Delivering the value of the audit – New insightful audit reports

January 2015

An overview of the

new global auditor

reporting model

www.pwc.com

Delivering the value of the audit

New insightful audit reports

Contents

Foreword 1

The key changes 2

Key audit matters – in detail 4

Describing key audit matters 6

Illustrations of key audit matters in UK reports 7

Reactions 8

Lessons learned so far 10

It’s time to get to work – we’re ready 11

Appendix 1: Overview of content of the new IAASB reporting model 13

Appendix 2: How the reporting models compare 14

Appendix 3: Developments around the world 15

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Auditor reporting

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Time for informative, insightful auditor reporting

The new auditor’s report is here. After three years of development, the International Auditing and Assurance Standards

Board (IAASB) has released a set of standards that we believe are truly game-changing for shareholders and the

profession.

Implementation will bring both opportunities and challenges.

The standards mark a move to reports that are more informative, discursive and insightful. The new reports will

undoubtedly stimulate enhanced conversations among auditors, companies, audit committees, shareholders and

regulators.

We believe that the more informative reports and dialogue will demonstrate more visibly the value and relevance of audit.

Relevant reports from a relevant profession – that’s the opportunity.

So far, the forerunners have been on the right track. Where similar proposals have been rolled out in the UK, auditors

have embraced the transformation – producing insightful reports with tailored information and less jargon. Shareholder

reaction has been very positive, referring to a ‘sea change’ in auditor reporting. This is a good start.

While the IAASB’s new standards are not eective until the end of 2016, auditors will need to hit the ground running.

There are some daunting changes which will require careful navigation. This will be as new to management and audit

committees and users as it is to auditors. Auditors around the world will be on a learning curve – so I ask that stakeholders

in the audit give us as much feedback as possible, good or bad, so that we can continue to improve the quality of our

reports. It is hugely important that we get this right.

Here at PwC, we are committed to producing informative and insightful reports that reﬂect the spirit of the reforms. We

have listened, we have understood and now we are changing.

Richard Sexton

Vice Chairman, Global Assurance

New insightful audit reports

The changes that the IAASB is introducing to auditor’s reports centre around three key aims: insight, transparency

and improved readability.

Insight

Without doubt, the most signiﬁcant innovation in the new standards is the introduction of ‘key audit matters’

(ISA 701) – it’s the section of the new UK reports that shareholders have inevitably pointed to as being the most

valuable. This new section of the report will shed light on those matters that, in the auditor’s judgement, were of

the most signiﬁcance in the audit of the ﬁnancial statements of the current period.

The intent is to introduce into auditor’s reports a bespoke description of key areas of focus in the audit – in a sense, a

window into what kept the auditor up at night. This won’t supplant the auditor’s opinion on the ﬁnancial statements

as a whole, which investors value, but it expands the report by asking auditors to describe what the signiﬁcant issues

were, why they were signiﬁcant, and how they addressed them.

Transparency

The main proposals to enhance transparency are to introduce an explicit statement regarding the auditor’s

independence in all audit reports and to identify the engagement partner’s name in audit reports for listed entities.

Both are already part of the auditor’s report in many parts of the world – but it is not the practice everywhere.

Readability

Under the new standards, the auditor’s report has been restructured to put audit and entity-speciﬁc information at the

beginning of the report – in particular, putting the audit opinion ﬁrst. Standardised wording in the report – such as the

descriptions of the auditor’s responsibilities and what’s involved in an audit – can be placed at the end of the report,

or some might even decide to put it in an appendix or refer to a common website (such as that of a standard-setter or

regulator).

“This innovation in auditor reporting

is radical, a step-change as some have

called it. It makes the auditor’s work

more transparent and relevant to users. It

stimulates public debate and analysis on

what auditors’ reports are most helpful.”

Arnold Schilder,

Chairman,

IAASB

The key changes

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Auditor reporting

Going concern will also be given more visibility in the auditor’s report. Both management’s and auditor’s

responsibilities regarding going concern will be described in the new reports. When there is a material uncertainty

about the entity’s ability to continue as a going concern, this will now be highlighted in a separate, clearly identiﬁed

section of the report. Even when the auditor concludes that there is not a material uncertainty, one or more matters

arising from the auditor’s work in arriving at that conclusion could be considered key audit matters. A revision to the

going concern standard (ISA 570) also reminds auditors to evaluate whether the ﬁnancial statements provide adequate

disclosures when events or conditions have been identiﬁed that may cast signiﬁcant doubt whether the organisation

has the ability to continue as a going concern, even if the auditor concludes that no material uncertainty exists.

