October 2014 Overview - EY

1 About OverviewWelcome to EY s Overview series. These documents provide a concise Overview of relevant topical or fast-moving global public policy and regulatory issues and are designed to give you current information on emerging 2014 OverviewOur Overview of topical issuesEnhancing the auditor s reportOver the course of many years, auditors have provided a binary pass/fail opinion on a company s financial statements. Either the financial statements fairly present the company s financial position and operations in accordance with applicable accounting standards, or they do not. While the traditional approach remains valuable, many believe it is no longer enough. Auditors have more insights to share, and investors are eager to hear them. And several regulators and standard setters have responded with measures that would require auditors to say more.

2 The United Kingdom adopted a new, principles-based standard in 2013, and UK auditors issued their first reports under the new standard earlier this year. Investors and other stakeholders have been generally positive about the new reports, which have varied in length and The International Auditing and Assurance Standards Board (IAASB) approved final standards to enhance the auditor s report in September (subject to review and approval of due process by the Public Interest Oversight Board) with issuance expected in early 2015. The standards will be effective for 2016 calendar year-end audits. The aspect of the IAASB s proposal that has attracted the most attention is its requirement for the auditor to communicate key audit matters in all auditors reports for listed entities. This would require auditors to report on those areas of the audit that demanded the most significant auditor attention.

3 The European Union adopted its new auditor reporting requirements as part of the recent audit reform legislation. The legislation will be effective for 30 June 2017 fiscal year-end audits. The EU approach is similar in some respects to both the UK s and the IAASB s. One difference, though, is its requirement that the auditor s report include a statement that no prohibited non-audit services were The US Public Company Accounting Oversight Board (PCAOB) issued an initial proposal to enhance auditor reporting in 2013 and has indicated it intends to issue a re-proposal by March 2015. The PCAOB had proposed that the auditor be required to report on critical audit matters, which are similar but not identical to the IAASB s key audit matters. Critical audit matters, according to the PCAOB s definition, would represent the areas in the audit of the financial statements of most significant auditor difficulty.

4 1 See New UK Auditor s Report Update: Findings from the FTSE 100 New Auditor s Reports, Citi Research, Western Europe, 3 September 2014 , and New UK Auditor s Reports: A Review of the New Information, Citi Research, Western Europe, 27 March See Article 10(2)(f) of Regulation (EU) No. 537/ 2014 of the European Parliament and of the Council of 16 April 2014 on specific requirements regarding statutory audit of public interest entities and repealing Commission Decision 2005/909 the auditor s report: October 2014In all likelihood, of course, those areas that require the most significant auditor attention will be matters that are also the most difficult, subjective or complex. However, investors have said repeatedly and we agree that it would be much better if the IAASB, the EU and the PCAOB were more closely aligned.

5 While we recognize that legal, regulatory and reporting frameworks vary, comparability is important for global investors and global markets, and the auditor s report should be as consistent as possible across jurisdictions. Key provisions of the UK, IAASB, EU and PCAOB approaches are compared in Table Proponents of enhanced auditor reporting argue that it contributes to increased public confidence in financial reporting, the role of the audit committee and the audit itself by opening up what some have seen as a black box. They believe enhancements would lead to a greater understanding of what auditors do and don t do and increase the relevance of the audit report. Some proponents also believe that any changes to the auditor s report should complement the audit committee s disclosures. Even supporters caution, however, that the auditor s report should not become a source of original information about a company and that financial statement disclosure needs to remain management s responsibility.

6 Some commenters have raised concerns about the potential liability risks associated with an enhanced auditor s report. There also is a risk of the report devolving into more boilerplate language simply because, in most cases, the important matters on which the auditor is reporting are likely to be fairly consistent year to year. And some commenters, especially in the US, have highlighted that an enhanced auditor s report can never replicate the in-depth interactions that take place between an external auditor and the audit committee. The challenge is how to craft an auditor s report that provides relevant and meaningful information that can be helpful to users of the financial statements, without resulting in these or other unintended viewEY supports initiatives to enhance the auditor s report. We believe expanded auditor reporting will not only help respond to investor demands, but will also help increase public confidence in financial reporting and governance.

7 Despite the practical challenges, we believe that auditors should be more transparent with the public about the audit. This will contribute to the ongoing relevance of the financial statement audit and help serve the public 3 The Netherlands is considering proposals to expand the auditor s report as part of a broader focus on audit quality and independence. The new Dutch auditor s report is expected to reflect the IAASB s standards on key audit matters as well as the new EU requirements on independence. In addition, the Dutch proposals would require expanded reporting on going concern, materiality and scope. Recommendations are currently under review in Parliament. The profession is aiming to provide expanded auditor reporting for all 2014 opinions issued to public interest entities. 4 Point of view: Auditor reporting, EY, February the auditor s report: October 2014 Table 1: Comparing approaches to enhancing the auditor s reportUS PCAOBIAASBUKEUS tatusProposed rule issued August period closed December 2013 (248 comment letters filed).

8 Public hearing held April 2014 . Re-proposal expected before March draft issued July period closed November 2013. (139 comment letters filed.)Revised standards approved in September 2014 with issuance planned for January June 2013, effective for audits for periods commencing on or after 1 October April 2014 , as part of broad audit reform dateNot certain, but likely to align with IAASBE ffective for 2016 calendar year-end auditsAlready in effectMember State implementation beginning in fiscal years ending 30 June 2017 What entities are coveredPublic companies (SEC registrants)Required for all entities, except for KAM and naming of the engagement partner, which are required only for listed entities. KAM and EP name are voluntary for audits of other entities unless required by law or listed companiesPublic interest entities (PIE), which are companies with securities admitted to trading on a regulated market in the EU/EEA, private credit institutions and insurance undertakings.

9 Possibility of even wider the auditor s report should describe Critical audit matters. Critical audit matters represent the areas in the audit of the financial statements of most significant auditor difficulty (including those matters that involve the most difficult, subjective or complex auditor judgments). Key audit matters. Key audit matters represent those areas of most significance in the audit, determined from matters discussed with those charged with governance and that required significant auditor , the scope of the audit, the most significant risks of material misstatement, and how these were addressedA description of the most significant assessed risks of material misstatement (including those relating to fraud); a summary of the auditor s response to those risks; and key observations arising with respect to those risks, where relevantAuditor tenureWould be includedNot addressedNot addressedDate auditor was appointed and period of tenureGoing concernWill be considered by PCAOB as part of separate initiativeRequired statement when a material uncertainty exists relating to the entity s ability to continue as a going concern.

10 For all auditors reports, an enhanced description of the respective responsibilities of management and the auditor for evaluating going as part of separate initiativeSimilar to IAASB, except there is no requirement for an enhanced description of responsibilities for going concernAuditor s responsibility for other information ( , MD&A)Would require the auditor to read and evaluate other information and disclose the results of the evaluation in the reportConsidered by IAASB as part of a separate proposal (but when reporting is required, it will be in a separate section of the auditor s report with the same effective date as the other auditor reporting enhancements)Not addressed but should be seen in context of changes made to UK Corporate Governance Code and ISAs (UK and Ireland) in 2012 Requires auditor to confirm that the management report is consistent with the financial statementsNaming engagement partnerBeing considered by PCAOB as part of separate initiativeRequired for listed entitiesAlready requiredAlready requiredFormatNot addressedRequires placement of the auditor s opinion first within the for auditor to place identification of certain auditor s responsibilities in an appendix to the auditor s report, or, when permitted by an appropriate authority.