts of Emphasis of Matter (EOM) and Other Matter (OM) paragraphs have been retained within the auditor’s report. However, ISA 706 (Revised), Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report (ISA 706 (Revised)), prohibits the auditor from using an EOM or OM paragraph when the matter concerned has been determined to be a Key Audit Matter (KAM) and provides further guidance on the relationship between an EOM paragraph and KAM in the auditor’s report.
ISA 706 (Revised) also provides guidance as to the placement of the EOM and OM paragraphs in the auditor’s report, which will depend on the nature of the information to be communicated and the auditor’s judgement as to the relative significance of such information for intended users.
Key Audit Matters (KAM)
The auditor is required to communicate KAM in the auditor’s report for all audits of complete sets of general purpose financial statements of listed entities.
KAM are defined 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. KAM are selected from matters communicated to those charged with governance.
ISA 701, Communicating Key Audit Matters in the Independent Auditor’s Report, addresses the auditor’s judgement as to what to communicate in the auditor’s report and the form and content that such communication should take.
From all the changes to the auditor’s report, KAM are expected to have the most significant impact, not only on the auditor’s report but also on the users of audited financial statements. KAM may also be applicable to non-listed entities when the auditor is required by law or regulation to communicate KAM in the auditor’s report or when the auditor decides, for a particular audit, to voluntarily communicate KAM.
ISA 720 (Revised), The Auditor’s Responsibilities Relating to Other Information (ISA 720 (Revised)), deals with the auditor’s responsibilities relating to other information; that is, financial or non-financial information (other than financial statements and the auditor’s report thereon) included in an entity’s annual report.
A separate section in the auditor’s report is used to identify the other information, describe the auditor’s responsibilities in relation thereto and, if applicable, report on any material misstatement of the other information. It is also clearly stated that the auditor’s opinion on the financial statements does not cover the other information and that the auditor does not express any form of assurance conclusion thereon.
Without limiting the scope of ISA 720 (Revised), it is expected that, in South Africa, the Directors’ Report, the Audit Committee’s Report (when applicable) and the Company Secretary’s Certificate (when applicable), which form part of the annual financial statements prescribed by the Companies Act, will meet the definition of ‘other information’ and will be specifically identified as part of the other information identified and included in this section.
Responsibilities of the Directors for the Financial Statements
This section of the auditor’s report is now required also to include a description of the directors’ responsibilities for going concern. Furthermore, ISA 700 (Revised) requires that this section identifies those responsible for the oversight of the financial reporting process when they differ from those who fulfil the responsibilities for the preparation of the financial statements.
In the case of a South African company, the company’s directors are responsible for the preparation of the financial statements and for the oversight of the financial reporting process and, as such, no reference to oversight responsibilities is required in the auditor’s report. The ‘directors’ are identified in the relevant heading in the auditor’s report.
Auditor’s Responsibilities for the Audit of the Financial Statements
This section of the auditor’s report contains an enhanced description of the auditor’s responsibilities and describes the key features of an audit, with reference to matters such as the following not included in the extant standard: maintaining professional scepticism; a description of when misstatements are considered material; the nature of fraud; communicating with those charged with governance; and, if applicable, the identification and communication of KAM.
Furthermore, the auditor’s report shall include a description of the auditor’s responsibilities relating to going concern.
The Auditor’s Signature
ISA 700 (Revised) requires that the name of the engagement partner be included in the auditor’s reports of listed entities. In South Africa, section 150.6 of the IRBA Code requires that all auditor’s reports adhere to a signing convention that includes the name of the individual RA, in addition to the auditor’s signature and date of the auditor’s report.
SOUTH AFRICAN AUDITING PRACTICE STATEMENT 3, ILLUSTRATIVE REPORTS
The South African Auditing Practice Statement (SAAPS) 3 (Revised November 2013), Illustrative Reports (SAAPS 3 (Revised)), provides practical assistance to auditors when reporting on financial statements that meet the requirements of the ISAs and the International Standards on Review Engagements and comply with South African jurisdictional requirements. SAAPS 3 (Revised), is in the process of being updated as a result of the issue of the new and revised auditor reporting standards by the IAASB and the IRBA’s prescription of these standards for RAs in South Africa.