When?

The new standards will come into eect for audit reports for ﬁnancial statements relevant for periods ending on or

after 15 December 2016, but early application will be permitted. For an update on similar developments around the

world, please see Appendix 3, page 15.

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Auditor reporting

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Auditor reporting

How do auditors select key audit matters?

The new ISA 701 observes that professional judgement will be needed to determine which, and how many, key audit

matters to include in the audit report. This will be an important judgement. While key audit matters will be drawn

from matters discussed with the audit committee, it is not expected that all matters communicated to those charged

with governance would be considered key audit matters to be included in the auditor’s report. Neither is the ISA

looking for a long list, as that would be contrary to the notion of such matters being those of most signiﬁcance in the

audit.

Key audit matters are selected from those matters involving signiﬁcant auditor attention in the audit. The concept

of signiﬁcant auditor attention, the ISA says, “recognizes that an audit is risk-based”, and areas of signiﬁcant auditor

attention “often relate to areas of complexity and signiﬁcant management judgement in the ﬁnancial statements”.

These are, therefore, the areas that, “often involve dicult or complex auditor judgements”.

Key audit matters – in detail

The determination of matters that required signicant

auditor attention in performing the audit

The determination of which of those matters were of the most

signicance (the population of “key audit matters”)

Permission to carve out

“sensitive matters”

Starting population: all matters communicated

with those charged with governance

Key audit matters to be

described in the auditor’s report

Key audit matters

Carve out in extremely rare circumstances

Figure 1. Selecting key audit matters

“A good report is one where you can cover

the name of the company and still be able

to tell what industry the company is in

and maybe even which company it is”

UK investment professional

Auditor reporting

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In practice, this means that the selection of key audit matters is a multi-step judgement. The auditor is expected to take

into account:

• Signiﬁcant risks and areas of higher risk of material misstatement

• Areas requiring signiﬁcant auditor and management judgement, including accounting estimates identiﬁed

as having high estimation uncertainty and more subjective areas of the ﬁnancial statements

• The eect on the audit of signiﬁcant events or transactions that occurred during that year.

There are some situations in which the auditor would not be required to disclose a matter, such as if law or regulation

precludes it, or, in extremely rare circumstances, where the adverse consequences of public communication of a

matter would reasonably be expected to outweigh the public interest beneﬁts. The IAASB has been very clear that the

provisions should not be abused to avoid disclosing matters that do not ﬁrmly ﬁt these circumstances.

By way of implementation advice, the IAASB set out in ISA 701 some considerations that may be relevant to

determining whether a matter is signiﬁcant, and therefore may qualify as a key audit matter.

For an overview of content in the new IAASB reporting model, turn to Appendix 1, page 13.

Auditor reporting

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Auditor reporting

Describing key audit matters

The new ISA requires the auditor to: describe each key

audit matter; include a reference to related ﬁnancial

statement disclosures, (if any); and address why the

matter was considered to be one of most signiﬁcance

in the audit and how it was addressed in the audit.

While the amount of detail is a matter of professional

judgement, the ISA notes that this might include:

• Aspects of the auditor’s response or approach that

were most relevant to the matter or speciﬁc to the

assessed risk.

• A brief overview of procedures performed.

• An indication of the outcome of the auditor’s

procedures.

• Key observations with respect to the matter.

How far should auditors go in describing

ﬁndings?

Most of the UK reports in year 1 identiﬁed the risk,

explained why it was important and described how the

audit addressed it. While shareholders have welcomed

that insight, many said that they found the descriptions

incomplete without the auditor going further to describe

the ﬁndings or outcome. There are questions around

how this can be done meaningfully. For example, might

the auditor’s view (which will inevitably be subjective

to a certain degree) end up supplanting management or

directors’ judgement – and should it?

Or whether there is a need for some sort of ‘safe harbour’

that recognises that these are informed professional

views, but inevitably the views of an individual. This

will no doubt continue to be an area for discussion as

experience with the new reports evolves.

