The New Auditor’s Report
- Why Change the Auditor’s Report Now?
- What are the Intended Benefits?
- What’s New About the IAASB’s Auditor’s Report?
- Which ISAs are Changing?
- When Will the Standards Become Effective?
- Sample of Revised Auditor’s Report
Why Change the Auditor’s Report Now?
The auditor’s report is the key deliverable addressing the output of the audit process. Investors and other users of financial statements have called for the auditor’s report to be more informative – in particular, for auditors to provide more relevant information to users based on the audit that was performed.
Therefore, on 15 January 2015, the International Auditing and Assurance Standards Board (IAASB) released its new requirements on Auditor Reporting. The new requirements have been introduced to improve transparency and clarity regarding the auditor’s responsibilities in an audit, and the information that auditors provide to users about the audit that was performed.
The new requirements are not intended to change the scope of a financial statement audit, and therefore should not affect the underlying audit work.
However, for those entities where we do provide descriptions of key audit matters in the auditor’s report (Listed entities), senior audit engagement team members will need to invest more time in identifying, drafting and discussing key audit matters with management and those charged with governance.
What are the Intended Benefits?
The IAASB intends for its new and revised Auditor Reporting standards to result in an auditor’s report that increases confidence in the audit and the financial statements. The IAASB believes that in addition to the increased transparency and enhanced informational value of the auditor’s report, changes to auditor reporting will also have the benefit of:
- enhance the auditor’s report by providing greater transparency about the audit that was performed;
- enhanced communications between investors and the auditor, as well as the auditor and those charged with governance
- provide users with additional information to help them understand those matters that, in the auditor’s judgement, were of most significance in the audit of the financial statements;
Renewed focus of the auditor on matters to be communicated in the auditor’s report, which could indirectly result in an increase in professional skepticism
What’s New About the IAASB’s Auditor’s Report?
- Mandatory for audits of financial statements of listed entities, voluntarily application allowed for entities other than listed entities:
- New section to communicate key audit matters (KAM). KAM are those matters that, in the auditor’s judgment, were of most significance in the audit of the current period financial statements
- Disclosure of the name of the engagement partner
- For all audits:
- Opinion section required to be presented first, followed by the Basis for Opinion section, unless law or regulation prescribe otherwise
- Enhanced auditor reporting on going concern, including:
- Description of the respective responsibilities of management and the auditor for going concern
- A separate section when a material uncertainty exists and is adequately disclosed, under the heading “Material Uncertainty Related to Going Concern”
- New requirement to challenge adequacy of disclosures for “close calls“ in view of the applicable financial reporting framework when events or conditions are identified that may cast significant doubt on an entity’s ability to continue as a going concern
Which ISAs are Changing?
- Affirmative statement about the auditor’s independence and fulfillment of relevant ethical responsibilities, with disclosure of the jurisdiction of origin of those requirements or reference to the International Ethics Standards Board for Accountants’ Code of Ethics for Professional Accountants
- Enhanced description of the auditor’s responsibilities and key features of an audit. Certain components of the description of the auditor’s responsibilities may be presented in an appendix to the auditor’s report or, where law, regulation or national auditing standards expressly permit, by reference in the auditor’s report to a website of an appropriate authority
When Will the Standards Become Effective?
- ISA 700 (Revised), Forming an Opinion and Reporting on Financial Statements
- New ISA 701, Communicating Key Audit Matters in the Independent Auditor’s Report
- ISA 705 (Revised), Modifications to the Opinion in the Independent Auditor’s Report
- ISA 706 (Revised), Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report
- ISA 570 (Revised), Going Concern
- ISA 260 (Revised), Communication with Those Charged with Governance
- Conforming amendments to other ISAs
Revisions to ISA 260 and 706 as a result of ISA 701, and conforming amendments to related ISAs 210, 220, 230, 510, 540, 580, 600, 710
Sample of Revised Auditor’s Report
Independent Auditor’s Report to the Members of XYZ Bank
Opinions and conclusions arising from our audit
Our opinion on the financial statements is unmodified
We have audited the financial statements of XYZ Bank for the year ended 31 December 2014 set out on pages 10 to 80. In our opinion:
- the financial statements give a true and fair view of the state of the Bank’s and of the parent company’s affairs as at 31 December 2014 and of the Bank’s profit for the year then ended;
- the Bank financial statements have been properly prepared in accordance with International Financial Reporting Standards.
