I’ve seldom mentioned audit matters on this blog – it’s not the area that primarily concerns or interests me…
It’s worth spending a few moments though on pending changes to the current environment. Most imminently, Canadian Auditing Standard (CAS) 700 Forming an opinion and reporting on financial statements brings in an array of changes applying for audits of financial statements with periods ending on or after December 15, 2018 (with early application permitted). Among other things, the opinion paragraph will in future come at the start of the report rather than at the end, and the descriptions of relative responsibilities of the auditor and of management will be enhanced. For listed entities, the new standard requires disclosing the name of the engagement partner. All of this alone will change the look and length of the “standard” report considerably.
CAS 701, Communicating Key Audit Matters in the Independent Auditor’s Report, effective at the same time, is of even greater interest. This applies “when the auditor is required by law or regulation or decides to communicate key audit matters in the auditor’s report.” At the moment, Canadian auditors aren’t required to do that by law or regulation – a recent Canadian Accountant article suggested such a requirement might become effective only in 2020. In the meantime then, such matters will only be reported when the auditor “decides to” do it – I don’t have any sense of how often that might be.
These “Key Audit Matters” are matters that, in the auditor’s professional judgment, were of most significance in the audit of the entity’s financial statements of the current period. Under CAS 701, each of these will be described in a separate section of the auditor’s report, using an appropriate subheading. Here’s an example, from a CPA Canada Audit and Assurance alert, of how that might look:
- Under IFRSs, the Company is required to annually test the amount of goodwill for impairment. This annual impairment test was significant to our audit because the balance of $XX as of December 31, 20X1 is material to the financial statements and management’s assessment process is complex and highly judgmental and is based on assumptions, specifically [describe significant assumptions], which are affected by expected future market or economic conditions, particularly those in [name of country or geographic area] and cause a high degree of estimation uncertainty.
- Our audit procedures included, among others, using the work of a valuation expert to assist us in evaluating the methodologies, assumptions and data used by the Company, in particular those assumptions relating to the forecasted revenue growth and profit margins for [name of business line]. We also focused on the adequacy of the Company’s disclosures about those significant assumptions to which the outcome of the impairment test is most sensitive, that is, those that have the most significant effect on the determination of the recoverable amount of goodwill and cause the high degree of estimation uncertainty.
- The Company’s disclosures about goodwill are included in Note X, which specifically explains that small changes in the significant assumptions used could give rise to an impairment of the goodwill balance in the future.
The potential benefits of this might be (as a Swiss Deloitte publication put it in addressing a similar requirement in that country) that “no two reports will look the same. Up until now, users would merely look out for the pass/fail opinion and ignore the rest of the report. A more relevant report may improve the user’s interest in the auditor’s report and their understanding of the audit, adding to the credibility and value of the audit.”
Or it may not. Based on the polling at a recent CPA Canada outreach event “nearly 50 per cent think (reporting KAMs) will be of value to investors, 25 per cent are undecided and 25 per cent disagree. So more evidence is needed.” I’m probably in the undecided category myself. Taking the example above as a reference point, the added information might be useful I suppose to someone who’d never thought much about the nature and scope of an audit before (although as usual, the behavioral question intervenes – that is, how likely would such a person be anyway to read and contemplate all the content of the new expanded report?) but over years of repeated reporting it’s not hard to see how it might congeal into boilerplate (although no doubt various levels of regulatory scrutiny and intervention will be fighting against that). If you assess the example critically, you might conclude that all it really says is that goodwill is an especially tricky concept which carries particular risk of being written down in the future, and so is really hard to audit – none of which carries much information content for anyone even vaguely familiar with the territory. In other cases though, of course, the areas highlighted as KAMs might be more subtle or esoteric.
The recurring problems might be similar to those arising in the existing note disclosures of significant judgments and estimates – regulators have frequently pointed out how often these fail to highlight the most significant matters and/or to discuss them with sufficient specificity. Anyway, it’ll be interesting to see how all this develops…
The opinions expressed are solely those of the author