An insight into new auditors’ report

Before deliberating on the new auditors’ report, it is important to know the sequence of events that created the necessity to bring in changes to the auditors’ report. At the outset, it is worthy of noting that ‘auditing’ has become the mostly misunderstood profession in the eyes of the public. It seems gone were the days the auditor was seen as a watch dog rather than a blood hound.  

Gathering the storm 
At the dawn of the new millennia, there was a series of high-profile corporate failures. Enron, Xerox, WorldCom, Parmalat and many more corporates added to the list. At that time, the markets were recovering from the dotcom bubble. Amidst this, some of the high-profile auditors also went into bankruptcy. The stakeholders started questioning the role of the regulators and that of the auditors. 
These failures were considered as accounting scandals. However, I carry the view that these were corporate governance scandals. This is because there is no room for an accounting scandal if the corporate governance environment and practices are strong. These corporate failures resulted in many changes to the disciplines of corporate governance, accounting, auditing and certain laws governing the above aspects. 
Introduction of the Sarbanes-Oxley Act (SOX) in the USA can be considered as the groundbreaking law that exerted substantial influence in bringing in so many changes to the accounting and auditing profession. In the context of globalization, it took little time to spread the best practices as prescribed in the SOX across the world. SOX brought in additional reporting requirements to auditors. 
Discussions were slowly started in strengthening the financial reporting function and auditors’ reporting. With the advancement of technology and related information and communication, new business opportunities were created and some of the existing businesses had going concern issues. Truly speaking, disruptive technologies made certain business models obsolete creating more emphasis on going concern. All these developments have brought continuous changes to financial reporting and auditing literature.
Then the world faced the global financial crisis during 2007/2008. The US domestic issue, mainly due to the sub-prime mortgage loans (Ninja loans) became a global issue as a result of the cross-border investments. Some of the high-profile investment bankers, insurance companies and rating agencies were directly hit and so many other companies had indirect impact and the capital markets were seriously affected.   

Fact-finding 
Again the auditors’ role was questioned, especially in the context of going concern of such impacted entities. The stakeholders started to demand more transparency and relevance in auditors’ reporting. In the above context, prominent professional accounting bodies commissioned international academic research on user perceptions. 
Also, the International Accounting and Auditing Standards Board (IAASB) carried out public consultations, round table discussions and interaction with regulators, policymakers and national standard setters to clearly understand the perceptions and concerns on auditors’ reporting. Having deliberated on the feedback received from the public through various means, the IAASB had finally brought in substantial changes to the auditors’ reporting. 

Changes to auditors’ report  
The key changes to the auditors’ report on a listed company’s financial statements can be highlighted as follows: 
New section to communicate key audit matters (KAMs)
Disclosure of the name of the engagement partner
Audit opinion section required to be presented at the beginning 
Enhanced auditors’ reporting on going concern of the entity
Affirmative statement about the auditors’ independence and fulfilment of ethical responsibilities
Enhanced description of the auditors’ responsibilities and key features of an audit.  

Impact on audit committee and management 
Out of the above stated changes, the most significant one is the requirement to have a separate section on the KAMs in the auditors’ report of the public quoted companies. This requires the auditor to disclose the matters that the auditor thought would be detrimental to the audit and how the auditor approached these key audit matters in obtaining comfort to express his/her opinion.
In other words, this requirement may make the auditor to disclose certain information the management may deem to consider as sensitive. In the above context, the audit committee has got a significant role to play. 
The audit committee should consider the timing of meetings of the audit committee and management and whether these will accommodate the audit process and reporting time frame. The timing and methods of communications with the auditor will be affected since:
KAMs are derived from matters communicated with the audit committee. Therefore, early communication of all relevant matters affecting the audit is critical.
The audit committee should challenge the auditor as early as possible on the auditors’ responses to the KAMs and whether these are appropriate.
The audit committee will want to review an early draft of the auditors’ report in order to be able to understand which KAMs are being reported.
The report is likely to go through rigorous review processes within the entity and the audit firm and therefore, time frames need to be carefully considered to accommodate this.
The audit committee should question disclosures in the financial statements and annual report:
Whether the disclosures adequately and fairly describe the matters to which the KAMs pertain in accordance with the financial reporting framework.
Whether additional disclosures or commentary beyond those required by the financial reporting framework are necessary in order for users to fully understand the KAMs identified by the auditor and to ensure the auditor is not the original provider of information. (Such disclosures may be in the financial statements or the annual report.)
The audit committee should question the management’s response to the KAMs, although not disclosed by the auditor or in the financial statements; the audit committee may want to question how the management manages and responds to the KAMs and whether this is appropriate.

Independence and ethics
The audit committee should annually or regularly evaluate whether the auditor is independent in terms of the relevant codes and the companies act by:
Monitoring and pre-approving all non-audit services provided by the audit firm
Monitoring non-audit services provided by other auditing firms due to the potential impact of rotation requirement, particularly for entities with affiliations in the UK and Europe
Assessing the independence of the auditor, both the firm and individual engagement partner, when nominating the auditor for appointment
Going concern/responsibility of auditor, management and those charged with governance
The audit committee should scrutinize the management’s process for assessing the entity’s ability to continue as a going concern. Although these responsibilities are not new, there is increased focus on going concern and the related disclosures. Therefore, it is a good opportunity to evaluate these processes.
The audit committee should examine the relevance and completeness of the entity’s disclosures in the financial statements related to going concern, particularly for the entities that have ‘close call’ situations (i.e. where there are events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern, but the management has mitigating plans and the conclusion is that no material uncertainty exists).
The changes to the auditors’ report would expect to bridge any expectation gap that prevails with the stakeholders. In Sri Lanka, the new auditors’ report is effective for the auditors of financial statements for periods ending on or after March 31, 2018. 
(Tishan Subasinghe (FCA, CPFA (UK), ACMA, CISA, MBA(Finance)(Col.) is Head of Audit and Assurance at BDO Partners)