Significant changes are coming to the audit report. The Auditing Standards Board (ASB) issued SAS 134, Auditor Reporting and Amendments, Including Amendments Addressing Disclosures in the Audit of Financial Statements, in May 2019. This standards, like all ASB guidance, applies to non-issuers in the United States. The foundation section is AU-C section 700, Forming an Opinion and Reporting on Financial Statements. It addresses the auditor’s responsibility to form an opinion on the financial statements and prescribes the form and content of the auditor’s report when issuing an unmodified opinion.
The report begins with the title and appropriate addressee. The opinion will now be the first paragraph of the report, followed by the basis for opinion. Next comes a new concept, key audit matters (KAM), is provided for audits where it is requested. The KAM paragraph discusses the most important matters the auditor considered during the audit. Following the KAM text are paragraphs explaining the responsibilities of management and auditors’ responsibilities. Both of these last two paragraphs include comments on each party’s responsibility for assessing the ability of the entity to continue as a going concern. The last three sections are just the firm’s signature, city and state, and date.
A Sample Report
The following is an example of the new ASB report where there is no other legal or regulatory requirements (which are sometimes required, usually in government audits), but with the inclusion of KAMs. SAS 134 is effective for audit reports on financial statements for periods ending after December 15, 2019, with early adoption prohibited.
Comments in [red]
Independent Auditor’s Report
Opinion [The opinion paragraph has migrated to the beginning of the report.]
We have audited the financial statements of ABC Company, which comprise the balance sheets as of December 31, 20X1 and 20X0, and the related statements of income, changes in stockholders’ equity, and cash flows for the years then ended, and the related notes to the financial statements.
In our opinion, the accompanying financial statements present fairly, in all material respects, the financial position of ABC Company as of December 31, 20X1 and 20X0, and the results of its operations and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America.
Basis for Opinion [With the opinion up front, the basis logically follows next.]
We conducted our audits in accordance with auditing standards generally accepted in the United States of America (GAAS). Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are required to be independent of ABC Company and to meet our other ethical responsibilities, in accordance with the relevant ethical requirements relating to our audits. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Key Audit Matters [This optional segment is based upon the clients request to include, is new and is reported after the Basis for Opinion. ]
Key audit matters [KAM] are those matters that were communicated with those charged with governance and that, in our professional judgment, were of most significance in our audit of the financial statements for the current period. These matters were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters.
[Description of each key audit matter in accordance with section AU-C 701, Communicating Key Audit Matters in the Independent Auditor’s Report]
Responsibilities of Management for the Financial Statements [This section is essentially the same but specifically mentions ability to continue as a going concern.]
Management is responsible for the preparation and fair presentation of the financial statements in accordance with accounting principles generally accepted in the United States of America, and for the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.
In preparing the financial statements, management is required to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about ABC Company’s ability to continue as a going concern for [insert the time period set by the applicable financial reporting framework].
Auditor’s Responsibilities for the Audit of the Financial Statements [This section is essentially the same but specifically mentions the entity’s ability to continue as a going concern.]
Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but not absolute assurance, and therefore is not a guarantee that an audit conducted in accordance with Generally Accepted Auditing Standards (GAAS) will always detect a material misstatement when it exists. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. Misstatements are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users made on the basis of these financial statements.
In performing an audit in accordance with GAAS, we:
Exercise professional judgment and maintain professional skepticism throughout the audit.
Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, and design and perform audit procedures responsive to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements.
Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of ABC Company’s internal control. Accordingly, no such opinion is expressed. (In circumstances in which the auditor also has a responsibility to express an opinion on the effectiveness of internal control in conjunction with the audit of the financial statements, omit the following: “but not for the purpose of expressing an opinion on the effectiveness of ABC Company’s internal control. Accordingly, no such opinion is expressed.)”
Evaluate the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluate the overall presentation of the financial statements.
Conclude whether, in our judgment, there are conditions or events, considered in the aggregate, that raise substantial doubt about ABC Company’s ability to continue as a going concern for a reasonable period of time.
We are required to communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit, significant audit findings, and certain internal control—related matters that we identified during the audit.
[Signature of the auditor’s firm]
[City and state where the auditor’s report is issued]
[Date of the auditor’s report]
Modifications to the Report
Modifications of the audit report are discussed in AU-C section 705. This section discusses the circumstances under which a modification to the audit report is required and how the type of modification is determined. It discusses a qualified opinion, an adverse opinion, and a disclaimer of opinion. AU-C section 705 discusses the consequences to the other paragraphs in the report when a modification is warranted. Also, it provides illustrative auditors’ reports with modifications.
The following are other sections that have a direct impact on the audit report:
- AU-C section 706, “Emphasis of Matter and Other Matter Paragraphs”
- AU-C section 720, “The Auditor’s Responsibility Relating to Other Information Included in Annual Reports”
- AU-C section 725, “Supplementary Information in Relation to the Financial Statements as a Whole.”