The auditor’s report is the key deliverable of interest to stakeholders that arises from the audit process. The new and revised auditor reporting standards have opened a new era for auditor reporting. Preparers, those charged with governance and RAs are advised to familiarise themselves with the new and revised requirements ahead of the effective date, as well as with the new SAAPS 3 that is expected to be issued on exposure later this year, to ensure that all the ins and outs of the new and revised auditor reporting standards are understood and implemented in order to be able to realise their intended benefits.
AUTHOR: Nicolette Bester CA(SA) is Professional Manager: Standards at the Independent Regulatory Board for Auditors (IRBA)
This article addresses, in a Q&A format, some of the prominent matters that were considered
during the drafting of the new auditing standard on Key Audit Matters (KAM). By Ciara Craul Reintjes CA(SA)
The April 2015 number of Accountancy SA included an article entitled ‘Focus on key audit matters’, which addressed the technical requirements regarding the communication of KAM in the auditor’s report. The new International Standard on Auditing (ISA) 701, Communicating Key Audit Matters in the Independent Auditor’s Report, is part of the suite of new and revised auditor reporting standards issued by the International Auditing and Assurance Standards Board (IAASB), effective for 31 December 2016 financial year-ends.
ISA 701 defines KAM 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, and are selected from matters communicated with those charged with governance (TCWG). KAM are to be communicated for all listed companies in South Africa.
How does the auditor decide what to communicate as KAM?
During the drafting of ISA 701, there was clear support for an approach that allows KAM to be determined based on the auditor’s professional judgement, with robust guidance to inform that judgement. ISA 701 includes a three-step judgement-based decision-making framework to assist the auditor in determining KAM. The auditor begins with the matters communicated with TCWG. From these matters, the auditor selects those matters that required significant auditor attention in performing the audit. Finally, the auditor selects those matters of most significance in the audit. This framework allows KAM to be as entity-specific as possible, based on the facts and circumstances of the audit that was performed.
The debates also focused on the balance between relevance and consistency of KAM. The relationship between relevance and consistency is illustrated in diagram 1.
KAM should be entity – and audit – specific (relevant), and standardised or highly technical language should be avoided (not an over-emphasis on consistency only). As a risk-based audit approach is used, an audit may be conducted differently between entities that have similar facts and circumstances. Therefore, KAM may differ between similar entities.
DIAGRAM 1 RELEVANCE OF KAM COMMUNICATED VS CONSISTENCY OF KAM COMMUNICATED (Please click to enlarge)
What do ‘significant auditor attention’ and ‘matters of most significance’ mean?
Matters requiring significant auditor attention may be those where far more interaction with TCWG was required. Perhaps discussions were dynamic and frequent, the matters discussed were complex, and much time was spent in debates. The auditor asks the question: ‘What would help users understand what is “keeping the auditor up at night”?’ ISA 701 requires the auditor to specifically consider matters of higher assessed risk of material misstatement, or significant risks, significant auditor judgements relating to areas that required significant management judgement, and significant events or transactions that occurred during the year.
In order to determine matters of most significance, the auditor ranks the matters that required significant auditor attention (see above) in order of relative significance. Predictably and with some intuition, a few KAM should rise to the top of the list. Of interest is that, during the course of a round-table event held in South Africa, a ‘dry run’ on determining KAM was conducted by a listed entity. The accountants of the entity and the entity’s audit firm each compiled brief, separate lists of what they believed would be appropriate KAM, based on the previous year’s list of matters discussed with TCWG. The KAM identified were the same, indicating that the three-step judgement-based decision-making framework appears to work.
How many KAM should be communicated in the auditor’s report?
By definition KAM are the key audit issues. It therefore does not make sense and defeats the purpose of KAM to have a long list of matters to be communicated. Professional judgement is applied by the auditor to select those current period matters that were of most significance – that is, the most highly ranked matters from the ones that required significant auditor attention – and is affected by factors such as the nature of the business and its environment, the size and complexity of the entity, and the facts and circumstances of the audit.
Conversely, it is likely to be rare that the auditor of a listed entity would not determine at least one KAM to be communicated in the auditor’s report.
