The “Rolls Royce” of Auditors’ Reports

After two days of testimony from leading investor groups, company executives, academics, and audit professionals at the recent Public Company Accounting Oversight Board’s (PCAOB) Auditor Reporting Roundtable, a clear star emerged: Rolls Royce. The company wasn’t personally represented, but its recently issued auditor’s report was.

Rolls Royce’s website touts its reputation for developing and delivering world-class engineering. This world-class innovation now extends to the auditor’s report (see page 130) accompanying its 2013 financial results. Rolls Royce didn’t merely comply with a new auditor’s reporting standard from the Financial Reporting Council (FRC), the company and its auditor, KPMG, took it a step further.

For decades the auditor’s report has followed a “pass/fail” or “binary” model, which is a valuable indicator of the reliability of the financial statements, but is severely lacking when it comes to communicating anything substantial about the audit process or the detailed findings. Investors have been strongly in favor of having the auditor report more information about the audit (view a recent CFA Institute comment letter).

Under the FRC’s new requirement the auditor’s report must contain the following elements:

• Risks: A description of the risks of material misstatement that were identified by the auditor and which had the greatest effect on the overall strategy; the allocation of resources in the audit; and the efforts of the engagement team.
• Materiality: An explanation of how the auditor applied the concept of materiality in planning and performing the audit.
• Scope: An overview of the scope of the audit, including an explanation of how the scope addressed the risks of material misstatement.

In short, the auditor reports the greatest risk of material misstatement and how it responded to those risks. KPMG could have stopped there to be in compliance with the new standard, but that wasn’t good enough for Rolls Royce. With the investor user in mind, KPMG in cooperation with management took it a step further and included the findings. Aside from the communicative value of this information to investors, extending the auditor’s report to include the findings demonstrates a willingness on the part of the auditor and management to work together toward meaningful communication to investors — a major departure from past practice.

At a time when the PCAOB and the International Auditing and Assurance Standards Board (IAASB) are working to finalize their new requirements for the auditor’s report, Rolls Royce sets a high bar. For our part, CFA Institute is in favor of the possibilities that the Rolls Royce model holds for providing more transparency around the audit.

Rolls Royce cites the following in its vision statement:

We will succeed only by continually raising the standards. We constantly improve quality, performance and cost. We are inquisitive, energetic and ‘better’ every day. Even when we may be the best, we must continue to get better together.

Rolls Royce illustrated this concept by working with its auditor to provide a much better auditor’s report. We encourage other companies to follow this example.

As revised 6 May 2014.

If you liked this post, consider subscribing to Market Integrity Insights.

Photo credit: iStockphoto/vuk8691