Reporting on audited financial statements – significant changes proposed

The International Auditing and Assurance Standards Board (IAASB) plans to make significant changes to how the auditor communicates audit-related matters to shareholders and other users of audited financial statements.

In June 2012 an Invitation to Comment was published, asking for feedback on a range of proposed changes to the structure and content of the auditor’s report, aiming to enhance its usefulness for decision making. In July 2013 an Exposure Draft was issued which specifies the revisions planned to be made to a suite of International Standards on Auditing (ISAs), changes that will mark a substantial change in the way that auditors report their findings.

This article provides a summary of the main issues featured in the Invitation to Comment and a second article focusing on the specific Exposure Draft requirements will follow.

Background to the Invitation to Comment

In May 2011 a consultation paper, entitled Enhancing the Value of Auditor Reporting: Exploring Options for Change, was published by the IAASB. This, as well as academic research and the conclusions from dialogues between the IAASB and national standard setters, resulted in the draft proposals published in the Invitation to Comment. Findings of work carried out by the European Commission and the US Public Company Accounting Oversight Board backed the feedback from the consultation paper, suggesting that users of financial statements are calling for more information in the auditor’s report in order to understand key audit issues and their implications.

One of the themes of these findings is that users need more assistance to understand increasingly complex financial statements and to have information on where audit work has been focussed, particularly in relation to the subjective areas of the accounts.

The Invitation to Comment was issued to obtain specific feedback on how the auditor’s report can be changed to provide information that is more pertinent to the decisions made by users of the financial statements. In recent years, the auditor’s report has been criticised for being too short, too vague, and in summary not very useful. This sentiment was accentuated by the global financial crisis, which caused many investors and other users of financial statements to question whether the content of the auditor’s report could be made more informative, especially in relation to going concern matters and with a view to the report providing greater transparency in relation to significant audit-related matters and in how the audit was conducted.

Professor Arnold Schilder, chairman of the IAASB, summarises the need to consider revision to the auditor’s report in the forward to the Invitation to Comment by saying: 'More than ever before, however, users of audited financial statements are calling for more pertinent information for their decision-making in today’s global business environment with increasingly complex financial reporting requirements. The global financial crisis also has spurred users, in particular institutional investors and financial analysts, to want to know more about individual audits and to gain further insights into the audited entity and its financial statements. And while the auditor’s opinion is valued, many perceive that the auditor’s report could be more informative. Change, therefore, is essential.'

Key suggestions from the Invitation to Comment

Ordering of elements within the auditor’s report – the opinion and basis for opinion paragraphs
The Invitation to Comment contains an illustrative auditor’s report. The structure begins with the opinion paragraph, followed by the basis for opinion paragraph. The IAASB believes that placing the opinion paragraph at the start of the auditor’s report makes it more prominent, and the inclusion of a basis for opinion paragraph in all auditor’s reports whether the opinion is modified or not will enhance understandability. The basis for opinion paragraph states compliance with ISAs and relevant ethical requirements, and that the audit evidence obtained is sufficient and appropriate to provide a basis for opinion.

Going concern
This is one of the more important areas of potential change, stemming from criticism that the existing auditor’s report says too little about going concern matters, leaving shareholders and other users with insufficient information to reach an informed conclusion on going concern matters. The illustrative auditor’s report contains a separate paragraph immediately beneath the basis for opinion paragraph, highlighting the importance of going concern matters. The IAASB sees this as a significant matter, stating in the Invitation to Comment: 'The recent global financial crisis has highlighted the importance to financial markets of clear and timely financial reporting. It has also resulted in a greater focus on the assessment of going concern and related disclosures… some respondents to the IAASB’s May 2011 consultation asked for clarification of the respective roles and responsibilities of management and the auditor regarding going concern, and for auditors to report the outcome of their audit work regarding going concern. These developments provide a significant impetus for the IAASB to seek to enhance auditor reporting in this area.'

Specifically, the suggestions are that all auditors’ reports should include, having regard to the applicable financial reporting framework:

  • A conclusion regarding the appropriateness of management’s use of the going concern assumption, and
  • A statement regarding whether, based on the audit work performed, material uncertainties related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern have been identified.

To minimise potential misunderstanding, the illustrative report makes clear that, as not all future events or conditions can be predicted, the statement about the absence of material uncertainties is not a guarantee as to the entity’s ability to continue as a going concern.

Furthermore, a separate paragraph in the section of the auditor’s report dealing with management’s responsibilities will describe management’s responsibilities in relation to going concern. This explains that management make an assessment about the entity’s ability to continue as a going concern, taking into account all available information about the future, which is at least, but is not limited to, 12 months from the end of the reporting period.

Auditor commentary
Users of financial statements, especially analysts and investors, have been pressing for the auditor’s report to contain more information on important matters in the financial statements, or key audit findings, to facilitate more informed decision making. Many users of the accounts would welcome further insight into matters of judgment, where subjectivity has been used in preparing and in auditing the financial statements. Other users have suggested that relevant information could be included on features of the audit process itself, such as the use of experts, or the involvement of other auditors.