Our assessment of risks of material misstatement
In arriving at our audit opinion above, our strategy was to apply increasing audit procedures in proportion to increasing risk of material misstatement of the financial statements.
To conduct our risk assessment, we considered the inherent risks facing the Bank and the parent company, including those arising from the respective business models, and how the Bank controls those risks. In doing so, we considered a number of factors including: the Bank’s ability to continue as a going concern; the risk of fraud; the design and implementation of the Bank’s control environment; and the risk of management override of key controls.
We revisited our risk assessment after testing the operating effectiveness of a number of the Bank’s key controls including internal controls over financial reporting and specific anti-fraud controls as well as testing the basis of the going concern assumption. We also considered the inherent need for the directors to make and appropriately disclose judgments when preparing the financial statements.
As a result of this assessment, the risks of material misstatement that had the greatest effect on our Bank audit, and parent company audit where relevant, were areas where significant judgment was required and were as follows:
Impairment of loans and advances
The impairment of loans and advances is estimated by the directors through the exercise of judgment and use of highly subjective assumptions. Due to the significance of loans and advances and the related estimation uncertainty, this is considered a key audit risk. The portfolios which give rise to the greatest uncertainty are typically those which are unsecured or subject to potential collateral shortfalls. In 2014, we have focused particularly on collective provisioning methodologies in the Bank’s loan portfolios with highest loss experience, together with a small number of individually significant counterparties.
- Our audit procedures included the assessment of controls including controls over the approval, recording and monitoring of loans and advances, testing the methodologies, inputs and assumptions used by the Bank in calculating collectively assessed impairments and assessing the adequacy of impairment allowances for individually assessed loans and advances through forecast recoverable cash flows, including the realization of collateral.
- We compared the Bank’s assumptions for both collective and individual impairment allowances to externally available industry, financial and economic data and our own assessments in relation to key inputs such as historical default rates, recovery rates, collateral valuation, discount rates and economic factors and considered the sensitivity of these inputs on the assessment of impairment. We also assessed whether the financial statement disclosures, appropriately reflect the Bank’s exposure to credit risk.
Valuation of financial instruments
The fair value of financial instruments is determined through the application of valuation techniques which often involve the exercise of judgment by the directors and the use of assumptions and estimates. Due to the significance of financial instruments and the related estimation uncertainty, this is considered a key audit risk. Estimation uncertainty is particularly high for those instruments where significant valuation inputs are unobservable (i.e. Level 3 instruments). In 2013, we have focused particularly on industry-wide developments in the valuation of credit and collateral within derivative fair values and the methodologies applied by the Bank.
- Our audit procedures included the assessment of controls over the identification, measurement and management of valuation risk, and evaluating the methodologies, inputs and assumptions used by the Bank in determining fair values.
- We compared observable inputs into fair value models such as quoted prices to externally available market data and assessed whether valuation models and methodologies used by the Bank were in line with accepted market practice.
- For instruments with significant unobservable valuation inputs, we performed additional procedures on a sample basis and with the assistance of our own valuation specialists. We critically assessed the assumptions and models used or re-performed an independent valuation assessment, considering alternative methods available and sensitivities to key factors.
- Additionally, we assessed whether the financial statement disclosures of fair value risks and sensitivities appropriately reflect the Bank’s exposure to valuation risk.
Goodwill impairment testing of cash generating units (‘CGU’s) utilises estimates of value-in-use from estimated future cash flows. Due goodwill, this is deemed a to the uncertainty of forecasting and discounting future cash flows and the significance of the Bank’s recognized significant risk. Uncertainty is typically highest for those CGUs where headroom between value-in-use and carrying value is limited and where the value-in-use is most sensitive to estimates of future cash flows. In 2014, we continued to focus on businesses which are subject to structural reform or repositioning.
- Our audit procedures included the assessment of controls over the recognition and measurement of goodwill impairment and assumptions used. Assumptions tested include the cash flow projections based on the plans approved by the Board and the discount rates used to discount them as part of the value-in-use models applied.
- We assessed the reasonableness of cash flow projections and compared other key inputs to externally available industry, economic and financial data and the Bank’s own historical data and considered the sensitivity of significant CGUs to changes in value-in-use. With the assistance of our own specialists, we critically assessed the assumptions and methodologies used to forecast value-in-use for those CGUs where significant goodwill was found to be sensitive to changes in those assumptions.
