Changes in the Auditor s Report A fundamental shift

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1 Changes in the Auditor s Report A fundamental shift 16 March 2016 Arslan Khalid Institute of Chartered Accountants of Pakistan

2 Contents Background - Why change the auditor s report What is changing - New and revised audit reporting requirements Application in UK and US and other countries Legal requirements in Pakistan for auditor s report Implementation Issues and challenges in Pakistan Page 2

3 Why change the auditor s report? The Financial Crisis of 2008 brought into focus the concerns of investors and regulators about the auditor s report on the financial statements In particular, it was felt that the binary ( Pass / Fail ) auditor s report may not provide adequate transparency about the audit and the auditor s insights about the company based on its work The IAASB;s work to develop new audit reporting standards responds to this call to provide more entityspecific and relevant information in the auditor s report Page 3

4 What is changing? The auditor s report is the key deliverable addressing the output of the audit process To enhance the communicative value and relevance of the auditor s report, the IAASB has introduced new and revised Auditor Reporting Standards in January 2015 These standards require various enhancements in the auditor s report including the Communication of Key Audit Matters in the audit report The implementation of the new and revised standards will represent a significant change in the audit reporting practice Page 4

5 New and revised Auditor Reporting ISAs ISA 700 (Revised) Overarching Standard for Auditor Reporting NEW ISA 701 Key Audit Matters ISA 705 (Rev) Modifications to auditor s opinions ISA 570 (Rev) Going concern (including revised reporting) ISA 720 (Rev) Other information (including new reporting) Revisions to ISAs 260 and 706 as a result of ISA 701, and conforming amendments to related ISAs All ISAs effective for audits of financial statement for periods ending on or after 15 December 2016 Page 5

6 Key enhancements to the auditor s report New section to communicate Key audit matters (KAM) KAM is the heart of the revised auditor s reports for listed entities KAM are those matters that, in the auditor s judgement were of most significance in the audit of the financial statements ISA 701 sets out requirements and guidance for the auditor s determination and communication of key audit matters Page 6

7 Other Enhancements Going Concern A separate section with the heading Material uncertainty related to Going Concern is required in the auditor s report to highlight the existence of any material uncertainties related to going concern (instead of reporting under Emphasis of Matter para) New descriptions of responsibilities related to going concern to be included in the respective sections for management and auditor responsibilities A new requirement for auditor to evaluate the adequacy of disclosures in going concern close call situations Page 7

8 Audit report to state Management responsibilites In preparing the financial statements, management is responsible for assessing the Company s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Group or to cease operations, or has no realistic alternative but to do so Page 8

9 Other Enhancements (continued) Other Information in the Annual Report Identification in the auditor s report of what comprises the other information such as Director s report, Chairman review and other financial analysis etc, The responsibilities of the management and the auditors in relation to other information A statement that the other information is materially consistent or not consistent with the financial statements Page 9

10 Audit report to state Other information [or other appropriate title] Management is responsible for the other information. The other information comprises the director s report, analysis etc.. Our opinion on the financial statements does not cover the other information and we do not express any form of assurance conclusion thereon. In connection with our audit of the financial statements, our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the audit or otherwise appears to be materially misstated. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact. [We have nothing to report in this regard [or a statement that describes any material misstatement of the other information]]. Page 10

11 Other Enhancements (continued) Enhanced description of both the responsibilities of the auditor and key features of an audit Identification of Those Charged With Governance within the management s responsibilities section An affirmative statement about the auditor s independence and the auditor s fulfillment of relevant ethical responsibilities Disclosure of name of the engagement partner for listed entities Page 11

12 Form of Audit Report under revised standards Independent Auditors Report Report on the Audit of the Financial Statements Opinion Basis for Opinion Material Uncertainty Related to Going Concern (if applicable) Emphasis of Matter (if applicable) Key Audit Matters Other Matters (if any) Other Information (if applicable) Responsibilities of Management and TCWG for the Financial Statements Auditors Responsibilities for the Audit of Financial Statements Report on Other Legal and Regulatory Requirements The engagement partner on the audit [name]. Signature, Address and Date Page 12 Current Audit Report Identification of financial statements audited Management s responsibilities Description of audit scope Audit opinion