What should the auditor not communicate as a KAM or as part of a KAM?
The auditor notes the following as per ISA 701:
- KAM are not to include inappropriate disclosure by the auditor of original information about the entity, that is, information that is not otherwise publicly available.
- KAM are not a substitute for appropriate and relevant disclosures in the financial statements that are required to be made by management.
- KAM are not required to be communicated where law or regulation precludes public disclosure about the matter.
- In extremely rare circumstances where the auditor determines that the adverse consequences of the disclosure would reasonably be expected to outweigh the public interest benefit of the communication (‘sensitive matters’), the KAM is not required to be disclosed.
- Although matters giving rise to a modified opinion or a material uncertainty regarding going concern are KAM by their nature, they are not to be described as KAMs as these matters are included in their own sections in the auditor’s report.
Will KAM undermine the audit opinion and create piecemeal opinions?
Some auditors have expressed concern that there could be potential unintended consequences and misunderstandings resulting from the communication of KAM. This can be mitigated in several ways:
- There is a required standard introductory sentence to the KAM section in the audit report, stating that ‘These matters were addressed in the context of the audit of the financial statements as a whole, and in forming the auditor’s opinion thereon, and the auditor does not provide a separate opinion on these matters’.
- The auditor should carefully follow the requirements and related application material in ISA 701 in describing each KAM. The wording of the KAM is of utmost importance to ensure that the KAM does not imply that the matter has not been resolved and that it should have resulted in a modification to the auditor’s report.
- Where the auditor disclaims an opinion, no KAM is allowed to be communicated, since any discussion of KAM unrelated to the disclaimer of opinion may suggest the financial statements are more credible in relation to those matters than would be appropriate and would overshadow the disclaimer of opinion.
- The IAASB has issued a limited number of non-authoritative staff-prepared illustrative KAM examples and has indicated that it will provide listings and extracts of illustrative ISA auditor’s reports to further assist auditors.
What are the documentation requirements for KAM?
The auditor uses professional judgement to decide on the nature and extent of documentation. ISA 701 requires the documentation of the following:
- The matters that required significant auditor attention (note that the auditor is not required to document why other matters communicated with TCWG were not matters that required significant auditor attention)
- The rationale for the auditor’s determination as to whether or not each of these matters is a KAM
- Where applicable, the rationale for the auditor’s determination that there are no KAM to communicate in the auditor’s report or that the only KAM to communicate are those that are communicated in their own sections (for example a matter giving rise to a modified opinion)
- Where applicable, the rationale for the auditor’s determination not to communicate in the auditor’s report a matter determined to be a KAM
DIAGRAM 2 LINKS THE JUDGEMENT PROCESS FOR DETERMINING KAM WITH THE RELATED DOCUMENTATION REQUIREMENTS (Please click to enlarge)
KAM constitute a change in thinking for all stakeholders involved, and such change may be a long and intricate process. However, if both auditors and TCWG embrace the mind-set that KAM provide an extraordinary opportunity to vastly increase the informative value of auditor reports, then richer and more integrated relationships between auditors, TCWG, audit committees and investors will be built, enhancing the understanding of the audit.
IFAC, The new auditor’s report, https://www.ifac.org/auditing-assurance/new-auditors-report.
IAASB, International Standards on Auditing (ISAs), Reporting on Audited Financial Statements – New and Revised Auditor Reporting Standards and Related Conforming Amendments, and Staff of the IAASB, Basis for conclusions thereon, January 2015.
AUTHOR: Ciara Craul Reintjes CA(SA) and Registered Auditor is Senior Professional Manager: Standards at the Independent Regulatory Board for Auditors (IRBA)
Over the last years, business has become more complex and financial reporting has had to evolve. However, the auditor’s report has up until now provided no indication of the complexities relating to either the entity or the audit, says Natalie Klonaridis CA(SA)
With the release of its new and revised auditor reporting standards, the International Auditing and Assurance Standards Board (IAASB) indicated that one of the intended consequences of the enhanced auditor’s report is that it will provide a roadmap to help users better navigate complex financial reports and help them focus on matters likely to be important to their decision-making. As a result, the enhanced auditor’s report is likely to have a profound effect on management’s disclosures in the financial statements.