A learning curve – variation expected

As auditors implement the new style reports, there will

be an element of experimentation. It’s almost certain that

the resulting reports will vary in wording, tone and depth,

at least in the beginning. Clearly, there is a balance to be

struck: auditor’s reports need to respond to the spirit of

the standards, with a user focus in mind. And auditors

should be brave in confronting the cultural norms of

boilerplate and overwhelming caution.

But forcing the pace of change might have adverse

consequences – especially in litigious environments – and

this could result in a retreat back to boilerplate. Patience

may be needed as the auditing world grapples with how

to achieve informative and appropriately focused reports.

Already, we have come a long way.

Why the

matter

is considered to

be of the most

signicance

Reference

to related

disclosure(s)

if any

How the

matter was

addressed in

the audit

May describe the

most relevant aspects

of the response, brief

overview of procedures

performed

May also

include an indication

of the outcome of the

procedures, or

any key observations

Figure 2. What descriptions of key audit matters will include

“Investors do not want a list of procedures.

They want to know what the key risks

are, why they are key risks, how the

auditor responded to them and what

the auditor found.”

UK investment professional

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Auditor reporting

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Figure 3. Extract from PwC’s audit report

to shareholders of Smiths Group PLC

Figure 4. Extract from PwCs audit report

to shareholders of The Sage Group PLC

Illustrations of key audit matters in UK audit reports

Auditor reporting

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Auditor reporting

Common views heard on the new UK

reports

• The new reports are now more interesting and

informative.

• The most valuable section in the new reports is

the areas of focus (IAASB’s key audit matters).

• Shareholders are keen to hear the auditor’s

perspective on the signiﬁcant judgements made

in the entity’s critical accounting policies and

estimates.

• Shareholders are interested in which risks were

key in the audit and why, and how the audit

responded to them – but they also want to hear

what the auditor found.

• The best descriptions are tailored to the

particular audit and entity – ‘boilerplate’ wording

and generic descriptions are not helpful.

Reactions

Positive reaction to tailored UK reports

Reactions to the similarly enhanced auditor’s reports in

the UK have been very positive. In fact, many have said

that the ﬁrst year reports exceeded their expectations. As

one UK investment professional said, “I think they are

not only a major step forwards, but actually pretty useful

and interesting”.

Importantly, the UK experience reﬂects the fact that

the UK audit profession embraced the new reports with

enthusiasm. Audit ﬁrms issued bespoke reports that

provided insight into the key issues addressed in the audit.

There was motivation to do so, against a backdrop of an

engaged shareholder community, companion changes to

audit committee reporting and a competition enquiry that

promoted greater innovation.

That’s not to say that shareholders do not believe there

is room for improvement – shareholders clearly see some

reports being better than others. But it has been a very

good start.

Because the IAASB’s standards are only now going live, to understand their potential impact, we have to look at

responses to other reforms that closely resemble the new ISAs.

“One beneﬁt of the new reports is the clear

demonstration that earnings numbers

are subject to many assumptions and

estimates and that radically dierent

numbers could be permissible. That is not

news to auditors, but it may not be well

understood by many investors.”

Floyd Norris,

International New York Times

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Auditor reporting

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In some ways, then, it might be tempting to believe that the UK has set the bar for how the reforms might be

implemented elsewhere. But the same drivers for change do not exist everywhere; legal and regulatory provisions

inﬂuence what and how auditors need to report, and markets and culture vary in dierent jurisdictions around the

world. For example in the UK, the enhanced auditor’s reports were implemented at the same time as expanded audit

committee reporting requirements. Under the Financial Reporting Council’s changes to the Corporate Governance

Code, audit committees are expected to describe signiﬁcant issues in the ﬁnancial statements that they addressed.

These complementary reporting requirements provided a shared agenda for auditors and audit committees that may

explain in part why the ﬁrst year experience in the UK proved to be as successful as it was.

For years, auditors have been required to have standardised reports. Bespoke audit reports are, in a way, counter-

cultural. While there will inevitably be similarities between auditor’s reports for the same company over a number

of years, some fear a risk that the new audit reports could evolve quickly to the use of quite standardised wording to

describe similar risks and responses across audit reports. If both companies and the profession do not see the beneﬁts

of the new reporting model, and approach the new reports as a necessary compliance exercise only, there is a very real

risk of longer reports with simply more boilerplate language. If that is the case, the new reports will fall well short of

the aim.

