Insights
An FRC report has found that auditors are still struggling to move away from boilerplate reporting and use meaningful words, says Robert Bruce
This article was first published in the March 2016 UK edition of Accounting and Business magazine.
If there were ever a sign that the audit world is evolving at a rapid rate, it can be seen in a recent report from the Financial Reporting Council (FRC), Extended auditor’s reports – A further review of experience.
The report looks at efforts to expand on the information that auditors give investors and users of reports, and how these have brought about change. Instead of concentrating on the figures and worrying about how they have been reported, it looks at an entirely different area: language – and it likes what it sees.
Auditors have been moving from the generic, which we used to call ‘boilerplate’, to the granular; in other words actual, specific stuff. This is alarmingly clear thinking in an audit context. But when it comes to what the language is being used for, the report becomes less happy. Auditors may well be getting better at expanding their use of language, but when it comes to explanations of what they themselves have been up to, they suddenly become tongue-tied. Or, as the FRC puts it, there is ‘a widespread lack of explanations’.
All this dates back to the point a few years ago when the FRC created the requirement for boards to ensure the annual report presented a fair, balanced and understandable assessment of their company’s position and prospects, and for audit committees to formally report on what they had been up to. Slowly the internal processes around the communications and connections between auditors, companies and their audit committees, and with investors, have started to open up. Regular dialogue between these three parts of the conundrum has started to take place.
So the processes are up and running, but the picture remains complex. And one of the reasons for the complexity is the language. ‘Investors told us,’ says the FRC report, ‘they are still learning to decode and evaluate the language used by auditors in their reports, and it is likely that as they do so, there will be more opportunities for better dialogue and engagement between them’. The words ‘decode’ and ‘evaluate’ show that auditors are still not talking in the sort of language of explanation the rest of us would use. They are still talking in forms of language that have more to do with a strong influence and input from lawyers.
The report goes on to applaud auditors for having made significant progress in tailoring their words to the company concerned, rather than falling back into their old ways of pasting swathes of boilerplate across everything. But even so, investors were not that happy. What they want, the report suggests, is more precision. ‘Words like “significant” are not necessarily sufficiently informative,’ it says. Language needs to be used, as it normally would be, to describe clearly what has happened, or what is happening.
Explosive language
Perhaps what they require is something expressed in more explosive terms. All this gradual evolution of the process may not be concentrating minds enough. Over in the US, where auditing and accounting scandals and lurid, and bizarre details seem more commonplace, the corporate world and its auditors appear more prone to startling events.
A recent speech by Andrew Ceresney, the director of the division of enforcement at the US Securities and Exchange Commission (SEC), sets the tone. He talks of the good old days of accounting scandals, such as that of electronics retailer Crazy Eddie, which ‘involved millions of dollars of fictitious revenue and overstated inventory valuation’. He recounted how the Enron scandal had generated more than US$450m for the SEC in ‘monetary sanctions from 35 entities and individuals’. He talked of recent actions taken against audit committee members who had ‘approved public filings that they knew, were reckless in not knowing, or should have known, were false because of other information available to them’.
He talked of actions against audit firms over pretty spectacular corporate behaviour that had been compounded by audit failures. He talked of the virtue of having, in recent years, given up the old reactive culture and gone proactive in enforcement efforts ‘to try to detect misconduct before it becomes public’.
He detailed the ways in which they were leveraging data to spot anomalous patterns in financial statements, and how they were building a methodology for proactive identification of financial reporting audit issues. Whistleblowers have become a significant part of the operations. ‘We hope,’ he concluded, ‘this aggressive posture will deter misconduct and ensure that companies report accurate financial information.’
The language of blunt enforcement seems to get the joint jumping rather more effectively than an emphasis on cultural evolution and the assurance that the quality of corporate governance in the UK remains high. Both have their place, but you know which gains the most attention.
Meanwhile, the FRC has been listening to what investors have been telling them and trying to pull it all together into useful advice. Much of it is obvious, but the old problems lie just below the surface. Investors say they want, ‘information about the outcome of audit work rather than generic descriptions of process’. They want to know the rationale behind the choice of benchmarks. They want better explanations of how materiality ‘practically’ impacts on the conduct of the audit. They want clearer explanations about the quality of assurance ‘derived from component audit teams’. And they want explanations of the basic characteristics of the auditor’s approach – in particular, ‘how judgments are made about the balance between substantive procedures and controls reliance as a source of assurance’.
Cut to the chase
What people want – both the regulators in the US and investors in the UK – is practical information and insight. They want auditors to provide specifics. They want, in effect, the sort of information they might get if they sat down with the audit team in a pub after the audit and chatted about how it had gone. They want to have a real feel for what went on and how it panned out, as well as reassurance that the company concerned was in good and reliable shape.
All these are issues of language rather than format. And that is the direction to travel.
Robert Bruce is an accountancy commentator and journalist