Wanted: True and Frank View

By Errol Oh

NEXT month, Kuala Lumpur will be the venue for the last of three roundtables organised by the International Auditing and Assurance Standards Board (IAASB) to gather feedback on the board's proposals to improve the auditors' report on financial statements.

Considering that the first two legs were held earlier this month in New York and Brussels, it's quite an honour for KL to host the final one. And the topic of discussion is significant.

“The auditor's report is the auditor's primary means of communication with an entity's stakeholders,” Prof Arnold Schilder wrote in the chairman's statement of a document issued in June by the IAASB, an independent standard-setting body.

“It is generally a short, standardised report that describes the financial statements subject to audit, the audit itself, and the respective responsibilities of management and the auditor. A cornerstone of the auditor's report is the auditor's opinion, which is either a clean' (unmodified) or modified opinion with an explanation of the basis for such.”

(In Malaysia, those responsible for a company audit are usually referred to in the plural form of auditors', and the report is accordingly called the auditors' report'.)

Titled Improving the Auditor's Report, the IAASB document is an Invitation to Comment (ITC) that encourages stakeholders to respond to the board's suggestions on how the report can be changed so as to be more relevant, informative and useful.

The suggested improvements set out in the ITC include:

Having “Auditor Commentary” in the auditors' report. This is additional information to highlight matters that the auditors believe are likely to be most important to users' understanding of the financial statements or the audit. The plan is to make such information a requirement for public interest entities (PIEs). In the Malaysian context, PIEs include listed companies, banking and financial, insurance companies and takaful operators, and holders of Capital Market Services Licences (such as securities and futures trading firms, and fund management companies).

Auditor conclusion on the appropriateness of management's use of the going concern assumption in preparing the financial statements and an explicit statement as to whether material uncertainties in relation to going concern have been identified.

Auditor statement as to whether any material inconsistencies between the audited financial statements and other information have been identified based on the auditor's reading of other information, and specific identification of the information considered by the auditor.

Prominent placement of the auditor's opinion and other entity-specific information in the auditor's report If these become part of the international auditing standards, users of accounts will know more about the audit work done and the thoughts of the auditors.

Currently, a “clean” audit opinion in Malaysia is typically no more than a single sentence, albeit a long one, that offers the auditors' opinion that the financial statements “have been properly drawn up in accordance with Financial Reporting Standards and the Companies Act, 1965, in Malaysia so as to give a true and fair view” of the company's financial position and performance, and cash flows.

Such a succinct and flat statement is a disproportionate product of an audit. The audit opinion is supposed to be the result of a lot of time, effort and judgement, and yet it's merely a simple thumbs up.

Schilder, the IAASB chairman, says it best in the ITC: “More than ever before, however, users of audited financial statements are calling for more pertinent information for their decision-making in today's global business environment with increasingly complex financial reporting requirements.

“The global financial crisis also has spurred users, in particular institutional investors and financial analysts, to want to know more about individual audits and to gain further insights into the audited entity and its financial statements. And while the auditor's opinion is valued, many perceive that the auditor's report could be more informative. Change, therefore, is essential.”

The IAASB's suggested improvements certainly represent a step in the right direction. Hopefully, the stakeholders will embrace these changes and will provide wise input to sharpen them further.

But let's bear in mind that it's easy for the auditors to fall into the habit of issuing boilerplate statements, even when the standards have been enhanced. If that happens, we will end up back to square one.

No matter how much the auditing standards are tweaked and polished, we will always have to rely on the integrity and professionalism of the auditors.

It's hard to reach that level of trust on some days, when corporate failures erupt without warning.

We'll probably feel a lot better if the auditors' reports also show utter candour. Wouldn't it be great if the reports contain lines like these?

“Haven't you heard the old argument that auditors are watchdogs, not bloodhounds? Don't depend on us to sniff out fraud with a once-a-year visit. If the management is smart and determined enough, we'll never detect its wrongdoing in the course of a normal audit.”

“We've been auditing this company for many years and we know well the guys running the show. If we've never found anything wrong all this while and the management hasn't changed, why would we be suspicious?”

“Let's get real here. The board of directors are only willing to pay us X amount of audit fees. Sure, we can expand the scope of the audit work, but who'll pay for the extra man hours required to perform the additional work?”

“Hey, the audit market is very competitive. Companies have been known to switch auditors after their accounts had been slapped with modified audit opinions or after disputes over accounting treatment. “

“Spare a thought for us auditors. Costs are rising and employee retention is getting more challenging. The accounting rules and business conditions are increasingly complex. On top of that, the regulators are more watchful. And you expect us to keep doing better and better?”

Executive editor Errol Oh wonders if the discussions during the IAASB's KL roundtable will be noticeably different from those in New York and Brussels.