Suddenly, Audit Reports Get Sexy

Dull, uninformative audit reports have been part of the European accounting landscape for decades. Now auditors will reveal a great deal more.
Andrew SawersJune 27, 2012

The auditor’s report is usually the most boring page in any company’s annual financial statements and that’s saying something. But now, in what could be the most important development in global financial reporting since Europe decided in 2002 to adopt international financial reporting standards, the staid, boilerplate letter from the firm that signs off on the accounts could be the first page investors turn to.

For perhaps as long as anyone can remember, the report of the independent auditors has been a long, detailed, and uniquely uninformative letter that sheds no light on any control issues or valuation concerns arising between the audit firm and its client. In many jurisdictions, the wording has almost always been virtually identical from one company to the next.

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Now, the International Auditing and Assurance Standards Board (IAASB), the authority that publishes the rules regulating the audit profession’s work for clients, is suggesting that audit reports should actually say something interesting about the company concerned. It has issued an “Invitation to Comment” on its proposals, Improving the Auditor’s Report. (The IAASB’s standards have been adopted by 75 jurisdictions internationally, including for auditors of  private companies in the United States.)

This could mean that auditors will explicitly comment on the quality of financial controls, the valuation models used to calculate the worth of financial instruments, the assumptions driving the decision to make or avoid a goodwill impairment charge in short, all the things that can make big trouble for companies in the weeks and months after their accounts have gotten the all-clear.

It looks like a development that will not only change corporate behavior but also improve auditor independence. Instead of an audit firm approving a set of accounts, signing off on them through gritted teeth after wrangling over some edge-of-the-envelope valuations pushed hard by its fee-paying client, the audit firm could have the ability in fact, the requirement to reveal that the assumptions underlying the financial statements are far from conservative, though they may just fall within what the auditor regards as an acceptable range of valuations.

That puts the auditor in a stronger position and perhaps even urges the corporate client to think again about the numbers it wants to publish. Instead of auditing being a “black box” that prevents anyone from knowing what’s really going on, a new environment of transparency will give everyone a clearer idea of the tussle between aggressive clients and cautious auditors.

Fifteen years ago, you could have asked the heads of audit at any of the Big Six audit firms (as they were then; Big Four now) what sorts of discussions they had had with institutional investors about what they, as the shareholders, wanted from the audit. And each one would have looked at you as though you were from Mars. Why would an auditor talk to an investor?

So it’s interesting to see in the IAASB’s document that “the call for change initially came primarily from institutional investors and financial analysts.” Why? Because as financial reporting got more and more complex, they wanted guidance from auditors as to “the areas on which the auditor’s work effort was focused particularly on the most subjective matters within the financial statements.” Those financial instruments are one example; goodwill is another.

The IAASB’s paper admits there is a possibility that the language used in these new audit reports could degenerate into template statements, but that seems unlikely. If auditors are asked to report on individual clients’ critical audit issues, they will not get away with using standardized statements.

The document contains a mockup of what a new-model audit report could look like, along with details about the proposals and an invitation to all interested parties to comment by October 8, 2012. The timetable points to an exposure draft by mid-2013 with a final standard a year later. Until then, you may have to use matchsticks to keep your eyelids open.

Andrew Sawers is editor of CFO European Briefing, a CFO online publication.