Enhancing the audit report: the good, the bad, and the (far from) ugly

Singapore

COME next year, the audit reports attached to all listed companies' financials are going to look very different.

Far from reflecting just a cosmetic change, the new enhanced audit report will contain a lot more information about what the auditor thinks about the audited company's financial statements than the current "pass/fail" view. When presented well, the new report will offer investors greater clarity and insight into the company's business.

The change is set to immediately benefit investors and other stakeholders in the company - if they take the time to understand the impending changes.

The new report will also cast more light on the work performed by auditors and the information they glean during their audits, making the audit report more relevant.

The development is, however, not taking place without some concerns: some worry that the enhanced disclosure could increase the exposure and liability of auditors; and more than a few companies have been heard grumbling about the added burden the increased disclosure could bring.

With the new reports soon to be upon us, The Business Times looks at just what changes are afoot, how much more work and exposure these new audit reports will entail, how companies, auditors and stakeholders can ensure that these reports are meaningful, and how they will change the face of investing here.

What is it?

To begin with, let's look at how exactly the traditional audit report will change with the new requirements.

Currently, audit reports tend to be a one-page report by the company's external auditors on whether the company's financial statements have passed or failed the audit.

New standards adopted by Singapore, which will take effect for the audits of financial statements ending on or after Dec 15, 2016, will lead to a lot more information being reported by the auditors.

There will be two key changes:

First, auditors will have to communicate the key audit matters (KAMs) encountered in their audit. These are areas they have assessed to be of greatest significance during the audit, such as significant risk areas of the financial statements most susceptible to misstatements, the company's major transactions during the year that required extensive auditing efforts, or areas involving key management judgments and estimates such as the valuation of investments.

The auditors would also have to explain how these issues were addressed in the audit. Now, KAMs tend to be confined to discussions that take place between the auditor, the company's management and its audit committee.

The second change relates to the aspect of going concern, that is, the ability of a company to continue its operations. At present, auditors need to flag in their reports any circumstances - such as loss of a major customer - that could result in a material uncertainty over the company's going concern.

Under the enhanced standards, there is an added responsibility on the auditors to ensure that the company has made adequate disclosures in its financial statements regarding management's judgment and assessment on going concern, even if the circumstances do not result in a material uncertainty - for example, the loss of a major customer being mitigated by secured orders from other customers.

This is to ensure more transparency on a company's viability.

These changes are expected to help investors focus on the significant risk areas of the company, enabling them to better engage directly with auditors and raise more in-depth questions for management and directors during shareholders' meetings.

It would also encourage company directors and management to become more transparent in their engagements with shareholders, helping them to provide more insightful responses to queries raised and improve the quality of those disclosures.

Bobby Chin, former managing partner of KPMG and a leading force in Singapore's recent efforts to develop its accountancy sector, told The Business Times that these changes are "a big step forward and (it was) high time (they came about)".

How it came about

The changes are the result of strong calls - not just in Singapore, but worldwide - by investors and users of financial statements for more pertinent information to be included in the auditor's report to augment their decision-making.

Independent standards setting body, the International Auditing and Assurance Standards Board (IAASB), first issued standards for such enhanced auditor reporting in January 2015 to national audit regulators and professional bodies for localised adoption.

Embraced by a number of jurisdictions around the world - in some cases with exceptions - they were also taken on by Singapore; national accountancy body, the Institute of Singapore Chartered Accountants (ISCA), issued the standards in July 2015, after they were reviewed and approved by the Accounting and Corporate Regulatory Authority's (Acra) Public Accountants Oversight Committee.

ISCA CEO Lee Fook Chiew said at the time: "This is probably the most significant development impacting the auditing profession in recent times."

How significantly it will impact the market remains to be seen.

More transparency?

David Smith, head of corporate governance at Aberdeen Asset Management Asia, says of the new standards: "Investors always want more information about the audit, rather than the current binary (pass/fail) outcome, so I think this is a good step.

"Indeed, the UK experience of enhanced auditor reporting has generally been positive, with auditor comments on the whole thoughtful and useful.

"The Singapore experience will, of course, depend on the kind of issues identified as KAMs, as well as the depth and quality of the auditor's statements, so time will tell as to how useful this will be."

Tham Sai Choy, chairman of KPMG Asia Pacific and managing partner at KPMG in Singapore, says: "What we found as we learnt the lessons from the last financial crisis is that auditors have a lot of information about the company, much more than what is presented in the standard audit report. They consider risks that are not easily presented in financial statements, and the work they carry out on those risks was previously unreported.

"The enhanced audit report will provide much useful information to a wide group of stakeholders that have an interest in the sharing of information to support the healthy functioning of capital markets."

However, he adds: "This new disclosure tool has a lot of potential, but of course it is only as good as how users want to use it. The tool can just as well be used to communicate meaningful information that helps markets function, or to obfuscate and frustrate such communication, since by its nature it is not possible to apply a standard form of language."