This is followed by sections regarding special situations, including special purpose frameworks, single financial statements and specific elements, summary financials, and statements prepared under other frameworks.
These changes have been developed from a continuing effort to converge with international standards.
In 2004, the International Auditing and Assurance Standards Board (IAASB) began a project to address the clarity, terminology, and complexity of auditing standards. The final set of clarified standards comprise 36 International Standards on Auditing (ISA) and an International Standard on Quality Control (ISQC). The standards were issued in February 2009.
The ISAs established a new structure for the standards, under which information is presented in five separate sections: introduction, objective, definitions, requirements, and application and other explanatory material.
Introduction.Introductory material may include information regarding the purpose, scope, and subject matter of the ISA, in addition to the responsibilities of the auditors and others in the context in which the ISA is set.
Objective. Each ISA contains a clear statement of the auditor’s objective in the area addressed by that ISA.
Definitions. For greater understanding of the ISAs, applicable terms have been defined in each ISA.
Requirements. Each objective is supported by clearly stated requirements. Requirements are always expressed as “the auditor shall.”
Application and Other Explanatory Material. The application and other explanatory material explains more precisely what a requirement means or is intended to cover or includes examples of procedures that may be appropriate under given circumstances.
The AICPA’s Auditing Standards Board (ASB) undertook a similar project, in order to enhance clarity and convergence with international standards. As part of the process, the ASB used the same structure as the ISAs (i.e., introduction, objective, definitions, requirements, applications). It also used the same section numbering as the ISAs. The AICPA issues Statements on Auditing Standards 122–125 in 2011, essentially completing the project and its guidance in line with international standards.
While IAASB was issuing the clarified standards, it was also working on a new audit report. In January 2015, the IAASB revised its statements regarding the audit report through New and Revised Auditor Reporting Standards. “The auditor’s report,” the board stated, “is the key deliverable communicating the results of the audit process. Investors and other financial statement users have asked for a more informative audit report–in particular for auditors to provide more relevant information to users” (https://www.iaasb.org/focus-areas/new-auditors-report). ISA section 701 set forth the ISA’s requirements relating to KAMs. Section 701 only applies to 1) listed entities (e.g., listed on a stock exchange); 2) when the auditor is required by law or regulation to report KAMs for nonlisted entities; and 3) other entities, when the auditor decides to report KAMs on a voluntary basis.
IAASB Managing Director, Professional Standards James Gunn said the following in a 2016 speech in Brazil:
The topic had been on our agenda for some time, since 2006. We started with commissioning academic research about how users feel about the auditor report. We learned that the only thing in an auditor’s report that was read is the audit opinion—a one-liner that tells you whether the financial statements are OK or not.
Important? Yes. But we heard from a variety of stakeholders, in particular users, that more was needed. It was asked why auditors don’t share more—about the audit, what they did, and why is it that none of that is made transparent—except the valued audit opinion? Well, they had a point. And all this even before the financial crisis. But that then heightened the demand for more communication from auditors….
To explain KAM very simply: auditors now describe in their public reports what they saw as the matters of most significance in the audit, and how those matters were addressed in the audit….
The new standard [KAM] is required for listed entity audits. Why? Well, the public market investor community has been the most vocal. But we also listened to feedback—again a message from Brazil and others—that perhaps now is not yet so critical for smaller audits. So, it is voluntary for them and others, but encouraged, as well for audits of public interest entities.
What are the basics of communicating KAM? Essentially:
- i) why the auditor judged a matter to be of most significance in the audit;
- ii) how that matter was addressed in the audit; and
iii) whether there is reference to any related financial statement disclosures
Attempts at Convergence
The ASB has made great efforts through its clarified standards to converge with the IAASB. What about these new audit report standards? In May 2019, the ASB issued SAS 134, which changed the audit report to converge with international standards again. Exhibit 1 compares the IAASB and ASB audit report requirements.
The PCAOB monitored international developments since 2009 and issued a concept release in 2011 (https://bit.ly/39NcvdH). It issued AS3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, on June 1, 2017. The standard was effective for audits of fiscal years ending on or after December 15, 2017, except for requirements related to Critical Audit Matters (CAM), which are effective for years ending on or after June 30, 2019 (for large accelerated filers) and December 31, 2020 (for others). It is very closely aligned with the international audit report.
Both the IAASB and PCAOB place the opinion paragraph first, with a basis of opinion directly thereafter. Both have a new section—KAM for the IAASB, and CAM for the PCAOB. The IAASB defines KAMs as those matters that, in the auditor’s professional judgment, were of most significance in the audit of the financial statements of the current period. The Auditing Standards Board (ASB) definition of KAMs is the same as that of the IAASB. KAMs are selected from matters communicated with those charged with governance.