- Additionally we considered whether the Bank’s disclosures of the application of judgment in estimating CGU cash flows and the sensitivity of the results of those estimates in Notes of the financial statements adequately reflect the risks associated with goodwill impairment.
- On an overall basis, we also compared aggregate values in use determined by the Bank to external market valuations.
Our application of materiality and an overview of the scope of our audit
The materiality for the Bank financial statements as a whole was set at JD 20m. This has been determined with reference to a benchmark of Bank profit before taxation which we believe to be one of the principal considerations for members of the bank in assessing financial performance. Materiality represents 5% of Bank profit before tax.
We agreed with the Bank Audit Committee to report to it all corrected and uncorrected misstatements we identified through our audit with a value in excess of JD 1M, in addition to other audit misstatements below that threshold that we believe warranted reporting on qualitative grounds. (example – Related Parties, effects of non compliance with laws and regulations)
Audits for Bank reporting purposes were performed by local audit teams at the key management reporting units and entities (together ‘components’) in all regions:
- Europe (1 components)
- North America (1 components)
- Middle East and North Africa (10 component)
These audits covered 86% of total Bank operating income; 84% of total profits and losses that made up Bank profit before tax; and 90% of total Bank assets. The segment disclosures in Notes set out the individual significance of each region.
The audits undertaken for Bank reporting purposes at the key reporting components were generally performed in accordance with the materiality levels used for local audits, which were set individually. Materiality used at the components ranged from JD 0.5m to JOD 19m.
Detailed audit instructions were sent to the auditors of all the key reporting components. These instructions covered the significant audit areas that should be covered by these audits (which included the relevant risks of material misstatement detailed above) and set out the information required to be reported back to the Bank audit team. The Bank audit team visited locations in all of the regions listed above and teams from components in each region attended a Bank audit planning meeting.
The Bank audit team also held regular telephone meetings with the regional and local auditors at all the regional locations and the majority of those other locations that were not physically visited. In addition, regional audit teams visited locations of key components within their regions.
Our separate opinion in relation to IFRSs as issued by the International Accounting Standards Board (IASB) is unmodified
As explained in Note 1(a) on the Bank financial statements, in addition to complying with its legal obligation to apply IFRSs as issued by the IASB.
In our opinion, the Bank financial statements comply with IFRSs as issued by the IASB.
Our opinion on other matters prescribed by the Companies Act XXXX is unmodified
In our opinion:
- the part of the Directors’ Remuneration Report to be audited has been properly prepared in accordance with the Companies Act XXXX; and
- the information given in the Strategic Report and Directors’ Report for the financial year for which the financial statements are prepared is consistent with the financial statements.
We have nothing to report in respect of matters on which we are required to report by exception
Under ISAs we are required to report to you if, based on the knowledge we acquired during our audit, we have identified other information in the annual report that contains a material inconsistency with either that knowledge or the financial statements, a material misstatement of fact, or that is otherwise misleading.
In particular, we are required to report to you if:
- we have identified material inconsistencies between the knowledge we acquired during our audit and the directors’ statement that they consider that the annual report and financial statements taken as a whole is fair, balanced and understandable and provides the information necessary for shareholders to assess the Bank’s performance, business model and strategy; or
- the Corporate Governance section of the Annual Report and Accounts describing the work of the Bank Audit Committee does not appropriately address matters communicated by us to the Bank Audit Committee.
Under the Companies Act XXX we are required to report to you if, in our opinion:
- adequate accounting records have not been kept by the company, or returns adequate for our audit have not been received from branches not visited by us; or
- the company financial statements and the part of the Directors’ Remuneration Report to be audited are not in agreement with the accounting records and returns; or
- certain disclosures of directors’ remuneration specified by law are not made; or
- we have not received all the information and explanations we require for our audit.
- the directors’ statement, set out on page 367, in relation to going concern; and
- the part of the Corporate Governance Statement relating to the company’s compliance with the provisions of the Corporate Governance Code issued by the Security Exchange Commission.
We have nothing to report in respect of the above responsibilities.
Scope of report and responsibilities
As explained more fully in the Directors’ Responsibilities Statement set out on pages 10 and 80, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view.
A description of the scope of an audit of financial statements is provided on the Financial Reporting Council’s website at www.xyz.com.