Over the next few weeks, new ‘long-form’ audit reports will start to accompany the full-year financial statements of Australian listed companies.
While there have been a small number of early adopters, this reporting season audit committees of listed companies releasing full-year financial statements will work through implementation issues that involve new levels of judgment and the need for crystal-clear communication between boards, management and auditors.
The new long-form audit report has been a requirement in the UK and the Netherlands for a couple of years, and is part of a global move towards more detailed auditor reporting.
Proponents of the new report in those jurisdictions have described it as a ‘sea change’ and an opportunity to close the long-discussed audit expectation gap – that is, the gap between the stakeholders’ expectations of what an audit is and what it is in reality.
The ability for auditors to describe key judgments and the audit work they have performed has resulted in better understanding of the role of the auditor. More importantly, it has also led to more transparent disclosure from companies, particularly in the UK where audit committees are required to directly discuss key judgments in information accompanying the financial statements.
On the other hand, critics of long-form audit reports have focused their arguments on the creation of a new level of difficult conversations and the potential for additional tensions between companies and their auditors over the description of key judgments in a public document.
The mindset we all bring to this big change is important. One pertinent question for everyone involved will be: do long-form audit reports represent a more onerous compliance exercise, or a once-in-a-generation opportunity to enhance trust and transparency in the Australian capital markets?
I see this change as a positive. The additional transparency and clarity in the new audit opinions will outweigh any perceived additional risk of tension or conflict. Indeed, a big part of being an auditor requires us to clearly communicate with clients in situations of judgment and differing opinions.
Key questions for audit committees
There is a critical role for the audit committee to play during discussions with both management and external auditors, especially with respect to key audit matters (KAMs). Here are some key questions an audit committee should consider:
- Are any of the KAMs described in the audit report a surprise? If so, is this an opportunity for a more detailed audit committee discussion with the external auditors and management?
- Are the KAMs consistent with the audit committee’s view of those areas that are subject to most judgment or sensitivity?
- Have the KAMs been previously communicated to the market by the company or disclosed in the accompanying financial statements?
- What natural follow-up questions from users of the financial statements could arise from the KAMs?
- Are the KAMs consistent with the areas of the financial statements that the audit committee spends most time discussing?
- How much debate has there been between management and the external auditors with respect to the identification and description of KAMs? What were the areas of sensitivity?
- For each KAM, what is the extent and quality of disclosure in the financial statements (e.g. critical estimates) and accompanying information? What additional disclosure (if any) is required to ensure consistency?
- What KAMs have been included in the audit reports of our competitors?
- The new audit report presents an opportunity for audit committees to have deeper discussions with their auditors about how they have become comfortable with the key judgments in the financial statements.
Like any new standard, custom and practice will likely evolve over time, which has been the case in the UK.
As we work through this transition phase, it is integral for all involved to continue to communicate and seek feedback from each other.
I encourage all parties to share their views as openly and authentically as possible as we work together to improve transparency, not just on the auditor’s side, but on the information provided to users of financial statements more broadly.
If this change is seen by the market as a compliance burden, a huge opportunity will be lost. We have in front of us a unique chance to play an important leadership role improving trust and transparency in the Australian capital markets. We’re looking forward to embracing it.