13 Appendix 1: Illustrative auditor s report Page 13

14 The new auditor s report (Extracted from ISA 700 (Revised) - Forming an Opinion and Reporting on Financial Statements) INDEPENDENT AUDITOR S REPORT To the Shareholders of ABC Company [or Other Appropriate Addressee] Report on the audit of the financial statements Enhancements to the auditor s report Opinion We have audited the financial statements of ABC Company (the Company), which comprise the statement of financial position as at December 31 20X1, and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies. In our opinion, the accompanying financial statements present fairly, in all material respects, (or give a true and fair view of) the financial position of the Company as at 31 December 20X1 and (of) its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards. Basis for opinion We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities under those standards are further described in the Auditor s responsibilities for the audit of the financial statements section of our report. We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the financial statements in [Country], and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Key audit matters Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the financial statements of the current period. These matters were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. [Description of each key audit matter in accordance with ISA 701.] Page 14 Opinion first. The auditor s opinion the pass/fail statement that users have said they continue to value is required to be positioned at the beginning of the report, followed by the Basis for Opinion. Required Basis for Opinion section. Currently required only when the auditor s opinion was modified. New affirmative statement about the auditor s fulfillment of independence and other relevant ethical responsibilities requirements. The new KAM section is the centerpiece of the revised auditor s report. Required for audits of listed entities, but may be applied voluntarily to other audits.

15 The new auditor s report Other information [or other appropriate title] Management is responsible for the other information. The other information comprises the [information included in the Annual Report, but does not include the financial statements and our auditor s report thereon.] Our opinion on the financial statements does not cover the other information and we do not express any form of assurance conclusion thereon. In connection with our audit of the financial statements, our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the audit or otherwise appears to be materially misstated. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact. [We have nothing to report in this regard [or a statement that describes any material misstatement of the other information]]. Responsibilities of management [and those charged with governance] for the financial statements Management is responsible for the preparation and fair presentation of the financial statements in accordance with IFRSs, and for such internal control as management determines is necessary to enable the preparation of financial statement that are free from material misstatement, whether due to fraud or error. In preparing the financial statements, management is responsible for assessing the Company s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Group or to cease operations, or has no realistic alternative but to do so. New descriptions of management s responsibilities relating to going concern. Intended to reflect the requirements of the applicable financial reporting framework. Identification of TCWG is required when a separate body exists that is responsible for the oversight of the financial reporting process (in many cases, the audit committee). When individuals responsible for such oversight are also responsible for the preparation of the financial statements, no reference to oversight responsibilities Is required. [Those charged with governance] are responsible for overseeing the Company s financial reporting process.] Page 15

16 The new auditor s report Auditor s responsibilities for the audit of the financial statements Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements. As part of an audit in accordance with ISAs, we exercise professional judgment and maintain professional skepticism throughout the audit. We also: Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company s internal control. Expanded description of the auditor s responsibilities, including key features of the audit. The auditor's responsibility section is intended to explain more fully the concept of a riskbased audit, as well as to clarify the meaning of certain audit-technical terms. This approach results in a fuller description of the auditor s responsibilities in relation to specific matters, including fraud; internal control, accounting policies and estimates, evaluating the overall presentation, structure and content of the financial statements and disclosures, group audits, and communications with TCWG. Because of the increased length of this section, ISA 700 include a provision that certain components of this description may be presented in an appendix to the auditor s report or, where law, regulation or national auditing standards expressly permit, by reference to a website of an appropriate authority. Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management. Page 16

17 The new auditor s report Auditor s responsibilities for the audit of the financial statements (continued) Conclude on the appropriateness of management s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Company s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor s report to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor s report. However, future events or conditions may cause the Company to cease to continue as a going concern. New descriptions of responsibilities relating to going concern. Reflects responsibilities under ISA 570, which are required regardless of the applicable framework. Evaluate the overall presentation, structure and content of the financial statements, including the disclosures, and whether the financial statements represent the underlying transactions and events in a manner that achieves fair presentation. [[For group audits] Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Group to express an opinion on the consolidated financial statements. We are responsible for the direction, supervision and performance of the group audit. We remain solely responsible for our audit opinion.] We communicate with [those charged with governance] regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit. We also provide [those charged with governance] with a statement that we have complied with relevant ethical requirements regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards. From the matters communicated with [those charged with governance], we determine those matters that were of most significance in the audit of the financial statements of the current period and are therefore the key audit matters. We describe these matters in our auditor s report unless law or regulation precludes public disclosure about the matter or when, in extremely rare circumstances, we determine that a matter should not be communicated in our report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication. Report on other legal and regulatory requirements [The form and content of this section of the auditor s report would vary depending on the nature of the auditor s other reporting responsibilities prescribed by local law or regulation] The partner in charge of the audit resulting in this independent auditor s report is [name]. [Signature] [Auditor address] [Date] A separate section (when applicable) relating to other information in an annual report. More information will be shared on the revised auditor s responsibilities, including its new reporting requirements, when ISA 720 The Auditor s Responsibilities Relating to Other Information is released in 2 nd quarter of Disclosure of the name of the engagement partner for audits of listed entities. Already common practice in many jurisdictions, the name of the engagement partner is now included in auditor s reports under the ISAs, but is only required for audits of listed entities. Page 17

