Toward more informative and transparent auditor’s reports

SUITS THE C-SUITE By Bernalyn M. Mendoza

Business World (11/14/2016 – p.S1/3)

Come 2017, users and readers of the auditor’s report on 2016 financial statements should expect dramatic and ground-breaking changes. The Professional Regulatory Board of Accountancy in its Resolution No. 125, Series of 2016 has approved and adopted new auditor’s reporting standards, which were based on updated new international auditor reporting standards. These new standards will be effective for audits of financial statements for periods ending on or after Dec. 15, 2016, the same effective date as the new international standards. Accordingly, financial statements for the year ending Dec. 31, 2016, which will be filed with the Securities and Exchange Commission in 2017, will have to be based on these new standards.

The new international auditor reporting standards were released in January 2015 by the International Auditing and Assurance Standards Board (IAASB) after several years of development. These standards will require auditors to provide more informative and transparent reports on the financial statements of companies they audit.

Other countries that have auditing standards aligned with the International Standards on Auditing (ISA), such as Singapore, Australia, Hong Kong, and Malaysia, are also adopting the new and revised standards for Dec. 15, 2016 audits. On the other hand, the United Kingdom and the Netherlands have already issued enhanced auditor’s reports starting 2013 and 2014, respectively, to which stockholders and investors have reacted positively.

WHY CHANGE?

The auditor’s report has remained unchanged for quite some time. However, in the wake of the recent global financial crisis, there were calls for more informative auditor’s reports — in particular, for the auditors to provide more transparent and relevant information about the audits performed. Investors, other users and stakeholders demanded more than the standard “pass/fail” opinion on a company’s financial statements. Responding to these calls, the IAASB revised the existing ISAs relating to the auditor’s report and introduced a significant number of changes.

The new auditor’s report will address the above concerns, and will improve communication among auditors, management, audit committees and stockholders. In addition, it is expected to contribute to the continued relevance of the financial statement audit and the public’s confidence in the financial statements of companies.

WHAT ARE THE BENEFITS OF THE CHANGES?

According to IAASB, aside from the increased transparency and enhanced informational value of the auditor’s report, changes to auditor reporting will also result in:

· Enhanced communication between the auditor and investors as well as between auditors and those charged with governance (TCWG);

· Increased attention by management and TCWG (e.g., the audit committee) to the disclosures in the financial statements to which reference is made in the auditor’s report; and

· Renewed focus of the auditor on matters to be reported, which could indirectly result in an increase in professional skepticism.

KEY AUDIT MATTERS

The centerpiece of the new auditor’s report and the most notable change in it for listed entities is the “Key Audit Matters” (KAM) section. KAM are those matters that, in the auditor’s judgment, were most significant in the audit of the financial statements. In a sense, this will describe the key focus areas in the audit.

In most cases, KAMs will relate to significant or complex matters disclosed in the financial statements, (e.g., impairment testing of goodwill and other long-term assets, valuation of financial instruments, difficult or unique aspects of revenue recognition, or accounting for significant acquisitions). The KAM section of the auditor’s report shall include an explanation on why the matter was considered as one with the most significance in the audit and therefore determined to be a KAM, and how it was addressed in the audit. There would also be a reference to the related disclosure elsewhere in the financial statements.

OTHER CHANGES TO THE AUDITOR’S REPORT

· Opinion first. The auditor’s opinion will be positioned at the beginning of the report, followed by the Basis for Opinion.

· Basis for Opinion section. This section will be included in all auditor’s reports and will explain that the audit was conducted in accordance with PSAs and whether the audit evidence obtained is sufficient and appropriate to provide a basis for the opinion. Previously, this section was required only when the auditor’s opinion was modified.

· New affirmative statement about the auditor’s independence and the fulfillment of other relevant ethical requirements. The Basis for Opinion section will also include a new affirmative statement that the auditor is independent of the entity and has fulfilled the auditor’s other relevant ethical responsibilities relating to the audit.

· Required reporting on other information. This will increases the transparency of the auditor’s responsibilities related to other information. Other information is defined as financial or non-financial information (other than financial statements and the auditor’s report) included in an entity’s annual report.

· New descriptions of responsibilities relating to going concern in the sections for management and auditor responsibilities. The description of management’s responsibility for going concern reflects the requirements of the applicable financial reporting framework (e.g., Philippine Financial Reporting Standards), while the description of the auditor’s responsibility reflects responsibilities under Philippine Standards on Auditing 570, Going Concern, which are required regardless of the applicable framework.

· Identification of those charged with governance (TCWG) within the management’s responsibilities section. This will be required when a separate body exists that is responsible for the oversight of the financial reporting process (in many cases, the audit committee).

· Expanded description of the auditor’s responsibilities, including key features of the audit. The auditor’s responsibilities section will provide a fuller explanation of the concept of a risk-based audit, as well as clarification on the meaning of certain audit-technical terms and consequently, a fuller description of the auditor’s responsibilities in relation to specific matters, including fraud; internal control, accounting policies and estimates, evaluating the overall presentation, structure and content of the financial statements and disclosures, group audits, and communications with TCWG.

PREPARING FOR THE NEW AUDITOR’S REPORT

Historically, preparing the auditor’s report has been a straightforward process for “clean” opinions. However, with the inclusion of KAMs, even if the auditor shall issue a “clean” opinion, management and TCWG should anticipate that there will be an increased level of communication, discussion and interaction with the external auditors throughout the audit process, even as early as the planning stage. Perhaps even more importantly, management and/or TCWG may take proactive measures to inform and educate their stakeholders about what to expect in the new auditor’s report.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.

Bernalyn M. Mendoza is a Senior Director of SGV & Co.