In Brief
The PCAOB recently issued changes to the audit report, one of which explicitly clarifies auditors’ responsibilities for fraud by adding the phrase “whether due to error or fraud” when describing the responsibility to obtain reasonable assurance about whether the financial statements are free of material misstatements. The authors surveyed commercial lenders to examine the impact of this explicit clarification for fraud in the auditor report along four dimensions: general statements, informative value, responsibility, and liability. The findings should be of interest to regulators, auditors, financial statement users, and researchers.
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On June 1, 2017, the PCAOB issued a new auditing standard, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion [Auditing Standard (AS) 3101, PCAOB Release 2017-001]. On October 23, 2017, the SEC approved this new PCAOB standard (SEC Release 34-81916). The standard presents several alternatives for changing the auditor’s reporting model, including an explicit clarification of auditors’ responsibility for fraud by adding the phrase “whether due to error or fraud” when describing auditors’ responsibilities to obtain reasonable assurance about whether the financial statements are free of material misstatements. The current standards require that an auditor “plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud” (AS 1001, Responsibilities and Functions of the Independent Auditor, http://bit.ly/2t0NCri). The current standard auditor’s report, however, does not explicitly mention fraud; thus, this proposal would align the auditor’s report with the standards.
In 2008, the U.S. Department of the Treasury’s Advisory Committee on the Auditing Profession (ACAP) urged the PCAOB to explicitly clarify in the auditor’s report the auditor’s role in detecting fraud under current auditing standards. ACAP believed that explicitly clarifying the auditor’s role would enhance auditors’ fraud prevention and detection skills, improve financial reporting and audit quality, and enhance investor confidence in financial reporting and the auditing function.
Other regulators and standards setters, such as the International Auditing and Assurance Standards Board (IAASB), the European Union (EU), and the United Kingdom’s Financial Reporting Council (FRC), have already adopted requirements for expanded auditor reporting. The explicit fraud wording is included in the auditor’s report to state that the objective is to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, “whether due to error or fraud.” In its comments on Release 2011-003, the auditing standards committee of the American Accounting Association suggested that the benefits of the changes to the auditor reporting model would outweigh the potential costs over time (Current Issues in Auditing, December 2011, http://bit.ly/2CpYuhQ); the committee specifically believed that the explicit clarification language would provide investors with a better understanding of the auditor’s role and the nature of an audit. This article reports the findings of a nationwide survey used to evaluate commercial lenders’ perceptions of the fraud wording.
Background
While the standard was still in the proposal stage, the authors developed the survey and sent it to U.S. commercial lenders via Qualtrics. Commercial lenders were selected as the subjects of this study because they represent a group of sophisticated professional financial statement users with special expertise and a range of judgments they make in evaluating financial reporting reliability and assessing creditworthiness for informed decisions.
The results suggest that, overall, commercial lenders were in favor of the proposed changes to the audit report with respect to the enhanced fraud responsibility language.
Participants were presented with 16 statements organized in four perceptual dimensions—general statements, informative value, responsibility, and liability—based on the results of similar prior research regarding users’ perceptions of auditors’ responsibility for fraud. Responses were measured with a 5-point scale (from 1, strongly disagree to 5, strongly agree). One hundred seventy complete responses were included for analysis. Demographic information was collected from respondents with regard to 10 variables: 1) years of professional experience in banking industry, 2) years of making commercial lending decisions, 3) percentage of time devoted to loan decisions, 4) bank asset size, 5) knowledge of auditing, 6) title of current position, 7) highest educational degree, 8) professional designation, 9) gender, and 10) age.
All respondents had substantial experience in the banking and commercial lending decisions. Sixty percent of the respondents had five or more years of experience in banking industry, and 47% had five or more years of experience in commercial lending. Approximately 87% of the participants devote more than 50% of their time to making loan decisions, and more than 89% represent banks with asset of more than $100 million. Participants were knowledgeable of auditing at an average of 4.12 on a 5-point Likert scale, indicating that they have good knowledge of the various issues related to auditing. Approximately 43% of participants reported their current title as vice president or president of the bank. Nearly 89% of the participants reported holding a bachelor’s degree or higher, with approximately 48% holding a master’s degree and almost 6% holding a doctorate degree. More than 24% of the respondents have a professional designation. More than 57% of the respondents were male, and more than 59% of the respondents were 35 years old or older.