Many others have echoed Mr Tham's view: the enhanced audit report will only provide greater transparency about a company if the disclosures are meaningful.

Mr Smith says: "A risk is that these reports gravitate towards generic, boilerplate language, which would be a shame. But experiences elsewhere do give us reason to be optimistic, and certainly some of the reports put out by early adopters in Singapore have been well put together."

Well-known corporate governance advocate, associate professor of Accounting Mak Yuen Teen, adds: "There is a risk that the boilerplate binary opinion becomes a boilerplate longer opinion, with higher costs and limited benefit.

"Oversight by Acra can help ensure that KAM reporting is meaningful and covers issues most relevant to each specific listed entity and that auditors do not bow to client pressure in their KAM reporting."

Acra's chief executive (CE) Kenneth Yap assures BT that it will keep a close eye on this: "In the coming year, Acra will be focusing its audit inspection on auditors' compliance with the enhanced standards. We will also be issuing an Audit Practice Bulletin to guide auditors on Acra's expectations on these standards."

Of course, the relevance and usefulness of such reports would also depend very much on how well they are understood by the investing community, particulary the retail investing community.

David Gerald, who heads investor watchdog, the Securities Investors Association of Singapore (Sias), has welcomed the changes as offering a "good source of information", as compared to the current "one-page standard opinion".

"This is good particularly for retail investors, who may not have the resources like institutional investors to perform detailed analyses and research."

He says that public education is essential. "With a 17-month lead time ahead of its implementation date of Dec 15, 2016, Sias has embarked on initiatives with Acra and Isca to raise awareness amongst its members of the enhanced audit reporting requirements. It will also continue to work closely with Acra to educate its members on how to use and leverage on the enhanced auditor's report."

He also says auditors should do their part - drafting their reports simply, avoiding jargon and technicalities, to facilitate understanding and with the investors' interest in mind.

Mr Chin, who is also chairman of the audit committee for SingTel, one of the early adopters of the enhanced auditor reporting requirements, agrees that the enhanced audit report should be written clearly. "In my view, the report should be written without accounting jargon and in plain English which the users can understand," he said.

More liability?

More disclosure could, however, also mean increased exposure for auditors and greater liability risks - or would it?

Mr Yap also feels it won't. "The responsibility of an auditor lies in performing all necessary procedures required by the auditing standards to arrive at the true and fair opinion. These enhancements from the auditor reporting standards will mean added responsibilities for auditors to disclose more but should not add to the auditors' liability if they have adhered to the auditing standards, applied sound judgment and documented robustly to show that they have adequately discharged their responsibilities," the Acra CE said.

Mr Tham adds: "Auditor liability becomes an issue when things go wrong, and investors suffer a loss that the audit report did not prepare them for. Investors are prepared to take risks, but are rightly outraged if they find themselves surprised by risks they were unaware of.

"An enhanced audit report that provides more meaningful information, equipping the investor to understand not just the financial statements but also the risks that are part of the business, can only be helpful in reducing the incidence of surprises. In that way, enhanced audit reports should reduce the liability of auditors if used in the right way."

More work?

There is also a concern that, given the amount of additional input by auditors into the new report, it could evolve into a source of original information about the company; the company and its management could also develop the perception that the preparation of the enhanced audit report is largely the responsibility of the auditors and not theirs.

Early adopters of the enhanced audit report are quick to point out that this will not be the case.

Mr Chin says that the new report will not become a source of original information about the company as the issues contained in the report would already have been discussed and agreed with the company's management.

Euleen Goh, chairman of the audit committee of CapitaLand, another early adopter of the enhanced audit report, said: "In accepting the enhanced audit reporting, the company is on notice to ensure that the key matters identified have been adequately addressed and should be ready to answer any questions from its investors on these matters."

She also pointed out that the adoption of the enhanced audit report would not replace the need for management, the audit committee and the external auditors to hold substantive discussions on audit matters.

"It will certainly give rise to more substantive dialogue to ensure that the company and especially its audit committee have line of sight on the key matters raised in the audit report and have adequately addressed all concerns."

Given that such discussions already take place between companies and their auditors, the new audit reporting requirements should not mean more work for companies.

Conclusion

Still, however more informative the new audit report may be, however much more clarity it may provide on a company's financials, it can only be relevant if investors understand how to use it effectively.

As Mr Gerald points out: "Such information is only as good as it is used.

"Hence, investors should strive to use such information to deepen their engagement with companies and pose more discerning questions so as to demand accountability from the companies. It should prompt them to ask those questions that matter in the AGMs (annual general meetings)," he said.

Prof Mak adds: "I hope that investors will not take the quality of financial reporting and audit reporting as a given, and will instead use the enhanced reports as a tool for better engagement with directors, management and auditors."