Enhanced auditor’s reporting - EY

1 January 2016 Enhancedauditor sreportingAssurance Special editionA new foundation in auditor s reportingIn January 2015, the International Auditing andAssurance Standards Board (IAASB) issued its new andrevised Auditor reporting Standards, which requireauditors to provide more transparent and informativereports on the companies they audit. These standardshave been issued in response to demand from users offinancial statements, in the wake of the financial crisis,for more relevant information on aim of the standards is to provide auditor s reportsthat increase the public s confidence in both the auditprocess itself and the financial statements of IAASB also believes that enhancing auditor reportingwill improve communications between the auditor andinvestors, as well as between auditors and those chargedwith new and revised Auditor reporting Standards areeffective for audits of financial statements for periodsendingon or after 15 December 31 August 2015, the Hong Kong Institute of CertifiedPublic Accountants (HKICPA)

2 Released the new andrevised auditor reporting standards. These standards arebased on the international standards (ISAs) and have thesame effective 8 January 2016, the Chinese Institute of CertifiedPublic Accountants (CICPA) issued exposure drafts for itsnew and revised auditor reporting standards to cope withthis new reporting new standards are expected to reinvigorate theaudit and change the manner in which auditorscommunicate their work in the auditor s report. This willinevitably impact other stakeholder groups, including thepreparers of the financial statements (CFOs and theirfinance team), the directors, the investors and the new standards apply (in many jurisdictions) tothe audits of the financial statements towards the end of2016, management, those charged with governance andauditors must start preparing for their 700 ( revised ) Overarching standard for auditor reportingRevisions toISAs 260 and 706as a result of ISA 701,and conforming amendments to relatedISAsISA 705( revised )Modificationsto auditor sopinionsNEWISA 701 KeyauditmattersISA 570( revised )Goingconcern(includingrevise dreporting)ISA 720( revised )Otherinformation(includingne wreporting)

3 2 Enhanced Auditor s ReportingKey Audit MattersOne of the challenges with the financial statements isthat they are fairly complicated. As a result, the audit isalso quite complex and requires the auditor s assessmentof risks of material misstatement to those financialstatements to drive the performance of the today s boilerplate auditor s report, it is not possiblefor financial statements users to understand where thegreatest of those risks lie in the eyes of the this reason, a particular area of focus within the newstandards is the requirements as set out in the new ISA701 Communicating Key Audit Matters in theIndependent Auditor s audits of listed entities, a new section in the auditor sreport called Key Audit Matters (KAM)

4 Will highlight thosematters that, in the auditor s professional judgment,were of most significance in the are included in a separate section of the auditor sreport explaining the nature and intent of , KAM isnot: A substitute for disclosures in the financialstatements A substitute for the auditor to express a modifiedopinion A substitute for reporting any matters relating togoing concern or A separate opinion on an individual matter The IAASB has responded to calls frominvestors and others that it is in the publicinterest for an auditor to provide greatertransparency about the audit that wasperformed. Increasing the communicativevalue of the auditor s report is critical to theperceived value of the financial statementaudit. From the matters that required the auditor s significantattention, the auditor determines which were of the mostsignificance in the audit of the current period.

5 Thesematters are most cases, KAM relate to significant complex mattersdisclosed in the financial statements, , valuation ofgoodwill and other long-term assets, valuation offinancial instruments, difficult or unique aspects ofrevenue recognition, or accounting for description of a KAM should be clear, concise,understandable and describes Whythe matter was determined tobe a KAM;Howit was addressed inthe audit; and Reference todisclosure(s)in the financialstatements Dan Montgomery, former IAASBD eputy Chair and Chair of theAuditor reporting projectSource: IAASB press release dated 15 Jan 2015 KAM:Mattersof mostsignificancein the auditMatters communicatedwith TCWGM atters requiringsignificant auditorattentionAlways consider: Higher assessed risks on financialstatements misstatement Areas of significant managementjudgment and estimationuncertainty Significant transactions or eventsDescription of each KAM in theauditor s report is required to include.

6 Why the matter was considered tobe one of most significance in theaudit How the matter was addressed inthe audit Reference to the relateddisclosure(s)KAM Decision-making framework3 Enhanced Auditor s ReportingWhat is KAM?KAM is defined in the standard as Those matters that, inthe auditor s professional judgment, were of mostsignificance in the audit of the financial statements of thecurrent period. KAM are selected from matterscommunicated with those charged with governance .In essence, KAM are drawn from matters that arecommunicated with those charged with governance(TCWG).ISA 701 includes a judgment-based decision-makingframework to help the auditor decide which issues fromthe audit would count as auditor firstly narrows the matters communicatedwith TCWG to matters that required significant auditorattention.

7 In doing so, auditors will explicitly consider: Areas of higher risk of financial statements materialmisstatement Significant auditor judgments relating to areas in thefinancial statements that involved significantmanagement judgment, including accountingestimates that have been identified as having highestimation uncertainty The effect on the audit of significant events ortransactions that occurred during the periodThe fact that these considerations are required doesnotimply that matters related to them are always a KAM a form of qualification?Stakeholders are used to the binary pass/fail KAM reporting , the stakeholders might perceive itas a piecemeal qualification on matters determined to beKAMs. The description of auditor s procedures containedin the KAM section of the auditor s report might bemisunderstood without proper concerns are: Will KAMs make the auditor s report as the primarysource of red flags , such as going concern?

8 How will KAMs be interpreted by stakeholders and themarket? Would it trigger a negative market response? Will stakeholders perceive matters highlighted asKAMs as areas where management and TCWG failedto discharge their responsibilities properly?One very important message to be conveyed to thestakeholders is that KAMs are not an avenue for theauditor to express qualification on matters highlighted asKAMs. KAMs are addressed in the context of the audit ofthe financial statements as a whole, and the auditor doesnot provide a separate opinion on these , stakeholder education is critical in addressingthe potential consequences of misinterpreting KAMs. Theentities, the relevant professional bodies and authoritiesshould actively engage and educate the stakeholders sothat they understand the objective of KAMs, and how amatter is determined to be a changing audit reporting landscapeMany jurisdictions that use the ISAs have already issuedexposure drafts or new auditing standards to implementthese new requirements.

9 Some jurisdictions may extendthe applicability of certain requirements in the ISAs foraudits of listed entities to audits of other entities, suchas public interest entities. As a result, additionaljurisdiction-specific guidance may be issued to furtheraddress auditor reporting and standard-setters in several jurisdictionshave also undertaken auditor reporting initiatives,including the UK, the Netherlands, the US, and theEuropean Union. For instance, the UK measures wereeffective for audits for periods commencing on or after 1 October 2012 while the Netherlands issued a standard inlate December 2014 that applies to periods ended on orafter 15 December , the UK Financial reporting Council (FRC)conducted a post-implementation review.

10 In a survey ofmore than 150 auditor s reports, it was found that thetop five KAMs most reported in the UK were: Impairment of assets Tax Goodwill impairment Management override of controls and Fraud in revenue recognitionOther changesIn addition to the KAM, some of the other changesintroduced to the auditor s report are: Prominent placement of the auditor s opinion towardsthe beginning of the auditor s report New descriptions of responsibilities relating to goingconcern to be included in the respective sections formanagement s and auditor s responsibilities Enhanced reporting requirements when a materialuncertainty related to going concern exists Identification of TCWG within the management sresponsibilities section who is responsible for theoversight of the financial reporting process (in manycases, the Audit Committee)