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About OverviewWelcome to EY’s Overview series. These documents provide a concise overview of relevant topical or fast-moving global public policy and regulatory issues and are designed to give you current information on emerging developments.
October 2014
OverviewOur overview of topical issues
Enhancing the auditor’s reportOver the course of many years, auditors have provided a binary “pass/fail” opinion on a company’s financial statements. Either the financial statements fairly present the company’s financial position and operations in accordance with applicable accounting standards, or they do not. While the traditional approach remains valuable, many believe it is no longer enough. Auditors have more insights to share, and investors are eager to hear them. And several regulators and standard setters have responded with measures that would require auditors to say more.
• The United Kingdom adopted a new, principles-based standard in 2013, and UK auditors issued their first reports under the new standard earlier this year. Investors and other stakeholders have been generally positive about the new reports, which have varied in length and detail.1
• The International Auditing and Assurance Standards Board (IAASB) approved final standards to enhance the auditor’s report in September (subject to review and approval of due process by the Public Interest Oversight Board) with issuance expected in early 2015. The standards will be effective for 2016 calendar year-end audits. The aspect of the IAASB’s proposal that has attracted the most attention is its requirement for the auditor to communicate “key audit matters” in all auditors’ reports for listed entities. This would require auditors to report on those areas of the audit that demanded the most significant auditor attention.
• The European Union adopted its new auditor reporting requirements as part of the recent audit reform legislation. The legislation will be effective for 30 June 2017 fiscal year-end audits. The EU approach is similar in some respects to both the UK’s and the IAASB’s. One difference, though, is its requirement that the auditor’s report include a statement that no prohibited non-audit services were provided.2
• The US Public Company Accounting Oversight Board (PCAOB) issued an initial proposal to enhance auditor reporting in 2013 and has indicated it intends to issue a re-proposal by March 2015. The PCAOB had proposed that the auditor be required to report on “critical audit matters,” which are similar but not identical to the IAASB’s “key audit matters.” “Critical audit matters,” according to the PCAOB’s definition, would represent the areas in the audit of the financial statements of most significant auditor difficulty.
1 See New UK Auditor’s Report Update: Findings from the FTSE 100 New Auditor’s Reports, Citi Research, Western Europe, 3 September 2014, and New UK Auditor’s Reports: A Review of the New Information, Citi Research, Western Europe, 27 March 2014.
2 See Article 10(2)(f) of Regulation (EU) No. 537/2014 of the European Parliament and of the Council of 16 April 2014 on specific requirements regarding statutory audit of public interest entities and repealing Commission Decision 2005/909/EC.
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Enhancing the auditor’s report: October 2014
In all likelihood, of course, those areas that require the most significant auditor attention will be matters that are also the most difficult, subjective or complex. However, investors have said repeatedly — and we agree — that it would be much better if the IAASB, the EU and the PCAOB were more closely aligned. While we recognize that legal, regulatory and reporting frameworks vary, comparability is important for global investors and global markets, and the auditor’s report should be as consistent as possible across jurisdictions. Key provisions of the UK, IAASB, EU and PCAOB approaches are compared in Table 1.3
Proponents of enhanced auditor reporting argue that it contributes to increased public confidence in financial reporting, the role of the audit committee and the audit itself by opening up what some have seen as a “black box.” They believe enhancements would lead
to a greater understanding of what auditors do and don’t do and increase the relevance of the audit report. Some proponents also believe that any changes to the auditor’s report should complement the audit committee’s disclosures.
Even supporters caution, however, that the auditor’s report should not become a source of original information about a company and that financial statement disclosure needs to remain management’s responsibility. Some commenters have raised concerns about the potential liability risks associated with an enhanced auditor’s report. There also is a risk of the report devolving into more boilerplate language simply because, in most cases, the important matters on which the auditor is reporting are likely to be fairly consistent year to year. And some commenters, especially in the US, have highlighted that an enhanced auditor’s report can never replicate the
in-depth interactions that take place between an external auditor and the audit committee. The challenge is how to craft an auditor’s report that provides relevant and meaningful information that can be helpful to users of the financial statements, without resulting in these or other unintended consequences.
