Secrets of Auditors … Finally Revealed!

By in Accounting and Finance, Business Trends, Opinion

Auditors have been keeping secrets for a long time…

As you can imagine, the role of auditors requires very high levels of independence, confidentiality and prudence. This is due to the market sensitive information we obtain, evaluate, discuss with management and Boards and for which ultimately, we form an opinion in respect of an external financial report. What we learn in the course of our engagements can be most revealing and you can imagine how sensitive both management (in the first instance) and Boards are to auditors – being aware of issues like poor financial and operational performance, potential breaches of the corporate law, breaches of accounting standards, inadequate internal control systems or potential impairments of acquired goodwill and other intangible assets.

Rigorous discussions can occur, and they do, and so they should.

If those charged with governance (TCWG) – being management and Boards – are not having very thorough and searching discussions with their auditors then I suggest something is very wrong; because those TCWG and the auditor have similar levels of responsibility and liability when they sign their respective reports. Ultimately, stakeholders want an audited financial report they can rely upon and for which adequate care, diligence and foresight have been conducted by all parties.

But here’s the thing… previously for entities like listed entities, the Independent Auditor’s Report required merely a “Yes or No” decision on the over-riding question of “does the financial report present a true and fair view of the financial position and performance of the Company for the period and in accordance with the accounting policies”? If the answer of the auditor was “Yes”, then Q.E.D. that’s the end of the argument and the auditor said no more. If the answer was “No”, well oh dear, that could result in in a modification to explain why not. When Boards are confronted with a potential “No” position from the auditor, then that can tend to re-evaluate their stance on the measurement or disclosures in their financial report, making appropriate changes such that the auditor returns to the “Yes” position and the secret of the issues debated remain in the audit file not to be revealed!

So, let’s refer to the discussions, debates and sensitive issues which have been documented in the audit file as the “Chamber of Secrets”.

Until recently, the only way to look into the “Chamber of Secrets” was to know the right questions to ask the auditor at the Annual General Meeting (AGM). Strangely enough, it is a rare occasion that auditors are ever asked questions at an AGM and even where they are, the corporations law has a narrowly defined scope on which the auditor can elaborate from their knowledge.

An example of how narrow the scope for questions of an auditor, are illustrated from an AGM where a shareholder – in a most assertive manner – asked me how I could possibly conclude that remuneration paid to the Key Management Personnel was “fair and reasonable,” because the extent of the payments in his view were completely excessive. It was a dramatic and very intimidating question which set my heart racing with concern as to whether we had overlooked this issue? With a deep breath and fast thinking, I answered the shareholder by thanking him for his question, noting that our opinion requires a determination of whether the remuneration is stated fairly and reasonably, not whether it is in fact fair and reasonable and thus handing the question back to the Chair and keeping the “Chamber of Secrets” firmly closed!

So, what’s changed?

The introduction of enhanced auditor reporting or long form audit reports has completely changed the landscape of financial reporting in Australian and New Zealand. Auditors are required to disclose the “Key Audit Matters”, being those matters which in our professional judgement were of most significance in our audit of the financial report. The long form audit report then discloses each of those matters and how the auditor addressed these matters in their work.

The types of key audit matters which most typically are being disclosed by auditors are:

  • Impairment of goodwill / other intangible assets
  • Valuation of property, plant and equipment
  • Revenue recognition
  • Business combinations and acquisitions
  • Financial instruments
  • Inventories
  • Provisions
  • Going concern basis

The auditor is required to tailor these key audit matters to the particular circumstances of the company, making it as relevant as possible. Where this is done properly, rather than the boiler plate approach which auditors, standard setters and regulators are all keen to avoid, it can make for informative reading. The CFO is typically the first member of TCWG to read and discuss the draft long form audit report with the auditor and has a key role to play ensuring the accuracy and completeness of the key audit matters.

If I was the CFO, I would maintain control of the reporting process with relevant and appropriate discloses in the original draft of financial report, which satisfies the auditor and enables the auditor to minimise their reporting by referring back to the disclosures in the financial report. This approach is far more likely to time efficiently and effectively, address the key audit matters and to cross reference these matters to disclosures in the financial report.

In terms of the number of key audit matters, “the ball lands where the ball lands”, meaning it is normally self-evident which are the key audit matters; but the interesting question likely to arise when university research is conducted, will be around whether there is a correlation between the number of key audit matters reported and the volatility of the Company’s share price. In other words, do companies which have a higher number of key audit matters also represent a higher level of risk for investors?

The smarter CFO’s [and/or Audit Committee Chairs] will insist that auditors present their draft long form audit reports in the planning stage of the audit, to minimise the possibility of any surprises closer to signing date. While key audit matters should be assessed all the way up until the audit report is finalised, it is likely that most of the matters will have been identified earlier. The CFO can add value for the company by recommending that key audit matters be consolidated. For example, where there have been similar business acquisitions made during the period, then consider whether these can be rolled into the one matter – given that the auditor will have probably addressed the acquisitions with similar audit procedures. Ultimately it will depend of the respective circumstances, but the constructive input of CFO’s early in the audit process should be welcomed by auditors.

So, there you have it, the auditor’s “Chamber of Secrets” is now officially opened and my expectation is that shareholders will read the key audit matters and direct more detailed and searching questions to Boards and auditors at AGM’s in future.

The real secret lies with CFO’s who can prepare high quality financial reports which fully disclose the financial performance and position of the Company; and throughout the process to proactively work with auditors to best reflect the key audit matters emanating from the financial report.

0 Comments

Leave a reply

Your email address will not be published. Required fields are marked *

*

Do NOT follow this link or you will be banned from the site!