Views on improving the integrity of global capital markets
04 May 2011

Let’s Make the Auditor Report More Informative

Similar to market crises and accountancy-related corporate scandals that have occurred in the past, the extent to which auditors act in the interests of investors has yet again been brought into sharp focus in the aftermath of the 2007-2009 market crisis. This has resulted in increased attention by several regulatory authorities on the adequacy of the role of auditors, especially in light of the significant expenditure by corporations on audit fees, and the perceived failure of the audit process to contribute to an early-warning mechanism for investors. An important part of this discussion is the current form of the independent auditor report.

As the only observable output of audit effort, the auditor report contributes to investor perception of the overall utility of the audit process. There is an underlying expectation that the auditors should convey their unique auditor insight regarding the state of financial affairs of the reporting entity. The auditor’s report is perceived to be an integral part of the financial reporting communication package for investors. In fact, a March 2010 CFA Institute survey showed that 72 percent of respondent members regarded the auditor report as being either very important or important to their analysis. 

Nevertheless, it would not be an exaggeration to characterise the existing version of the auditor’s report as being caught in what resembles a “time warp” — it has neither kept pace with increasingly complex business models nor sufficiently adjusted to the need to provide unique auditor insight in response to increasingly subjective accounting standards, such as the application of entity-specific fair values and the application of significant managerial judgment when recognising revenues for multiple element contracts. For the benefit of investors, there is both an urgent and important need to ramp up the information content beyond the current pass/fail auditor report. 

This perspective was conveyed by CFA Institute during the International Forum of Independent Audit Regulators (IFIAR) Investor Working Group panel session on the auditor report in Berlin on 12 April. The session was organized by Public Company Accounting and Oversight Board (PCAOB) board member Steve Harris. Other panel speakers included Martin Bauman from the PCAOB and Daniel Montgomery from Ernst & Young. Concurrently, during the session, representatives from the European Commission, UK’s Financial Reporting Council, and the International Organization of Securities Commissions (IOSCO) provided updates on their auditor report-related efforts. The audience included global audit regulators and representatives from a number of key supranational institutions including the World Bank and the Financial Stability Board.

Members Weigh in

A core part of the CFA Institute presentation was sharing the results of a more recent member survey, from March 2011, in which 58 percent of respondents indicated their support for more information within the auditor report. The survey results also showed that from those respondents supporting a more detailed auditor report, there is support for more information on:

* assessment of management’s critical accounting judgments and estimates (86 percent support)

* assessment of the quality, not just the acceptability, of management’s selection and application of accounting principles (90 percent support)

* understanding of the entity’s business model and operating environment in assessing the entity’s material mis-statement risk occurring in the financial statements (77 percent support)

 

The above areas are not exhaustive. Previous CFA Institute surveys and those by other investor groups also show the need for information on auditor materiality assessment, sensitivity analysis, key financial risks, and unusual transactions. 

Across the panel, there was consensus on the need for reform of the auditor report, with differing emphasis on specific aspects of potential improvement. However, the challenge remains to ensure that the reform is seen as important and urgent, and that all regulatory bodies act in a harmonized and expedited fashion so as to provide an auditor report that fulfills investor requirements without undue exaggeration of the costs of providing additional information.

 

 

About the Author(s)
Vincent Papa, PhD, CPA, FSA, CFA

Vincent Papa, PhD, CPA, FSA Credential, CFA, is director of financial reporting policy at CFA Institute. He is responsible for representing the interests of CFA Institute on financial reporting and on wider corporate reporting developments to major accounting standard setting bodies, enhanced reporting initiatives, and key stakeholders. He is a member of ESMA’s consultative working group for the Corporate Reporting Standing Committee, EFRAG user panel, and a former member of the IFRS Advisory Council, Capital Markets Advisory Committee, and Financial Stability Board Enhanced Disclosure Task Force. Prior to joining CFA Institute, he served in investment analysis, management consulting, and auditing roles.

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