Management may experience pressure to improve the disclosures in the financial statements. This pressure will be influenced by various factors. If the auditor provides detailed information about a matter, and management fails to do the same, it could influence the users’ perception of management.
With the auditor under the spotlight, the auditor will more cautiously consider his/her response to key audit matters, improving audit quality through enhanced levels of professional scepticism about such matters. In turn, this will facilitate a more robust conversation between the auditor and management relating to the audit, in particular key audit matters and how the related items have been disclosed in the financial statements. Furthermore, the enhancements to ISA 570 relating to going concern, have a particular focus on the auditor’s challenge of management’s disclosures on going concern, including the disclosures in the financial statements in ‘close call’ situations. Such situations arise when there are events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern but management have mitigating plans in place and the conclusion is that no material uncertainty exists.
Some countries have experienced enhanced auditor reporting for several years. The United Kingdom is heading into its third year of more informative auditor’s reports. Although not exactly the same as the requirements under the new and revised auditor reporting standards of the IAASB, the experience in the UK has provided some valuable insights. The most important of these is that auditors who disclosed entity-specific information with detailed insights into the risks, including why the matter was a risk and specific descriptions of the auditor’s response to the risk, and who courageously divulged their observations and findings relating to the matter, were lauded by the investor community.
It is important to note that the enhancements to the UK auditor’s reports were effected in conjunction with additional reporting obligations on audit committees. These deal with significant issues it considered in relation to the financial statements and increased disclosures in the annual report relating to critical judgements and key estimates. Evidently the UK has understood the important link between an enhanced auditor’s report and enhanced disclosures by management. A recent survey released by the UK Financial Reporting Council1 of their enhanced auditor’s reports identified that the risks discussed by the auditor and the significant issues discussed by the audit committee complemented each other well. However, in general the audit committee’s descriptions were considered to be more concise while the auditor’s report was considered to be more informative. A Citi Research2 report released in March 2014 made the observation that the UK auditor’s reports contained helpful information that enabled a better understanding of the complexities relating to the matters discussed, which are not typically discussed in the financial statements. This research also cited evidence that the enhanced disclosure in the auditor’s report had driven improved disclosures in the financial statements.
Although it is encouraging that there is evidence that enhanced auditor reporting has been embraced by the investor community who find the auditor’s perspectives helpful and informative in understanding the financial statements, the responsibility for the disclosure of information which fairly presents the financial condition of the entity is that of management. The auditor should never be the original provider of information, and certainly this was a significant concern raised by commentators during the IAASB’s deliberations on this topic. The danger is that where the auditor’s report is perceived to be more informative than the financial statements, it may become the primary roadmap for users to understand the complexities relating to the entity. The risk is then that other important disclosures contained in the financial statements are overlooked. Research conducted by the International Association for Accounting Education and Research3 on behalf of the IAASB identified that users disproportionately focus on the key audit matters, with the consequence that valuable information contained in the financial statements may be overlooked. Furthermore, they observed that the higher the number of key audit matters disclosed, the more users are likely to rely on the key audit matters instead of reading the financial statements.
It is critical that users still perceive (and use) the financial statements as the primary source of information about the entity’s financial position, financial performance and cash flows. Accordingly management may need to improve the disclosures in the financial statements, or relook at how the complex matters and judgements are emphasised. Certainly the more detail the auditor chooses to disclose in the auditor’s report, the greater the need for correlating disclosures in the financial statements to substantiate the auditor’s views. Ultimately, it is management’s responsibility to ensure that the financial statements fairly present the state of affairs to facilitate the users’ understanding of the matters included in the financial statements.
Unfortunately, unlike in the UK, the IAASB does not have the ability to impose obligations on boards and audit committees to comment on the significant issues impacting the financial statements. The auditor will need to robustly challenge management on their disclosures in the financial statements to facilitate succinct communication of key audit matters in the auditor’s report that are understandable, transparent and relevant. This is an opportunity for management and the auditor to embrace a global initiative aimed at improving trust, transparency and quality, which can be demonstrated not only through high-quality auditor’s reports, but also through high-quality financial statement disclosures.