While the PCAOB defines CAMs as any matter arising from the audit of the financial statements that was communicated or required to be communicated to the audit committee and that: 1) relates to accounts or disclosures that are material to the financial statements, and 2) involves especially challenging, subjective, or complex auditor judgment. Both are similar and are intended to result in the communication of matters in the author’s report that are likely to be of interest to users of the audit report. Both sets of standards expect these elements to be in the audit report. ISA section 701.A59 states: “The determination of key audit matters involves making a judgment about the relative importance of matters that required significant auditor attention. Therefore, it may be rare that the auditor of a complete set of general-purpose financial statements of a listed entity would not determine at least one key audit matter from the matters communicated with those charged with governance to be communicated in the auditor’s report.”
A comparison of the PCAOB and IAASB standards issued by the International Federation of Accountants (IFAC) in 2017 provides a helpful reference for auditors (https://bit.ly/3mQWnMa).
In the author’s opinion, most people who are familiar with the current audit reports would agree with James Gunn that users go directly to the opinion paragraph. The basis of opinion in the new audit report represents a change for the better. From Gunn’s comment regarding KAMs for non-listed companies “that perhaps now is not yet so critical for smaller audits,” on should expect that KAMs will become required for private companies if the concept is well received for listed companies.
Voluntary reporting usually means that the client has specifically engaged the auditor to report KAMs. Although management might be reluctant to disclose any nonrequired information, clients may be required to request it by a capital provider or other third party, such as a regulatory body other than the SEC. Anecdotally, the author has already seen a membership organization address this for next year’s audit by requesting KAMs in order to provide a more transparent audit report to its membership.
The IAASB has committed to post-implementation review of the new auditor’s report. Because the focus of the changes is to be more transparent to users, all standards setters should follow suit, and users should be encouraged to respond.
Nicholas J. Mastracchio, Jr., PhD, CPA, was the Arthur Andersen alumni Professor of Accounting at the University at Albany, where he has emeritus status and recently retired from the University of South Florida as an associate professor. He has taught valuation courses at Union College and the University of South Florida, published books on valuation for the AICPA and Bloomberg BNA, and his testimony on valuation methodology is case law in New York. He is a member of the CPA Journal Editorial Advisory Board.
A Comparison of IAASB and ASB Audit Reporting Standards
|The opinion section is required to be presented first, followed by the basis for opinion, unless law or regulation prescribes a different placement
|The opinion section is required to be presented first, followed by the basis for opinion section (AU-C 700.25 & .28)
|In the basis for opinion section, there is a statement indicating that the auditor is independent and has fulfilled the auditor’s other ethical responsibilities.
|In the basis for opinion section, there is a statement indicating that the auditor is independent and has fulfilled the auditor’s other ethical responsibilities. (AU-C 700.28c)
|When the auditor modifies the opinion, the basis for the modification is included in the basis for opinion section. A Key Audit Matter [KAM] cannot substitute for a modified opinion and is not required for non-listed companies
|When the auditor modifies the opinion, the basis for the modification is included in the basis for opinion section (AU-C705.17). A KAM cannot be a substitute for a modified opinion (AU-C 701.03b) and a KAM is not required.
|Expanded descriptions of the responsibilities of management and those charged with governance, as well as the auditor’s responsibilities and the key features of an audit, are required in separate sections of the auditor’s report
|The language in the management and auditor responsibility sections has been expanded, including a description of the respective responsibilities of management and the auditor when reporting on going concern (AU-C 700.32 and 36e).
|Emphasis of matter (EOM) and other matter (OM) paragraphs are required in certain circumstances and otherwise permitted at the auditor’s discretion.
|EOM and OM paragraphs are required in certain circumstances and otherwise permitted at the auditor’s discretion
For purposes of the ISAs, KAMs are matters that, in the auditor’s professional judgment, were of most significance in the audit of the financial statements of the current period. KAMs are selected from matters communicated with those charged with governance.
One significant change is the new International Standards on Auditing (ISA) section 701, Communicating Key Audit Matters in the Independent Auditor’s Report. This ISA applies both to audits of financial statements of listed entities and in circumstances when the auditor otherwise decides to communicate KAMs in the auditor’s report. The auditor should describe each KAM, using an appropriate subheading, in a separate section “Key Audit Matters,” unless precluded by law, regulation, or in rare circumstances where the adverse consequences of doing so outweigh the public interest benefits of disclosure. The exclusion does not apply if the entity has publicly disclosed information about the matter.
The ASB uses the same definition as the International Auditing and Assurance Standards Board (IAASB). The auditor should describe each key audit matter, using an appropriate subheading, in a separate section “Key Audit Matters,” unless precluded by law, regulation, or in rare circumstances where the adverse consequences of doing so outweigh the public interest benefits of disclosure.
|When substantial doubt exists, the auditor should include a separate section in the auditor’s report, “Substantial Doubt About the Entity’s Ability to Continue as a Going Concern.”
|When substantial doubt exists, the auditor should include a separate section in the auditor’s report, “Substantial Doubt About the Entity’s Ability to Continue as a Going Concern” (AU-C 570.A51).