5 Jun 2014 04:08pm

Audit reports: what next?

In January, I commented on the first few long-form audit reports. It was a huge but exciting challenge and we were already seeing some great examples. I also said that the real test would be whether the reports caught the attention of the investment community – the shareholders who are the ultimate client – and if they voiced their views on what is valuable and what isn’t

With the December reporting season over we’ve taken stock and you can read about what we found in our survey and economia’s “New audit reports go down a storm with investors".

The highlight for me is the fact that audit reports are being read with real interest by investors. It’s a broad range of investors: those focused on governance are, of course, leading the field, but I also hear that, for example, individual fund managers and buy-side analysts are showing a strong interest. They are also being vocal about what they do and don’t value, for example becoming discerning about the quality of the auditor’s description of the risk and his work in response. Lastly, the reports have shed transparency on audit coverage and materiality; the precursor to a valuable conversation on this topic.

Overall, I am enormously encouraged that the new audit reports are a trigger for better dialogue between the audit profession and the investment community. This can only be to the good.

There is an elephant in the room: the new rules require reporting only on the audit risks and the auditor’s response, but not the auditor’s findings

So far so good. But I’m already thinking about where we go next. I flagged this question in January, but now we need to answer it. For example, one of the challenges of the second year will be to keep it fresh. That’s quite difficult if the audit risks at a company remain the same – and it’s true to say that they rarely change dramatically from year to year. The better reports this year were specific as to why the issue was significant and that will add valuable colour year-on-year.

Yet there remains a risk that year two could look rather similar to year one. Hmmm. Perhaps there is something that can be done to describe how the auditor identified the significant risks, provided it can be kept specific rather than semi-standard.

However, in terms of “what next?” there is an elephant in the room: the new rules require reporting only on the audit risks and the auditor’s response, but not the auditor’s findings. Why? I believe it is better to talk about this, rather than pretend that the elephant isn’t there. So with the agreement of three of our clients we did a live field test of exactly that idea. In three reports we included our findings on, for example, how acceptable were the policies, the estimates and the disclosures; expressed in a graduated way rather than a binary, “acceptable-vs-unacceptable” way – adding more colour. To paraphrase one of our findings, shouldn’t audit reports be more than mildly interesting?

Indeed, these reports have attracted keen interest amongst investors. It enables them to engage on accounting issues, for example to seek and react to more transparency of accounting estimates and judgements. Those that I have spoken to have certainly voiced their views that audit reports that include findings are highly valued. I might even call a “game changer”. However, it has not yet become nearly so much of a talking point among companies. That is a shame. Even though I can understand companies’ caution – which probably isn’t wholly about the transparency itself, but also about its coming from the auditor rather than from the company or its audit committee – it’s vital that companies are involved in a public debate with investors about whether this is the way forward.

The UK’s FRC has led the world with this year’s audit reports. Even the New York Times recently ran a piece praising UK audit reporting. And the FRC may be forced to go still further from 2016, subject to interpretation, as the mint-new EU Audit Regulation (see our survey) appears to require findings in audit reports – the detail is being debated as the cellophane is removed. But for me that would be too late, an opportunity missed, the momentum lost.

I believe that the FRC could continue to lead the EU and the world on whether and how to report findings, based on a consensus of investors and companies. After all, audit is about facilitating stewardship: the relationship between shareholders and the company. The FRC and audit profession need to be thinking about what more we can do together to promote that.

Tony Cates Tony Cates, Head of Audit, KPMG in the UK



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