- Financial Reporting Council, Extended auditor’s reports: a review of experience in the first year, https://www.frc.org.uk/News-and-Events/FRC-Press/Press/2015/March/FRC-finds-good-take-up-of-new-auditor-reporting-re.aspx.
- Citi Research, New UK auditor’s reports: a review of the new information, http://icas.org.uk/Technical-Knowledge/Audit-and-Assurance/Research/Citigroup-on-UK-audit-reports/.
- Louis-Philippe Sirois, Jean Bédard and Palash Bera, The informational value of key audit matters in the auditor’s report: evidence from an eye-tracking study, 2015, https://www.ifac.org/sites/default/files/meetings/files/20150316-IAASB-March_2015_Meeting-Agenda_Item_10-A-final.pdf.
AUTHOR: Natalie Klonaridis CA(SA) is Senior Manager: Audit and Regulatory Technical at Deloitte
The new, expanded auditor reporting requirements will have a big impact on auditors, but why should audit committees care? What, if any, impact will these changes have on audit committees, on what they do and how they do it? By Tina Davidson CA(SA)
Much has been written about the new requirement in the International Standards on Auditing (ISAs) that auditors have to report Key Audit Matters (KAM) in their reports. Given that the KAM will be selected from matters that were discussed with ‘those charged with governance’, the starting point is to understand who those charged with governance are for a company.
In South Africa, the Companies Act 71 of 2008 states that neither the appointment nor the duties of an audit committee reduce the functions and duties of the board or the directors of the company, except with respect to the appointment, fees and terms of engagement of the auditor (section 94(10)). The overall responsibility for overseeing the strategic direction of the company and obligations related to accountability of the company thus rests with the directors, which means that the directors are defined as ‘those charged with governance’ for the purpose of the auditing standards.1
In addition, the audit committee plays a vital role in overseeing the financial reporting process – in reviewing and commenting on the financial statements included in the integrated report and recommending the approval of the integrated report to the board of directors in terms of King III. Through the audit committee’s interaction with the auditor, it will be aware of the areas that were of most significance to the audit and where the auditor focused his/her attention – the areas that will ultimately be reported as KAM. As the auditor’s KAM will highlight certain financial statement disclosures, the knowledge gained from interactions with the auditor will help the audit committee to evaluate whether those disclosures are relevant and sufficient, assisting them in discharging their duties.
While the Companies Act and King III have audit committee reporting requirements, audit committees will have to consider whether the current format of their report really enables users of the financial statements to understand the significant role that they play. In other words, if the auditor’s report is going to be expanded to discuss KAM and their impact on the audit, will users understand or misunderstand the role that the audit committee plays in considering these matters? While King IV may expand audit committee reporting requirements in the future, the new and revised auditor reporting requirements may come into effect before King IV has been finalised.
In the United Kingdom expanded auditor reporting has been effective since 2013, requiring listed company auditors to describe (among other matters) the assessed risks of material misstatement that had the greatest effect on the overall audit strategy, allocation of resources, and efforts of the engagement team during the audit.2 At the same time, the UK Corporate Governance Code was updated, requiring audit committees to report on the significant issues that it considered in relation to the financial statements, as well as how it addressed such issues.3
Owing to the slightly different reporting requirements for auditors and audit committees, the matters discussed are similar but not identical. For example, an area such as information technology governance may be a burning issue for the audit committee but may not give rise to a risk that had the greatest impact on the audit. Nevertheless, in the first year of expanded reporting in the UK, there was an overlap of about 74% in the matters discussed by the audit committee and the auditor.4 In those areas of overlap, users of the financial statements were offered three perspectives on the financial statements: the perspective of the directors in preparing the financial statements, particularly the significant assumptions that the directors had made; the perspective of the auditor on why certain areas were significant to the audit and how they affected the audit; and the perspective of the audit committees and how they discharged their responsibilities in relation to those areas of the financial statements.
The UK approach to audit committee reporting could be considered for best practice in South Africa, too. It allows the audit committee to give its perspective on significant financial statement matters and issues and focus on how the audit committee discharged its duties, in order to avoid misunderstandings about its role. A concern has been voiced that this may increase the risk to audit committee members, particularly if they describe, for example, what they consider to be the committee’s five top significant issues and the business subsequently fails because of the sixth item on that list, which was not reported. If audit committees expand their reporting, it will be very important that they minute their deliberations about what to include in the report and why they considered these matters to be the most significant issues to be dealt with.