Results
The survey results are summarized below; the full results are available at http://www.cpaj.com/.
General statements.
There were four general statements in the survey. The first was: “The clarification of the auditor’s responsibility for fraud in the auditor’s report helps me understand better the nature of an audit.” An overwhelming majority of lenders (87%) agreed with this statement, only 3% disagreed, and 10% chose a neutral stance. For Statement 2, “The clarification of the auditor’s responsibility for fraud is not a meaningful addition to the auditor’s report,” nearly 50% of lenders disagreed, while approximately 33% agreed and about 17% neither agreed nor disagreed.
Approximately 78% of the lenders agreed with Statement 3, “The clarification of the auditor’s responsibility for fraud helps to enhance communication between auditors and users of the auditor’s report,” while 4% disagreed and 18% neither agreed nor disagreed. Finally, for Statement 4, “The clarification of the auditor’s responsibility for fraud will increase audit fees,” approximately 65% of lenders agreed, while 14% disagreed and 21% neither agreed nor disagreed. Specifically, most lenders admitted that the clarification for fraud enhances the communication between auditors and users.
The results for Statements 1–4 suggest that, overall, commercial lenders were in favor of the proposed changes to the audit report with respect to the enhanced fraud responsibility language; however, they also believe that audit fees will also increase.
Informative value.
The section of the survey dealing with informative value also contains four statements. For Statement 5, “The clarification of the auditor’s responsibility for fraud helps me understand better the auditor’s responsibility for fraud,” 83% of respondents agreed with the statement, while approximately 5% disagreed and approximately 12% neither agreed nor disagreed. Approximately 81% of respondents agreed with Statement 6, which reads, “The auditor’s report will be more relevant and more useful to me for loan decision with the clarification of the auditor’s responsibility for fraud.” Only 4% of respondents disagreed with the statement, and approximately 15% were neutral.
Statement 7 was, “The clarification of the auditor’s responsibility for fraud provides little informative value.” Approximately 56% of respondents disagreed with this statement, nearly 15% of respondents neither disagreed nor agreed, and approximately 29% of respondents agreed. Finally, approximately 81% of respondents agreed with Statement 8, “The clarification of the auditor’s responsibility for fraud provides greater reliability on the audited financial statements,” while nearly 5% disagreed with the statement and 14% neither disagreed nor agreed.
These results suggest that commercial lenders believe the explicit clarification of the auditor’s responsibility for fraud will make the auditor’s report more informative and make financial statements more reliable. Again, these results suggest that commercial lenders are in favor of the enhancement.
Responsibility.
Four statements in the survey assessed lenders’ perceptions in terms of responsibility. Eighty percent of respondents agreed with Statement 9, “The clarification of the auditor’s responsibility for fraud implies that auditors have a greater responsibility to detect financial statement fraud.” Approximately 6% disagreed with the statement, and 14% neither agreed nor disagreed. For Statement 10, “The clarification of the auditor’s responsibility for fraud indicates that auditors devote more effort and time in performing the audit to assess the risks of material mis-statement of the financial statements,” approximately 76% of respondents agreed, while only 9% disagreed and 15% neither agreed nor disagreed.
Statement 11 reads, “The clarification of the auditor’s responsibility for fraud will not impact my understanding of auditor’s responsibility for fraud.” Approximately 57% of respondents disagreed with this statement, approximately 20% neither disagreed nor agreed, and 23% agreed. Finally, for Statement 12, “The clarification of the auditor’s responsibility for fraud will require auditors to utilize additional effort and time in performing the audit,” nearly 80% of respondents agreed, while approximately 7% disagreed and approximately 13% neither disagreed nor agreed.
