Third-party disclaimers have been a standard feature of audit reports for many years. Ever since the judgement in the Bannerman case in 2002, audit reports have featured standard clauses in which the auditors state that they are only respon - sible to the company and its shareholders for their audit work, audit opinion and audit report, and not responsible to anyone else.
The Bannerman paragraphs were introduced when audit reports looked very different from those in place today. The old-style stark audit reports, little more than a couple of paragraphs with an opinion baldly stated, are things of the past. Reports for all entities have got longer, setting out the work the auditors have performed and the main issues they have encountered.
The new detail in the audit reports left many auditors scratching their heads to work out what this might mean for their third-party disclosures. Should they stay the same or did they need to be changed? And where should they sit in their reports? ICAEW decided to do as it did originally when the issue of disclaimers first arose and take legal advice on the matter. The result of this advice and subsequent discussions with stakeholders is new guidance for practising members, which came out in May 2018.
The upshot is that the wording of the disclaimer should stay the same; but the position it takes in the audit report should change. MORE TO REPORT Extended audit reports have been in place for companies applying the UK corporate governance code for several years now, with the large firms who perform these audits taking a very much bespoke approach to the way in which they report to the companies’ shareholders. Changes to auditing standards mean that for accounting periods starting from 17 June 2016 onwards, audit reports of private companies have to include more detail than before.
These reports now require the auditor to report on going concern and other information, together with more detailed descriptions of the responsibilities of the directors and auditor. In addition, the position of the audit opinion within the report has been moved to the start. This raised a question on the location of thirdparty disclaimers.
The original ICAEW technical guidance on this, TR 01/03, suggested putting the Bannerman clause as the second paragraph of the audit report. With the opinion now taking precedence, the question was whether the disclaimer should be moved.
Soon after the new reports started being issued it became clear that there was no consensus among practitioners on where the disclaimer should sit. Firms had realised there was a problem, but had come up with different answers, says David Chopping, partner at Moore Stephens and chair of ICAEW’s Technical and Practical Auditing Committee.
“There were merits in the different treatments. You’d look at what one firm had done and think, that seems reasonable. Then you’d see how another had dealt with this differently and think, that seems reasonable too.” To start with, counsel considered how effective the Bannerman clause is. This disclaimer has only been tested once in the courts, in a case brought by Barclays against Grant Thornton in 2015 and which the bank lost.
“This showed that the Bannerman paragraph works, which is a very positive message,” says Chopping. The legal advice received by ICAEW honed in on consistency, both of the wording and the paragraph’s position in audit reports.
“The ICAEW guidance says it is desirable that the same wording should appear in the same position across audit reports, as this consistency will promote clarity in the scope of the auditor’s responsibility,” says Sophie Campkin, technical manager in the Audit and Assurance Faculty.
The revised ICAEW guidance is that the Bannerman paragraph should sit in the final section of the audit report, after the opinion and all the items that need to be included and directly preceding the auditor’s signature. The wording of the suggested disclaimer is unchanged. The decision on location was reached after much debate, says Chopping. “It seems logical to most people that it should go either close to the start or close to the end, as being hidden in the middle would not seem to work. Most people are now fine with it being at the end.”
However, not everyone is happy with the change. Peter Upton, sole practitioner and member of the Audit and Assurance Faculty Committee, sees the new location as a backward step. “I think the disclaimer was better placed in the second paragraph,” he says. “This gives it a prominence. It tells you who the report is addressed to, who is intended to benefit from it and who is not intended to benefit from it. It’s making this clear upfront before you go into all the other detail.”
Meanwhile the FRC says that putting the Bannerman paragraph at the end is sensible. “It avoids giving it undue prominence in the auditor’s report, and it avoids the risk that any caveat is considered in the context of the auditor’s opinion,” says Mark Babington, deputy director, Audit Policy. This is despite the fact that the FRC does not support the use of Bannerman paragraphs. “Anything that caveats the auditor’s work undermines user confidence in the audit, which is not in the public interest,” says Babington.
“Bannerman paragraphs are not included to be of use to the users of financial statements. They are a risk management tool developed by audit firms. Auditors should think carefully about reservations they put on who the audit is undertaken for – especially as many stakeholders now seem much more interested in more and wider assurance, and the range of stakeholders expressing an interest in the audit is becoming more diverse.”
Chopping does not see the problem with disclaimers being risk management tools (“That’s the intention!” he states). However, he points out that the disclaimer is also a statement of the law. “I find it difficult to see how you can object to someone stating what the law is as we understand it.
The Bannerman paragraph has been tested by the courts in the Barclays v Grant Thornton case and its use has been upheld. It seems perfectly reasonable for an auditor to state the law of responsibility around the audit in their report.” And yet that responsibility might change over time. Any variation could affect the people to whom the auditor was responsible or the scope of the audit work – both of which would require a change in the law. The issue of whether auditors should audit the entire annual report has come up many times over the years. The question, says Chopping, is not just should the auditors do that but, if they do, how would they do that? “How do you audit a statement of the company’s plans for the next five years? Or how do you audit management’s intentions? You can’t audit these in the sense that we audit at the moment. But if you can do something, you need to make sure people understand the extent of what you are doing. Many people think we should be doing more on the front half of the annual report, but there’s less agreement as to what this ‘something more’ should be. That’s why this debate has been ongoing for some time and why it won’t be going away for some years.”
In the meantime, ICAEW continues to advocate use of the Bannerman paragraph. “This has been accepted practice by the profession for 15 years,” says Campkin. “The wording of the paragraph itself is unchanged as a result of the guidance. The Bannerman paragraph does not affect auditors’ obligations to their clients, which are the same as they have always been: in fact it clarifies that the audit is for the benefit of the company’s members.”
Most practitioners reporting on private companies use accounts preparation software for the financial statements and audit reports. This means that they will need to be aware of the change in the recommended position of the Bannerman paragraph and bear in mind that this will take time to flow through to the software they are using. Practitioners should talk to their software provider and ask when the changes will be made, advises Peter Upton. “Once you know when the change will happen, be aware that you will have to re-write bits of the audit report in the interim to reflect the revised guidance.”