Audit committees will face the same challenges as auditors in deciding how many issues they consider to be the most significant in discharging their duties, while making it clear that these were not the only issues that the committee dealt with. The audit committees will also need to carefully consider what they say about the issues, and to describe them in such a way that it does not give the impression that the financial statements are misstated. There is always a chance that users will read something into the description of the matter that the audit committee did not intend; therefore it will be important for the audit committee to receive guidance on the wording it intends to use, possibly from the board of directors and the auditors, and maybe even legal counsel in certain circumstances.
Enhanced auditor reporting under the new and revised requirements of the ISAs also highlights the need for expanded audit committee reporting. Ultimately, any expanded reporting should be driven by a desire to provide more transparency about the audit committee’s role to the users of the financial statements. Audit committees should engage with stakeholders to understand if the latter have specific information needs, because audit committees will only be able to meet those needs successfully if they are understood.
Including the audit committee’s perspective on the significant issues that they dealt with will be a significant contribution to the users’ understanding of the audit committee’s role. The provision of relevant disclosures in the financial statements, the discussion of significant issues by the audit committee and the reporting of KAM by the auditor, will hopefully help the users of the financial statements to gain a better understanding of not only the financial statements, but also the company’s governance processes.
- 1 ISA 260, Communication with Those Charged with Governance, defines ‘those charged with governance’ as ‘the person(s) or organization(s) … with responsibility for overseeing the strategic direction of the entity and obligations related to the accountability of the entity. This includes overseeing the financial reporting process’ (paragraph 10(a)).
- 2 International Standard on Auditing (UK and Ireland) 700, The independent auditor’s report on financial statements (Revised June 2013), paragraph 19A(a), effective for periods beginning on or after 1 October 2012.
- 3 The UK Corporate Governance Code, September 2012, section C.3.8.
- 4 Financial Reporting Council, Extended auditor’s reports: a review of experience in the first year, March 2015, https://www.google.com/search?q=UK+Financial+Reporting+Council%2C+Extended+auditor%E2%80%99s+reports%3A+A+review+of+experience+in+the+first+year%2C+&ie=utf-8&oe=utf-8.
AUTHOR | Tina Davidson, CA(SA), Senior Manager at KPMG
Going concern has increasingly been a key focus of audit regulators and stock exchanges around the world in light of the global financial crisis. Amongst the changes introduced have also been changes to enhance reporting about going concern. By Edwin Selbst CA(SA)
International Standard on Auditing 570 (Revised), Going Concern, is applicable to audits of financial statements of all entities, not only listed entities, and is effective for financial periods ending on or after 15 December 2016.
The necessity of the changes to the standard may be questioned given the fact that the existing ISA 570 has only been around for five years. In an interview with Linda de Beer, immediate past chairman of the Consultative Advisory Group of the International Auditing and Assurance Standards Board (IAASB), she pointed out that: ‘Since the most recent financial crisis, auditors had commented that they had emerged relatively unscathed. This raised the question why were there not early warning flags in the audit report, to assist investors to identify problems being faced by entities? One would have expected audit reports to have raised a yellow flag alerting users of potential going concern risks.’
The initial proposal of the auditor reporting project was to include a going concern section in every audit report. This would have provided a conclusion about the appropriateness of the use of the going concern basis of accounting and a positive statement by the auditor as to whether a material uncertainty was identified. One of the primary reasons why the changes in the auditor’s report did not go this far is because of shortcomings in financial reporting frameworks with respect to certain concepts around going concern and related disclosure requirements. Therefore the alternative approach adopted by the IAASB in the final version of ISA 570 (Revised) was to draw attention to going concern in the public interest through the following changes: enhancement of the auditor’s responsibilities with respect to going concern disclosures in the financial statements; a requirement that the auditor’s report must describe management’s and the auditor’s responsibilities for going concern; and inclusion of a new section in the auditors’ report when a material uncertainty relating to going concern exists.