These results suggest that lenders believe that the explicit clarification of an auditors’ responsibility for fraud in the audit report helps users to have a better understanding of that responsibility. Specifically, the explicit fraud clarification indicates that auditors have a responsibility to detect material financial statement fraud and that auditors must devote effort and time to risk assessment of material misstatements, including those associated with fraud.
Liability.
The final four statements in the survey evaluated lenders’ perceptions in terms of liability. Statement 13 reads, “The clarification of the auditor’s responsibility for fraud will expose the independent auditors to greater legal liability.” Approximately 68% of respondents agreed with the statement, while only 13% disagree and 19% neither agreed nor disagreed. For Statement 14, “By issuing the auditor’s report with the explicit clarification of the auditor’s responsibility for fraud, the independent auditors assume a greater amount of risk,” approximately 69% of respondents agreed with the statement, while only 12% of respondents disagreed and 19% neither agreed nor disagreed with the statement.
The survey results suggest that increased transparency in the auditor’s report affects lenders’ perceptions of the usefulness of the auditor’s report and their decisions.
Approximately 65% of respondents agreed with Statement 15, which reads, “Auditors’ exposure to liability will remain the same with or without the clarification of the auditor’s responsibility for fraud in the auditor’s report.” Eighteen percent of respondents neither disagreed nor agreed with this statement, and 17% of respondents disagreed. This result is somewhat inconsistent with the results from Statements 13 and 14; nevertheless, moving from the current report’s implicit obligation for material fraud to a report with an explicit obligation could have implications for liability. Since the auditing standard on fraud is not changing, it is difficult to ascertain the implications for audit liability. Finally, Statement 16 reads, “An auditor’s report with the clarification of the auditor’s responsibility for fraud will lead to additional litigation against the independent auditors.” Approximately 64% of respondents agreed with the statement, while 15% disagreed and approximately 21% neither disagreed nor agreed.
In summary, these results suggest that lenders perceive that the explicit clarification of auditors’ responsibility for fraud in the audit report provides informational value in terms of auditors’ liability. Specifically, the fraud clarification will increase lenders’ perceptions of auditors’ legal liability, risk, and perhaps additional litigation.
Recommendations
In the authors’ opinion, the results of this survey suggest that commercial lenders support the new, explicit audit report clarification regarding fraud. Most participants believe that the clarification would result in auditors devoting more effort and time in performing the audit to assess the risks of material misstatements of the financial statements due to fraud. While lenders believe audit fees will increase as a result, a substantial majority believes the resulting report will be more relevant and more useful for making loan decisions.
Regulators around the world, such as the Canadian Public Accountability Board (CPAB), are considering approaches to provide stakeholders with more information about the quality of financial reporting, including clarifying the auditor’s responsibility for fraud (“Succeeding amid Change and Uncertainty: Action Plans for Audit Committees,” Deloitte, http://bit.ly/2EObrY7). In January 2015, the IAASB issued its new and revised auditor reporting standards (effective for audits of financial statements for periods ending on or after December 15, 2016), designed to enhance auditors’ reports for investors and other users. Under the new standards, the section of the auditor’s report with the heading “Auditor’s Responsibilities for the Audit of the Financial Statements” states that the objectives of the auditor are to “obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error” (“The New Auditor’s Report: Greater Transparency into the Financial Statement Audit,” http://bit.ly/2EwTpX0).
The survey results suggest that increased transparency in the auditor’s report affects lenders’ perceptions of the usefulness of the auditor’s report and their decisions. Furthermore, this survey has practical implications for auditors because the explicit clarification of the auditors’ responsibility may motivate auditors to increase due professional care and take more responsibility for fraud detection in the audit process, in compliance with the auditing standards. Auditors should be aware of the importance of conducting high quality audits that strictly adhere to guidance in PCAOB auditing standards. The survey results are, however, confined to the perceptions of commercial lenders; views of other users should also be considered in evaluating perceptions of the changes.
