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Does more auditor reporting mean better reporting?

Author: ICAEW Insights

Published: 20 Aug 2021

The extended audit report was put under the spotlight at a panel discussion at the American Accounting Association’s (AAA’s) annual meeting – which took place in August 2021.

“The extended audit report is all about improving auditor communication,” said Robert Hodgkinson, ICAEW Senior Strategic Adviser. “That is why we have called this session ‘The art of conversation.’”

However, Miguel Minutti-Meza, Associate Professor of Accounting at the University of Miami, has been vocal in his concerns about the effectiveness of the extended audit report. His PD Leake lecture in 2020 was emphatic about the expectations gap he sees.

Specifically, this AAA session endeavoured to identify the differences between the approaches taken in the UK – which pioneered this approach, pointed out Hodgkinson – and internationally, compared with the US, in producing more extensive information in the auditor’s report.

To recap, in the US, the Public Company Accounting Oversight Board (PCAOB) has adopted a standard entitled ‘The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion’ which requires the auditor’s report to include a description of “critical audit matters” (CAM). CAMs are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee.

Meanwhile, the International Auditing and Assurance Standards Board (IAASB) has adopted International Standard on Auditing (ISA) 701, ‘Communicating Key Audit Matters (KAM) in the Independent Auditor’s Report’. KAMs are those matters that, in the auditor’s professional judgement, were of most significance in the audit of the financial statements of the current period.

In the UK, the Financial Reporting Council (FRC) has pioneered both the EU’s extended audit report requirements and the IAASB’s requirements as part of an ongoing response to the trust in company information issues that have followed high-profile company collapse. Importantly, the FRC has adopted the IAASB’s definition of KAMs.

Minutti-Meza pointed out that it is through this CAMs/KAMs mechanism that high-risk issues are intended to be surfaced. He said that whatever the jurisdiction, the regulators’ objectives are to increase information, increase external monitoring and open lines of conversation between auditors and users of financial statements, especially investors.

He is sceptical as to whether standards enable auditors to meet these objectives and questioned whether auditors should be encouraged by regulators to say the thing management is unwilling to say. Minutti-Meza pointed out that much of the information in question can be collected by the users of financial information themselves, saying the standards set a low bar and can easily be achieved without the auditor saying anything new.

ICAEW agrees with the need for more informative auditor reporting, and in its 2017 publication ‘The start of a conversation’, welcomed how far the UK has come: from the short, boilerplate, uninformative report to the extended report covering KAM over a number of pages.

Dennis McGowan, Senior Director, Professional Practice at the Center for Audit Quality, said that there are fewer US CAMs than KAMs because the standards that govern them are different, and so too is the legal environment in which they operate. He said that many audit firms took a dry run at introducing this process which helped audit teams focus on those elements that were of most significance to the users.

Is there a right number of CAMs to report to an audit committee, he asked? No, said McGowan. There is no right number but, evidence to date suggests that, in practice around two CAMs are being produced for each S&P100 company.

Anne Thompson, Associate Professor of Accountancy and Arthur Andersen Faculty Fellow at Gies College of Business in Illinois, spoke of the impact on research of the new KAMs/CAMs environment. She said she is seeing an increasing number of papers on text analysis and concurred that CAMs in the US are failing to inform investors better because much of this information is already in the public domain.

Watching the situation evolve in both the UK and the US is Allister Wilson, recently retired from EY. He pointed out that the extended audit report is about more than KAMs and CAMs. In the UK, the extended audit report provides a lens on company information from cradle to grave and provides much more detail about the entire audit process.

Wilson spoke of the UK requirement to reveal how the auditors communicated the KAM in the audit report and how the auditors concluded on it – and then communicated this conclusion to the audit committee. This is a very different situation to that in the US. Wilson reminded us that the KAMs in the UK are seeking to address the trust deficit between UK company auditors and society and that, in the UK, the audit partner signs the audit report in their own name, an important differentiator when it comes to tendering. Firms now compete on quality, he said.

In the final analysis, what matters is what information is useful to investors and stakeholders at large. Much more work needs to be done to understand what is being reported, whether it is of value (especially in years to come) and, if it is not, what would be.

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