An overview of the proposed new and revised International Standards on Auditing.
The International Auditing and Assurance Standards Board (IAASB) has recently issued an exposure draft (ED) Reporting on Audited Financial Statements containing proposed new and revised International Standards on Auditing (ISAs).
This follows on from the invitation to comment (ITC) Improving the Auditor’s Report released last June.
This article provides a brief overview of the proposals, with a comparison to the initial suggestions for improvements that were outlined in the October 2012 Journal article “Enhanced Auditor Reporting”.
The auditor’s report is the key deliverable that addresses the output of the audit process for users of the audited financial statements. The IAASB is of the view that changes in auditor reporting may have positive benefits on audit quality, or users’ perceptions of it. It is thought that a renewed focus on matters to be reported could indirectly result in an increase in the auditor’s professional scepticism, and result in a more robust dialogue with those charged with governance, both of which may contribute to increased audit quality.
Enhanced auditor reporting is viewed as critical to the perceived value of the financial statement audit and thus to the continued relevance of the auditing profession.
Key audit matters
An auditor reporting on “key audit matters” for listed entities replaces the concept in the ITC of “auditor commentary” which was suggested for public interest entities. For this, a new auditing standard is proposed: ISA 701 Communicating Key Audit Matters in the Independent Auditor’s Report to establish requirements and guidance for the auditor’s determination and communication of key audit matters.
Key audit matters are defined as those matters that, in the auditor’s professional judgement, are of most significance in the audit of the financial statements of the current period. Although this is a matter of professional judgement, the focus should be on areas of significant auditor attention, including:
a) areas identified as significant risks or involving significant auditor judgement
b) areas in which the auditor encountered significant difficulty during the audit, including with respect to obtaining sufficient appropriate audit evidence
c) circumstances that required significant modification of the auditor’s planned approach to the audit, including as a result of the identification of a significant deficiency in internal control.
Matters giving rise to a modification of the auditor’s opinion are, by their nature, key audit matters, but are to be reported separately in the Basis for Qualified (or Adverse) Opinion section of the auditor’s report. When the auditor disclaims an opinion, proposed ISA 705 (Revised) Modifications to the Opinion in the Independent Auditor’s Report prohibits the auditor from including additional information on key audit matters, going concern or other information.
The IAASB is of the view that changes in auditor reporting may have positive benefits on audit quality, or users’ perceptions of it
The concept of key audit matters is relative, so it is likely there will always be one or more matters of “most significance” in an audit. However, the IAASB accepts it is conceivable that there may be certain limited circumstances in which there are no key audit matters. In this case proposed ISA 701 requires a statement in the auditor’s report that there are no key audit matters, to signal that the auditor has still made this determination.
The communication of key audit matters in accordance with proposed ISA 701 represents a particularly significant change in practice.
Despite the emphasis on the Key Audit Matters section needing to be entity-specific, there is still a risk that such information would likely become boilerplate over time. Auditors would need to make a conscious effort for this not to be the case. Also, the description of key audit matters cannot merely reiterate what is disclosed in the financial statements or simply point to those disclosures without providing additional context.
It is acknowledged that auditors of financial statements of entities other than listed entities may wish to use the new mechanism of key audit matters on a voluntary basis. A post-implementation review of the standard would inform the IAASB whether broader applicability of proposed
ISA 701 to entities other than listed entities might be appropriate in the future.
Key audit matters are selected from matters communicated with those charged with governance. Accordingly, the IAASB determined that limited amendments to ISA 260 Communication with Those Charged with Governance were necessary in light of proposed ISA 701.
The IAASB is proposing to require that auditors communicate with those charged with governance about the significant risks the auditor has identified. In addition to this, when communicating the significant findings from the audit, to also communicate any circumstances that required significant modification of the auditor’s planned approach to the audit.
The IAASB believes it is in the public interest to establish this requirement for all entities, not only for listed entities.
Emphasis of Matter and Other Matter paragraphs
The mechanism of Emphasis of Matter paragraphs and Other Matter paragraphs has been retained, and the IAASB is not proposing any change to the underlying concepts. This is because key audit matters are not required to be reported for audits of non-listed entities.