All audit reports will be required to include a description of management’s responsibility for assessing the entity’s ability to continue as a going concern, the appropriateness of the use of the going concern basis of accounting in terms of the applicable reporting framework, and where necessary, disclosure of any going concern matters. Included in the description of the auditor’s responsibilities is a statement that the auditor concludes on the appropriateness of management’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern.
In cases where based on the audit evidence obtained, the auditor reaches a conclusion that no material uncertainty exists, after having identified events or conditions that may cast significant doubt on the entity’s going concern ability (often referred to as a ‘close call’ situation), the auditor is required to ensure adequate disclosures in the financial statements about such events or conditions. Depending on the facts and circumstances, the auditor needs to consider whether additional disclosures are required to achieve fair presentation.
However, in cases where the auditor concludes that a material uncertainty does exist, a new section under the heading ‘Material Uncertainty Related to going Concern’ must be included in the auditor’s report in addition to an evaluation of the disclosures in the financial statements. This new section must include reference to the note in the financial statements which adequately discusses the events or conditions that give rise to the material uncertainty, including management’s plans to deal with these events or conditions, and which clearly disclose that there is a material uncertainty that may cast significant doubt on the entity’s ability to continue as a going concern.
Where disclosure in the financial statements about the going concern basis of accounting is inadequate, in either a ‘close call’ situation or where a material uncertainty exists, a qualified or adverse opinion will need to be issued, as appropriate, in accordance with ISA 705 (Revised), Modifications to the Opinion in the Independent Auditor’s Report.
Note that a material uncertainty about the ability of an entity to continue as a going concern would by its nature meet the requirement that it be disclosed as a Key Audit Matter (KAM). However, owing to the importance of going concern, separate disclosure in the going concern section of the auditor’s report will still be required in cases where a material uncertainty does exist, with the KAM section of the auditor’s report referring to the ‘Material Uncertainty Related to Going Concern’ section.
These changes highlighting going concern in the auditor’s report are intended to provide a level of early warning and to satisfy some of the needs of investors and other users about the going concern of an entity. Audit standard setters have acknowledged that further reforms around going concern are required, which are dependent on and will be coordinated with corresponding going concern developments in financial reporting frameworks.
AUTHOR: Edwin Selbst CA(SA) RA is Head of Audit Risk Consulting at W. Technical Consulting South Africa and chairman of SAICA’s Assurance Guidance Committee
The new auditor reporting requirements are not just going to affect the audits of listed entities, Henk Heymans CA(SA) and Dexter Moyo CA(SA) highlight some of the considerations for smaller entities in terms of the requirements applicable to all entities, and those that may be applied on a voluntary basis
The new auditor reporting standards will come into effect as from 15 December 2016. The requirements to communicate KAM and to disclose the name of the engagement partner have been well communicated already and are compulsory for listed entities only. But there are other changes that impact all audits:
- The ‘Opinion’ section must now be presented first, followed by the ‘Basis for Opinion’ section.
- There is a requirement that a positive statement must be made about independence and ethical responsibilities.
- There are additional requirements to report on going concern.
- More details regarding the auditor’s responsibilities and the key features of an audit.
It should be noted, however, that the application of the specific requirements applicable to listed companies regarding the communication of KAM may also be applied in other audits (that is, voluntary application). This leads to the question: Will the disclosure of KAM be beneficial for non-listed entities, particularly for smaller and owner-managed companies?
VOLUNTARY DISCLOSURE OF KEY AUDIT MATTERS
KAM are defined 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. Although this is a matter of professional judgement, some guidance is given and the focus should be on areas of significant auditor attention in the context that an audit is risk based. Examples include areas identified as significant risks or involving significant auditor judgement; areas in which the auditor encountered significant difficulty during the audit, including with respect to obtaining sufficient appropriate audit evidence; and circumstances that required significant modification of the auditor’s planned approach to the audit, including as a result of the identification of significant deficiencies in internal control.
The partner and firm who audit smaller entities (small and medium-sized enterprises, SMEs) may often have more opportunities to communicate their audit approach and provide comments in relation to identified significant matters than the auditor of a listed company, particularly if it is a large corporation, for whom it may be impractical to communicate with all levels of management. However, the auditor’s report is still the key deliverable that addresses the output of the audit process for users of the audited financial statements, whether they are listed, non-listed companies or SMEs.
