1 Unit
CPD technical article
As auditors get up to speed with the IAASB’s revised ISA on audit reports, Martyn Jones and Carol Masters look at the UK experience
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This article was first published in the March 2017 UK edition of Accounting and Business magazine.
There have always been differences between audit reporting requirements in the UK and those applied by the profession in the rest of the world. The latest set of UK changes to the requirements, issued by the Financial Reporting Council (FRC) in its June 2013 release of ISA 700 (UK and Ireland), The Independent Auditor’s Report on Financial Statements, only exacerbated the differences with the version of the standard issued by the International Auditing and Assurance Standards Board (IAASB). The FRC’s standard added three new areas: risks of material misstatement, materiality and the scope of the audit.
However, there will shortly be a period of greater harmonisation. Early in 2015 the IAASB issued its new auditor reporting standards, including ISA 701, Communicating Key Audit Matters in the Independent Auditor’s Report. ISA 701 became effective for the audit of financial statements for periods ending on or after 15 December 2016. And in June 2016 the Financial Reporting Council issued ISA (UK) 700 (revised June 2016), Forming an Opinion and Reporting on Financial Statements, and ISA (UK) 701, Communicating Key Audit Matters in the Independent Auditor’s Report. Both FRC standards are effective for audits of financial statements for periods starting on or after 17 June 2016.
There is considerable overlap between the global and UK versions, but a few differences remain. The IAASB defines key audit matters (KAMs) as ‘matters of most significance in the audit for the current period’ and are selected from matters communicated with those charged with governance. The 2013 UK requirement was more specific, requiring auditors to report on their assessment of risks of material misstatement, how they applied materiality and an overview of the audit scope.
The FRC has undertaken two reviews of the extended auditor’s report since it came into effect – one in 2015 and another in 2016. The findings make for interesting reading. The 2015 review concluded that auditors were going beyond the changes required by the new ISA, with many examples of innovation. The 2016 review reported that the pace of innovation had slowed down but found that overall there had been a period of consolidation and improvement.
Materiality controversy
Perhaps the most controversial area arising from the new longer-style audit reports has been that of materiality, which historically has proved not to be well understood by users. ISA (UK and Ireland) 700 requires the auditors to explain how they applied the concept of materiality in both planning and performing the audit.
Performance materiality is difficult to explain, and the 2016 review identified only one audit firm as routinely attempting to explain and describe performance materiality. Many audit firms argue that performance materiality is a highly technical area and question the value of further disclosure; on the other hand, many investors have asked for enhanced materiality disclosures.
Detail on risk
One of the most prominent aspects of the new UK extended audit reports is granularity and the extent to which the audit report increasingly focuses on entity-specific risks. The 2016 review identifies a shift towards more detailed descriptions of risk, which, it reports, has been the area of ‘keenest interest’ for investors.
Prior to the changes in the UK, the language of audit reports was highly standardised, with few entity-specific disclosures. It was described, critically, by the FRC as ‘boilerplate reporting with a binary opinion’. In the area of risk reporting, there has been a significant move away from generic and towards more tailored descriptions of the risk assessments made by the auditors. The FRC concludes that extended audit reports have become more relevant and insightful.
The 2016 review also identifies a strong alignment between the information contained in extended audit reports and that in audit committee reports. It suggests that there is much commonality between auditors and audit committees in risk reporting.
Order of disclosures
The 2013 version of ISA (UK and Ireland) 700 did not specify where the opinion paragraph should appear in the extended audit report, as it was thought that this would be too prescriptive and would stifle innovation. The illustration in the ISA put it after the scope paragraph, but following on from the IAASB consultation it later recommended putting it the start of the audit report to make it more prominent. Auditors agreed: in the first year of UK extended audit reporting, 61% of audit reports started with the opinion, and by 2016 this had increased to 95%. The new 2016 ISA (UK) 700 now mandates this positioning.
Investor responses
The feedback from investors seems to be largely positive, although they have said that ‘more could still be done to enhance auditor’s reports’. Overall, however, the findings of the 2016 review identified that good-quality audit reporting was continuing to develop and concluded that investors have welcomed extended auditor reporting and greatly value the enhanced information that it provides.
One disappointing aspect of the changes, the review finds, is auditors’ poor explanations for changes in approach, such as in the assessed risks reported from one year to the next. This could be because, before the current ISA (UK and Ireland) 700, audit reports did not require an analysis of changes over time, so auditors have been slow to include this in the new extended reports.
Overall, though, the changes brought about by the 2013 UK and Ireland revised ISA 700 have added value to the audit process.
Martyn Jones is senior lecturer in accounting at Winchester University Business School. Carol Masters is principal teaching fellow in accounting at Southampton University Business School
1 Unit
CPD technical article
"Perhaps the most controversial area in the longer-style audit reports is materiality, which has not been well understood by users"