Our viewEY supports initiatives to enhance the auditor’s report. We believe expanded auditor reporting will not only help respond to investor demands, but will also help increase public confidence in financial reporting and governance. Despite the practical challenges, we believe that auditors should be more transparent with the public about the audit. This will contribute to the ongoing relevance of the financial statement audit and help serve the public interest.4
3 The Netherlands is considering proposals to expand the auditor’s report as part of a broader focus on audit quality and independence. The new Dutch auditor’s report is expected to reflect the IAASB’s standards on key audit matters as well as the new EU requirements on independence. In addition, the Dutch proposals would require expanded reporting on going concern, materiality and scope. Recommendations are currently under review in Parliament. The profession is aiming to provide expanded auditor reporting for all 2014 opinions issued to public interest entities.
4 Point of view: Auditor reporting, EY, February 2014.
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Enhancing the auditor’s report: October 2014
Table 1: Comparing approaches to enhancing the auditor’s report
US PCAOB IAASB UK EUStatus Proposed rule issued
August 2013.
Comment period closed December 2013 (248 comment letters filed).
Public hearing held April 2014.
Re-proposal expected before March 2015.
Exposure draft issued July 2013.
Comment period closed November 2013. (139 comment letters filed.)
Revised standards approved in September 2014 with issuance planned for January 2015.
Adopted June 2013, effective for audits for periods commencing on or after 1 October 2012.
Adopted April 2014, as part of broad audit reform legislation.
Effective date Not certain, but likely to align with IAASB
Effective for 2016 calendar year-end audits
Already in effect Member State implementation beginning in fiscal years ending 30 June 2017
What entities are covered
Public companies (SEC registrants)
Required for all entities, except for KAM and naming of the engagement partner, which are required only for listed entities. KAM and EP name are voluntary for audits of other entities unless required by law or regulation.
UK listed companies Public interest entities (PIE), which are companies with securities admitted to trading on a regulated market in the EU/EEA, private credit institutions and insurance undertakings. Possibility of even wider application.
What the auditor’s report should describe
“Critical audit matters.”
“Critical audit matters” represent the areas in the audit of the financial statements of most significant auditor difficulty (including those matters that involve the most difficult, subjective or complex auditor judgments).
“Key audit matters.”
“Key audit matters” represent those areas of most significance in the audit, determined from matters discussed with those charged with governance and that required significant auditor attention.
Materiality, the scope of the audit, the most significant risks of material misstatement, and how these were addressed
A description of the most significant assessed risks of material misstatement (including those relating to fraud); a summary of the auditor’s response to those risks; and key observations arising with respect to those risks, where relevant
Auditor tenure Would be included Not addressed Not addressed Date auditor was appointed and period of tenure
Going concern Will be considered by PCAOB as part of separate initiative
Required statement when a material uncertainty exists relating to the entity’s ability to continue as a going concern. For all auditors’ reports, an enhanced description of the respective responsibilities of management and the auditor for evaluating going concern.
Considered as part of separate initiative
Similar to IAASB, except there is no requirement for an enhanced description of responsibilities for going concern
Auditor’s responsibility for “other information” (e.g., MD&A)
Would require the auditor to “read and evaluate” other information and disclose the results of the evaluation in the report
Considered by IAASB as part of a separate proposal (but when reporting is required, it will be in a separate section of the auditor’s report with the same effective date as the other auditor reporting enhancements)
Not addressed but should be seen in context of changes made to UK Corporate Governance Code and ISAs (UK and Ireland) in 2012
Requires auditor to confirm that the management report is consistent with the financial statements
Naming engagement partner
Being considered by PCAOB as part of separate initiative
Required for listed entities Already required Already required
Format Not addressed Requires placement of the auditor’s opinion first within the report.
Allows for auditor to place identification of certain auditor’s responsibilities in an appendix to the auditor’s report, or, when permitted by an appropriate authority, to use a reference to a website that describes such responsibilities
Not addressed Not addressed
Other statements to be included
Not addressed Includes affirmative statement in auditor’s report about the auditor’s independence and other relevant ethical requirements
Auditor required to report if the board’s disclosures do not address the matters it communicated to the audit committee
Requires a certification that no prohibited non-audit services have been provided
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Enhancing the auditor’s report: October 2014
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