A new set of auditor reporting standards aims to make reports more relevant. Ramesh Ruben Louis explores the changes
This article was first published in the June 2015 Malaysia edition of Accounting and Business magazine.
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In 2006, the International Auditing and Assurance Standards Board (IAASB), together with the American Institute of Certified Public Accountants (AICPA), embarked on a project to enhance the communicative value and relevance of the auditor’s report and to accommodate evolving national financial reporting regimes, while ensuring that common and essential content was communicated. After almost a decade of deliberations, research and consultation, a new and revised set of auditor reporting standards was issued by IAASB in January 2015. The revision to the auditor’s report is effective for audits of financial statements for periods ending on or after 15 December 2016.
The key changes involve ISA 700 (revised), ISA 701 (new standard) and ISA 570 (revised).
One of the most notable changes in terms of the presentation of the auditor’s report is that the opinion section will be presented first, immediately after the introduction and identification of financial statements paragraph.
This is illustrated in the following independent auditor’s report to the shareholders of ABC Sdn Bhd:
‘We have audited the financial statements of ABC Sdn Bhd, which comprise the statement of financial position as at 31 December 20XY, and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies.
In our opinion, the accompanying financial statements present fairly, in all material respects, (or give a true and fair view of) the financial position of the Company as at 31 December 20XY, and (of) its financial performance and its cash flows for the year then ended in accordance with Malaysian Financial Reporting Standards and provisions of the Companies Act 19XY.‘
Basis for opinion
Also noting a change is the basis for opinion paragraph which will immediately follow the opinion paragraph. This will include a statement that the auditor is independent of the entity in accordance with the relevant ethical requirements, and has fulfilled the other ethical responsibilities in accordance with these requirements. Previously, complying with ethical requirements was described in the Auditor’s Responsibilities section.
The revised presentation is illustrated below:
‘We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report.
We are independent of the Company in accordance with the International Ethics Standards Board for Accountants’ Code of Ethics for Professional Accountants (IESBA code) together with the ethical requirements that are relevant to our audit of the financial statements in Malaysia, and we have fulfilled our other ethical responsibilities in accordance with these requirements and the IESBA code. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.’
Another key area of change in the auditor’s report is the Auditor’s Responsibilities section, where new and enhanced representations are to be made, including:
- Enhanced representations relating to misstatements arising from fraud or error.
- Exercise of professional judgment and scepticism throughout the audit.
- Appropriateness of management’s use of the going concern basis of accounting.
Communication with those charged with governance regarding the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control.
For audits of financial statements of listed entities, a statement that the auditor has complied with relevant ethical requirements regarding independence.
For audits of financial statements of listed entities and any other entities for which key audit matters are communicated in accordance with ISA 701, the auditor determines those matters that were of most significance in the audit of the current period.
Paragraph 40(b) of ISA 700 (Revised) explains that the enhancements can be found in an appendix to the auditor’s report. Paragraph 40(c) says that when law, regulation or national auditing standards expressly permit, reference can be made to a website of an appropriate authority that contains the description of the auditor’s responsibilities, rather than including this material in the auditor’s report. In the case of Malaysia, this would probably have to be the website of the Malaysian Institute of Accountants.
Four different illustrations of the revised presentation of the Auditor’s Responsibilities section can be found in ISA 700 (Revised).
A new component of the auditor’s report is a section on Key Audit Matters (KAM). For audits of complete sets of general purpose financial statements of listed entities, the auditor has to communicate KAM in accordance with ISA 701 Communicating Key Audit Matters in the Independent Auditor’s Report.
The rationale behind reporting KAM, according to the IAASB, is to highlight, ‘through the eyes of the auditor’, the most significant issues in the audit. Having KAM in auditor’s reports could improve audit quality, which in turn may increase the confidence that users have in the audit and the financial statements.
As a starting point, the auditor is required to determine KAM based on communication with those charged with governance (TCWG) matters that required significant attention. These encompass high risk areas to the audit. The following situations may be relevant in considerations as KAM:
Areas identified as significant risks in accordance with ISA 315 (Revised) or involving significant auditor judgment.
A material matter that is of concern to users of the financial statements.
Complex or subjective selection of an appropriate accounting policy by management compared to other entities within its industry.
Nature and materiality of corrected and accumulated uncorrected misstatements due to fraud or error related to the matter, if any.
Areas in which the auditor encountered significant difficulty during the audit, including those relating to obtaining sufficient appropriate audit evidence and seeking consultation.
Severe control deficiencies identified.
The number of KAM may be affected by the size and complexity of the entity, the nature of its business and environment, and the facts and circumstances of the audit engagement. Except in certain limited circumstances (for example, a listed entity that has very limited operations or assets), it is unlikely that the auditor of financial statements of a listed entity would not determine at least one KAM from the matters communicated with those charged with governance.
The changes to ISA 570 Going Concern were made in response to calls for earlier warning of potential issues that affect an entity’s ability to continue as a going concern. This is particularly the case in situations where events or conditions were identified that may cast significant doubt on the entity’s ability to continue as a going concern but, after considering management’s plans to deal with these events or conditions, management and the auditor conclude that no material uncertainty exists (‘close-call’ situations). The IAASB has therefore laid out entity-specific information about the auditor’s findings on going concern and more standardised language describing how to approach this issue. As well as the revisions to ISA 570, changes were also made to ISA 700 to enhance communications about going concern.
The changes to ISA 570 encompass:
Further guidance on consideration of appropriate disclosures when a material uncertainty exists.
A requirement for the auditor to evaluate the adequacy of disclosures in close-call situations in view of the requirements of the applicable financial reporting framework.
In some circumstances, matters relating to going concern (including close calls) may be determined to be KAM, in part because this may be a significant or difficult auditor judgment in forming an opinion on the financial statements as a whole as prescribed in ISA 701.
There are also enhanced explicit statements relating to going concern that are included under the Auditor’s Responsibilities and Management’s Responsibilities sections, as illustrated below.
The Auditor’s Responsibilities section reads: ‘We also conclude on the appropriateness of management’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Company’s ability to continue as a going concern.
If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the Company to cease to continue as a going concern.’
The Management’s Responsibilities section reads: ‘In preparing the financial statements, management is responsible for assessing the Company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Company or to cease operations, or has no realistic alternative but to do so.’
The changes to the auditor’s report are aimed at making the information provided more relevant to users. Undoubtedly, this will lead to greater transparency about the role of auditors.
Ramesh Ruben Louis is a professional trainer and consultant in audit and assurance, risk management and corporate governance, corporate finance and public practice advisory
CPD technical article
"The rationale behind reporting key audit matters is to highlight the most significant issues through the eyes of the auditor."