18 Closer look Reporting of Key Audit Matters Those matters that, in the auditor s professional judgment, were of most significance in the audit of the financial statements for the current period Significant audit risks : areas of risk of material misstatement in the financial statements Significant judgmental areas in the financial statements: accounting estimates with high estimation uncertainty Significant events or transactions during the year: with the effects on the financial statements Page 18

19 Closer look Reporting of Key Audit Matters Going concern assessment Revenue recognition Effect of new accounting standards Impairment of assets Valuation of financial instruments Measurement of retirement benefit plan liabilities Disposal of a business unit Business combination and accounting impacts Deferred Taxation Goodwill impairment Provisions for contingencies Page 19

20 KAM - Decision-making framework Matters communicated with TCWG Matters requiring significant auditor attention KAM: Matters of most significance in the audit Auditor s communication of significant matters to the Board ( Those Charged with Governance ) should be the starting point to determine the Key Audit Matters The number of KAMs will vary depending on the size and complexity of the entity and the nature of its business environment Page 20

21 Sensitive matters ISA 701 allows for the possibility, in extremely rare circumstances, that the auditor might decide not to communicate a matter when: Laws or regulations preclude a disclosure such as a matter that may prejudice an investigation of illegal act Adverse consequences on the entity are expected to outweigh the public interest benefits of communication This is a complex decision and involve significant auditor judgment. Accordingly, the auditor may consider it appropriate to obtain legal advice Page 21

22 KAM what to state Description of each KAM in the auditor s report required to include: Why the matter was considered to be one of most ` significance in the audit How the matter was addressed in the audit audit approach and overview of procedures performed with an indication of outcome Reference to the related disclosure(s) Page 22

23 KAM points to note Should be specific to the entity avoid generic or standardized language Does not imply that the matter has not been appropriately resolved in the audit - KAM is Not an Audit Qualification KAM is not a substitute for disclosures required in financial statements Does not imply discrete opinions on separate elements of the financial statements Page 23

24 KAM expected impacts KAM does not change the audit scope Nor does it change the responsibilities of the Board (TCWG) and the management in relation to the financial statements KAM only intends to highlight Through the Eyes of the Auditor matters of most significance Will provide users of the financial statements a basis to further engage with the management and may be with the auditors Will require Enhanced communication between the Auditor and the Audit Committees Page 24

25 Appendix 2: Key audit matters an illustration Page 25

26 Key audit matters an illustration Goodwill [Why a matter was determined to be a KAM] Under IFRSs, the Group 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 31 December 20X6 is material to the financial statements. In addition, management s assessment process is complex and highly judgmental and is based on assumptions, specifically [describe certain assumptions], which are affected by expected future market or economic conditions, particularly those in [name of country or geographic area]. [How a KAM was addressed in the audit] Our audit procedures included, among others, using a valuation expert to assist us in evaluating the assumptions and methodologies used by the Group, in particular those relating to the forecasted revenue growth and profit margins for [name of business line]. We also focused on the adequacy of the Group s disclosures about those 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. [Refer to the related disclosures] The Company s disclosures about goodwill are included in Note X, which specifically explains that small changes in the key assumptions used could give rise to an impairment of the goodwill balance in the future. Page 26

27 Practice in UK Audit Committee UK Corporate Governance Code require to publish in the annual report a separate report describing the work of the Audit Committee including the significant issues that the Committee considered in relation to the financial statements and how these issues are addressed Auditors Extended audit report A description of significant risks An explanation of how the auditor applied the concept of materiality; and A summary or the audit scope, including response to the significant risk and application of the concept of materiality Page 27