The Invitation to Comment suggests that the following matters may be considered relevant for inclusion in an audit commentary paragraph:

  • Areas of significant management judgment (for example, in relation to the entity’s accounting practices, including accounting policies, accounting estimates, and financial statement disclosures).
  • Significant or unusual transactions (for example, significant related party transactions or restatements).
  • Matters of audit significance, including areas of significant auditor judgment in conducting the audit, for example:
    - Difficult or contentious matters noted during the audit, or other audit matters that would typically be discussed with an engagement quality control reviewer or those charged with governance, and
    - Other issues of significance related to the audit scope or strategy.

To provide examples of the kind of matters that could be included, the illustrative auditor’s report includes within the audit commentary paragraph sections discussing the accounting and audit issues relating to outstanding litigation, goodwill, the valuation of financial instruments, the audit strategy relating to the recording of revenue, accounts receivable, and cash receipts and the involvement of other auditors.

An important issue is that the content of the audit commentary paragraph would be very entity-specific, and would be likely to include the matters that are discussed with those charged with governance during the audit. The Invitation to Comment states that the IAASB believes auditor commentary should be tailored to the facts and circumstances of the entity to avoid being labelled as 'boilerplate'.

It may be that the need for emphasis of matter and other matter paragraphs is eliminated, as the issues commonly referred to in those paragraphs under existing ISA requirements, could be included instead in the audit commentary. The IAASB will make a decision on whether to retain the current requirements in relation to emphasis of matter and other matter paragraphs as part of its overall review of the auditor’s report.

Further deliberations are also being made as to whether the audit commentary paragraph should be required for all entities, or just for public interest entities with the auditors of other entities having the option to include the paragraph to highlight certain matters if deemed necessary.

Other information
Other information is defined as financial and non-financial information which is included in a document containing audited financial statements and the auditor’s report. Other information may typically include a chairman’s statement, directors’ report, operating and financial review and/or management disclosure and analysis, with the exact contents often mandated by local legislation or by listing requirements.

The IAASB’s May 2011 consultation paper specifically asked for respondents’ views as to whether there would be benefit in including a statement about the auditor’s responsibilities regarding other information in the auditor’s report. The feedback suggested a lot of support for a specific statement or conclusion in the auditor’s report on the other information presented alongside the audited financial statements.

The Invitation to Comment suggests that the auditor’s report should include a statement regarding whether, based on reading the other information, the auditor has identified material inconsistencies between the other information and the audited financial statements. The illustrative audit report includes a short paragraph explaining the auditor’s responsibilities regarding other information as well as a statement that no material inconsistencies have been found. To minimise the potential for misunderstanding, the illustrative report includes a disclaimer that the auditor has not audited the other information as part of the audit of the financial statements. In the event that material inconsistencies were found and not resolved, a more detailed explanation would be required.

Respective responsibilities of management and the auditor
The IAASB is suggesting that the paragraphs in the auditor’s report that deal with the responsibilities of management and of the auditor should be enhanced. It is hoped that additional disclosures will narrow the expectation gap by providing a more detailed and relevant description of the role of management and the auditor in the financial reporting and auditing process. As mentioned above, a specific responsibility of management is the assessment of going concern, and this would be made clear in a separate paragraph.

In terms of the auditor’s responsibilities, it is felt that more information to clarify technical terms would be useful to users of financial statements, and that this would help to better explain the nature of a risk-based audit. The downside to the more lengthy paragraphs is that they add volume to the auditor’s report, so the IAASB is considering making it more explicit that this content of the auditor’s report can be cross-referenced to a standard wording provided in another location, such as the national standard setter’s website. This is already common practice in some countries, such as the UK.

Further suggestions to provide transparency about the audit
The Invitation to Comment makes the following further suggestions:

  • Disclosure of the name of the engagement partner, the aim of which is to promote greater accountability of the partner who is ultimately responsible for the conduct of the audit.
  • A statement of compliance with relevant ethical requirements, the IAASB considers that the increased focus on auditor’s independence makes such a statement an important feature of the auditor’s report and that it would enhance the credibility of the report.
  • Description of the involvement of other auditors, which could either be presented within the audit commentary or in a separate part of the audit report. The IAASB believes that the involvement of other auditors is sometimes a significant audit issue which should be highlighted. The downside to this is that the disclosure may incorrectly imply that responsibility for the audit opinion is shared.


The IAASB has proposed some significant changes to the structure and content of the auditor’s report. It can be seen that there are many advantages to these proposals for the users of financial statements, especially given the increasing complexity of financial statements, and the need for both preparers and auditors to exercise significant judgments when performing their roles. The additional disclosures should enhance users’ understanding of the audit process and the nature of risk-based auditing, but there are some downsides to the proposals such as the increased length of the auditor’s report which, for some entities, means that the cost may well outweigh the benefit.

The proposed changes are considered relevant to Paper P7 (INT) and all adapted papers due to their general significance as a current issue for auditors worldwide.

Written by a member of the Paper P7 examining team