At a glance
It’s the biggest revolution in auditing for decades. Around the world, 111 countries have committed to adopting new standards from the International Auditing and Assurance Standards Board (IAASB), designed to make auditors’ reports more informative, transparent and revealing.
Enhanced reporting has been in place in the UK since 2013 and in the Netherlands since 2014. Now countries across Asia-Pacific, including Australia, China, Hong Kong, Japan, Malaysia, New Zealand, South Korea, Sri Lanka, Thailand and Vietnam, are set to follow suit by 15 December this year.
Former CPA Australia chief executive Alex Malley says the momentum for change began when the IAASB called for feedback from a range of investors and other audit report users. Most of them wanted the same thing: more transparency and openness in the audit process.
The result has been a series of revisions that Malley says are “the biggest shake-up in auditor reporting in decades”. The most significant is the introduction of a new standard (ISA 701) that requires auditors of listed companies to list key audit matters (KAMs).
“Key audit matters are issues that should have been communicated to the board or the audit committee,” says Malley.
It’s the biggest revolution in auditing for decades.
“They could include high-risk matters that involved significant judgement by management or significant events or transactions. The auditor must explain why they focused on these areas and how they addressed them in the audit.”
That means audit reports will become much more individualised, rather than blandly repeating boilerplate text that communicates the audit outcome but not the thinking behind it.
“KAMs will naturally vary from entity to entity, because they’ll deal with areas most critical for each company,” says Malley.
Making audits more valuable
Claire Grayston is CPA Australia’s policy adviser for audit & assurance. She says the changes have obvious benefits for investors and will also benefit the auditing community.
“It does present a very significant opportunity for auditors to demonstrate their value, to demonstrate the significance of the judgement and the complexity of the issues that they grapple with,” says Grayston.
“Hopefully it will also give investors and other stakeholders greater faith in the value of the auditor’s report and the function they serve.”
Choosing words carefully
A higher level of transparency also means that auditors will be more open to scrutiny. Grayston points out that they will need to choose their words very carefully to avoid legal risks or unnecessary conflict with the board.
“Through the key audit matters, auditors are putting their own perspective on issues and also drawing attention to matters that are disclosed in the financial report,” she says.
“They cannot disclose new information not provided by the entity – there should be no surprises, just better insights.”
Malley says the new rules will “give investors a window into the issues that keep auditors awake at night”.
“It’s about addressing the crisis of relevance auditors are facing in 21st century capital markets and providing audit professionals with an opportunity to display their professional judgement and expertise – and even innovation,” he says.
Preparing for change
Carolyn Ralph is a partner at KPMG, one of the few Australian firms to have put the standards into action. She says it’s time for auditors and companies to start getting ready for the new rules, even if they don’t plan to adopt them until after December.
“There’s no reason why audit committees and management can’t start preparing now for the new-style reports,” she says.
“As well as understanding the requirements, they should discuss their implementation plan with their auditor and how the new audit will look, then agree on timelines.”
Ralph says there have been positive reports from the UK, with regulators and audit committees supportive of the process.
“Investors have also found real value in the insight that the new-style reports provide,” she adds.
“This shows that if there is a shared sense of direction, a positive view of the changes and a willingness to advance, then expanded auditor reporting can benefit all stakeholders.”
New rules at a glance
The changes include significant revisions of six existing standards and the introduction of the new ISA 701 standard on communicating key audit matters in the auditor’s report.
Under the new rules, auditors must:
- Start their reports with an opinion section, explaining the basis on which they reached that opinion.
- Provide detailed commentary on key audit matters of most significance to the auditor, such as high-risk areas, significant transactions and significant auditor judgements on areas heavily reliant on management judgements.
- Provide wider reporting on going concern, including a description of the management’s and auditor’s responsibilities and highlighting any material uncertainties and “close calls”.
- Include a formal declaration that they are independent and have fulfilled all relevant ethical responsibilities.
- Provide or reference a description of the auditor’s responsibilities and key features of the audit.
The early adopters
In Australia, three listed companies have adopted the new standards ahead of the compulsory start date: Cochlear, Downer EDI and ASX. Together, they have already shown the potential for new-style reporting to cast a spotlight on issues of interest to investors.
In Cochlear’s report, the auditors highlighted a major, unresolved patent dispute, together with the “inherent subjectivity” in estimating the potential costs of Cochlear’s 2011 product recall.
Downer EDI’s auditors, KPMG, focused on the role that judgement played in a range of results, including key contract revenue and valuations of goodwill, plant and equipment.
“KPMG’s audit report on Downer EDI allowed investors to look under the bonnet of the audit – a place not seen before,” says KPMG partner Carolyn Ralph.
“It provided insights into what we, as auditors, considered to be the key areas of the audit and what we did in those areas.”
Ralph believes insights such as these empower shareholders to have more meaningful conversations with a company’s management.
“The key audit matters engage readers of the audit report with bespoke and specific information that investors can use in further discussions with audit committees and boards,” she says.