28 Audit Reports issued in UK Rolls Royce Holding plc Vodafone Group plc 6 Pages Report 7 Significant Risks reported Key risks include revenue recognition, consolidation of SPV, provisions for contingencies, Bribery and corruption 8 Pages Report 7 areas of focus reported Key risks include Taxation, Goodwill valuation, IT system and controls, revenue recognition Page 28

29 PCAOB proposals for changes in the audit reporting model In 2013 PCAOB proposed a new auditing standard to enhance the auditor s report The proposed new standard require the communication of Critical Audit Matters as determined by the auditor Enhancements to existing language have also been related to auditor s independence, auditor s responsibilities for fraud and other information in the annual report The effective date of the standard in not yet specified Page 29

30 Adoption in other countries Singapore adopted the revised standard effective 2016 Malaysia adopted the revised standard effective 2016 Australia comment period over for the exposure draft, effective date yet to be notified India auditing standards are aligned to ISAs and therefore, expect the Indian institute to adopt the standard in due course Saudi Arabia Planned to adopt in 2017 Page 30

31 Implementing the Change Audit Regulators Audit Firms Audit Committees Page 31

32 Implementing the Change National auditing standard setters to consider the change in view of the Laws and Regulations in their respective jurisdictions Audit firms have commenced the important work of developing implementation guidance, training and communications to educate the audit teams Audit Committees and CFOs to engage with the auditors at an early stage to identify potential KAMs and how these matters are currently addressed in the disclosures in the financial statements, director s report and CCG report Page 32

33 Laws and regulations in Pakistan Section 255 (3) of the Companies Ordinance, 1984 prescribes the contents of the auditor s report which include opinions on the following True and fair view of the financial statements: AND Completeness of information obtained for the purposes of audit Proper Books of accounts Compliance with the requirements of the Companies Ordinance, 1984 with regard to the accounts Expenditure incurred, investments made and business conducted for the purposes of the company s business and objects Page 33

34 Laws and regulations in Pakistan Form 35 A Auditors Report in case of Companies Form 35 B and SECP s directives Auditors Report in case of Banks Auditors Report for Insurance Companies Form 35 C Auditor s Report on Consolidated Financial Statements Page 34

35 Suggested Approach to Change in the legal forms relating to the auditor s report Independent Auditors Report Report on the Audit of the Financial Statements Opinion Basis for Opinion Material Uncertainty Related to Going Concern (if applicable) Emphasis of Matter (if applicable) Key Audit Matters Other Matters (if any) Other Information (if applicable) Responsibilities of Management and TCWG for the Financial Statements Auditors Responsibilities for the Audit of Financial Statements Report on Other Legal and Regulatory Requirements The engagement partner on the audit [name]. Signature, Address and Date Page 35 Opinions required by the Companies Ordinance, 1984 in addition to the opinion on the financial statements (true & fair view) may be reported under a separate section of the report in accordance with the ISAs

36 Role of Audit Committee As per the requirements of the Code of Corporate Governance for listed companies, the Audit Committee is required to review the financial statements prior to their approval focusing on: Major Judgmental areas The going concern assumption Any changes in the accounting policies and practices Compliance with accounting standards and other regulatory requirements Significant adjustments resulting from the audit Significant related part transactions Page 36

37 Public reporting by directors Section 236 of the Companies Ordinance, 198 requires the Director s Report to contain he fullest information and explanation with regard to any reservation, observation, qualification or adverse remarks contained in the auditor s report Under the listing regulations every listed company shall immediately disseminate material information such as merger or acquisition or loss of any material contract; purchase or sale of significant assets; any unforeseen or undisclosed impairment of assets due to technological obsolescence, etc Page 37

38 Suggestions We should take a holistic approach to incorporate the required changes in the laws and regulations The UK Model which requires both the Auditors and the Audit Committee to report on Key audit matters can be followed As we state in the audit report that the audit has been conducted in accordance with the ISAs, therefore, the form and content of the audit report should also comply with ISAs Page 38

39 Implementation Issues and challenges Auditor s report may be seen as the primary source of information about a company Key Audit Matters may be confused with auditor s observations or concerns Regulators and tax authorities may require additional information about Key Audit Matters or challenge the auditors rather than the management Changes in laws and regulations required to implement the change Page 39

40 Conclusion If you change the way you look at things, the things you look at change. Wayne Dyer Need to hold more awareness sessions and roundtables with investors, audit committees, regulators and all stakeholders to see their views on the potential changes to the auditor s report BEFORE deciding the date of implementation Page 40

41 Thank you Institute of Chartered Accountants of Pakistan

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