There are a number of factors that have to be considered in deciding on the voluntary disclosure of KAM. These include costs associated with disclosure and, most importantly, whether such disclosure will add value to the entity.
The purpose of communicating KAM is to enhance the communication value of the auditor’s report by providing greater transparency about the audit that has been performed. By supplementing the existing avenues of communication, such as the management report, and formalising informal communications, disclosure of KAM will provide additional information to owner-managers of SMEs, as well as to other intended users of the financial statements. This will assist them in understanding those matters that, in the auditor’s professional judgement, were of most significance in the audit and understand the entity and areas of significant management judgement in the audited financial statements. This is expected to have a positive effect on users’ perceptions of the audit and of the financial statements, even in the case of SMEs.
Voluntary disclosure of KAM may just be the opportunity for auditors to distinguish their product. By their nature SMEs have different challenges and issues that affect their financial and operational functioning. The shift from boilerplate templates for auditor’s reports to providing more entity-specific and audit-specific information, can serve to emphasise the unique challenges that affect an entity and one of its most important governance elements, the independent audit.
In addition to the cost-benefit considerations mentioned above, auditors may also be concerned about increased liability risk, costs that cannot be recovered, and delays to the completion of the audit. There is no evidence yet that this additional information will significantly affect any of these concerns or if it will indeed enhance communication in the case of smaller entities.
In summary, should auditors of smaller entities add KAM to their reports? Disclosure of KAM will uniquely identify entity-specific issues and challenges, and provide more relevant information about the audit that has been performed, using the requirements and application material and guidance provided in the new ISA 701, Communicating Key Audit Matters in the Independent Auditor’s Report. SMEs may get more from the audit services when KAMs are disclosed, further drawing the attention of those charged with governance (in the case of SMEs primarily the directors and owner-managers) to the value added by an audit of financial statements.
On the negative side, the informative value of such disclosures for smaller entities is still uncertain, in particular in those instances where the owner-managers of the entity are the primary users of the audited financial statements. Furthermore, it may cause delays and may add costs to audits that are already under time and cost pressure (for example owing to more interaction between the auditor and the audit client, and involvement of more senior audit personnel, including more audit partner time). There could also be a perception that it adds even more to the audited financial statements, which are already perceived to be suffering from ‘information overload’.
We would recommend that auditors evaluate each of their clients individually in terms of the above considerations, discuss the matter with that client and then make an informed decision on an engagement level. It could be worthwhile to try a once-off ‘dry-run’ to see if it adds value to SMEs.
GOING CONCERN REPORTING
Going concern is a key issue that affects most SMEs at some stage, but especially at the initial stages of the business as a result of lack of funding and other operational issues. Matters relating to going concern may be determined to be KAM and hence communicated in the auditor’s report in accordance with the new ISA 701, unless the auditor does conclude that a material uncertainty exists regarding going concern.
Where a material uncertainty exists regarding going concern, there are now more specific reporting requirements, even if such an uncertainty is adequately disclosed in the financial statements. This includes specific reference to such disclosure, as well as the inclusion of a new paragraph headed ‘Material Uncertainty Related to Going Concern’. The new requirements are expected to affect the audits of many smaller entities.
While this is a significant strengthening of the current requirement in extant ISA 570, which requires the matter to be highlighted in an ‘Emphasis of Matter’ paragraph, it is in fact a relatively small change. But it signals the beginning of a project that will include the reporting frameworks and that will revisit the entire going concern reporting regime. The standards do not yet require an explicit statement about the applicability of the going concern concept, but that is not ruled out for future developments.
These changes may have positive benefits for audit quality and users’ perceptions of it – also in relation to the audits of smaller entities. A renewed focus on matters to be reported could indirectly result in an increase in the auditor’s professional scepticism, and in a more robust dialogue with those charged with governance. Both of these may contribute to increased audit quality.
AUTHORS: Henk Heymans CA(SA) RA is Head of Audit and Dexter Moyo CA(SA) is a technical manager, both at RSM Betty & Dickson (Johannesburg)