Use of Emphasis of Matter paragraphs is infrequent. Therefore when a Key Audit Matters section is included in the auditor’s report, the IAASB believes Emphasis of Matter paragraphs will be rare.
Auditors should not use Emphasis of Matter paragraphs or Other Matter paragraphs for matters determined to be key audit matters. Proposed ISA 706 (Revised) Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report clarifies the relationship between Emphasis of Matter paragraphs, Other Matter paragraphs and the Key Audit Matters section of the auditor’s report.
The most common use of Emphasis of Matter paragraphs currently is to highlight material uncertainties relating to going concern, which will now be replaced by a similar paragraph as part of a separate Going Concern section.
The proposed changes to ISA 570 Going Concern are broadly consistent with the suggested improvements in the ITC, although the IAASB has decided to replace the term “going concern assumption” with the concept of “going concern basis of accounting”. It is proposed to include a conclusion on the appropriateness of management’s use of the going concern basis of accounting in preparing the financial statements, and a statement as to whether a material uncertainty that may cast significant doubt on the entity’s ability to continue as a going concern has been identified.
A material uncertainty relating to going concern would, by its nature, be a key audit matter. Accordingly, a material uncertainty relating to going concern will no longer be a required Emphasis of Matter paragraph.
The ITC suggested a statement of auditor compliance with relevant ethical requirements, including those relating to independence. This has been changed to require an explicit statement that the auditor is independent of the entity and has fulfilled the auditor’s other relevant ethical responsibilities, with disclosure of the source(s) of those requirements. This is similar to disclosing that the audit was conducted in accordance with ISAs or that the financial statements were prepared in accordance with IFRSs. The statement relating to independence is required to be placed in the Auditor’s Responsibilities for the Audit of the Financial Statements section rather than the Basis for Disclaimer of Opinion section as originally proposed.
In the New Zealand environment, “relevant ethical requirements” comprise NZICA’s Code of Ethics, and the New Zealand Auditing and Assurance Standards Board (NZAuASB) PES 1 Code of Ethics for Assurance Practitioners. However, there may be challenges around what such a disclosure would comprise in the context of complex group audit situations.
In the absence of established thresholds for what may constitute either a minor or a significant breach of independence, the IAASB decided against requiring public disclosure of breaches of independence requirements by the auditor.
Rather than require disclosure of the name of the engagement partner for all entities as suggested in the ITC, the IAASB has concluded it would be appropriate to limit the requirement in proposed ISA 700 (Revised) Forming an Opinion and Reporting on Financial Statements to audits of financial statements of listed entities, along with the inclusion of a “harm’s way” exemption. It is believed this would provide the engagement partner with a greater sense of personal responsibility and accountability, which would translate to improved audit quality.
Form of report
It was suggested in the ITC that the IAASB would mandate the ordering and placement of the required elements in the auditor’s report. As a result of feedback from respondents to the ITC, the IAASB reconsidered its position (with the exception of the introductory paragraph). However, specific headings are still required in the auditor’s report to ensure the required reporting elements can be recognised.
The IAASB’s preferred ordering and placement of the required auditor reporting elements is highlighted through the illustrative auditor’s reports in the appendix of ISA 700 (Revised) to encourage consistency in presentation.
The IAASB continues to pursue auditor reporting on other information, and is currently in process of considering comments on the exposure draft of proposed ISA 720 (Revised) The Auditor’s Responsibilities Relating to Other Information in Documents Containing or Accompanying Audited Financial Statements and the Auditor’s Report Thereon. These elements of proposed ISA 700 (Revised) will be finalised when the revision of ISA 720 is completed, so that reporting on other information will come into effect at the same time as the other enhancements addressed by the proposed ISAs.
What does this mean for us?
Ultimately it will be up to the NZAuASB to decide which entities any changes made to the auditor reporting model will apply to. The NZAuASB is proposing that a New Zealand ED run separately but in parallel with the IAASB ED to expose the changes required to the IAASB proposals as a result of legislative requirements and the new accounting standard frameworks in New Zealand. However, the international proposed amendments to auditor reporting will be adopted in New Zealand should the IAASB finalise the standards on auditor reporting as proposed in the ED and there are no compelling reasons for further amendments to the proposals identified during the consultation process in New Zealand.