“If this just becomes a boilerplate exercise

then it would be a setback, rather than a

step forward. For the standard to really be

successful, the challenge is to make sure

that the key audit matters are tailored to

the company and provide useful insight

to the various stakeholder groups – and

auditors should primarily be thinking

about investors”.

Bruce Winter,

IAASB Member

Some of the lessons we have learned so far include:

• Begin with the end in mind: The auditor’s report may be the culmination of the audit, but auditors need to be

thinking about the auditor reporting process from the very outset of the audit. A good audit starts with good risk

analysis and scoping, and that’s the starting point for reporting too.

• Anticipate the time involved: The reports will need to go through multiple iterations and review – that needs to be

factored into the audit planning. Keep in mind that discussions on the audit report may lead management to decide

to enhance or change their disclosures too.

• It is the auditor’s report, but management and audit committees are keenly interested: The selection of key

audit matters begins with the matters discussed with the audit committee. That is an important starting point. Audit

committees are also engaging early and, in most audits, we have found that discussions on what the audit report

might look like and the matters it might discuss start very early in the audit process, with a number of conversations

taking place before the reports are ﬁnalised.

• Getting the key audit matters right is a very challenging task: Most auditors intuitively know which matters

are the most signiﬁcant and would be of interest to stakeholders. They will dier from entity to entity. But then

it is important to be able to describe them clearly, being precise about what the particular area of focus is, clearly

articulating why the audit focused on it and how the audit addressed it. It is not as easy as it sounds.

• Write with the audience in mind: The challenge is to draft succinct key audit matters that address the technical

aspects, in language that is understandable to all stakeholders, whose backgrounds and levels of expertise in

ﬁnancial matters vary considerably. We have found that this is an iterative process that needs to be critically

reviewed from outside the audit team, including the engagement quality control reviewer and the central audit

technical team.

Auditor reporting

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Lessons learned so far

It’s time to get to work – we’re ready

Auditor reporting

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New UK audit

reporting standard

becomes eective for

reports issued after 1

Oct 2013

IAASB approves ﬁnal

auditor reporting

ISAs September 2014,

expect to be released

December 2014

PCAOB Roundtable

April 2014

New EU Audit Directive

and Regulation approved

April 2014, to be

followed by Member

State Implementation

by 2016

IAASB Exposure

Draft July 2013

PCAOB

Proposed

standard August

2013

Some auditors in the

Netherlands decide

to issue reports on

their Dec 2013 audits

following the

IAASB proposals

New style audit reports

to be required in the

Netherlands for

21 Dec 2014 audits of

public interest entities

PCAOB expects to

consult on a revised

proposed standard in

Q1 2015

Eective date for

the IAASB (and still

possible for the PCAOB)

is the 31 Dec 2016

reporting period

(i.e. reports issued

in 2017)

Figure 5. Overview of auditor reporting timeline

The positive reactions from shareholders and other stakeholders to the new style auditor’s reports issued in the UK and

piloted in the Netherlands provides comfort that the reports are heading in the right direction. They are being read

with interest, and the bespoke narrative and transparency is, according to feedback, giving the kind of insight from the

audit that users were seeking.

Implementation eorts now need to pick up momentum around the world. We have had a network of senior partners

across our network engaged in the developments from the outset. We experimented early with the art of the possible

and carried out ﬁeld tests and pilots. We are going into the second year of implementation of the similar UK reforms

and ﬁrst year in the Netherlands. This is the most fundamental change in auditor reporting in decades, and though

there will be challenges, we have been preparing for what’s to come.

Certainly, we are continuing to listen carefully to what all stakeholders in the audit are saying and in each case, we are

reﬂecting on how best to achieve the aim of embracing the new model. We will all be on a learning curve. Realistically,

this will not be a one, or even a two-year process.

But the time for debate about the shape of the reforms is over. Instead, it is now time to get to work producing the new

reports, sharing our knowledge and experiences and providing the insight that investors and others demand. We look

forward to what is to come.

Auditor reporting

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Appendices

Contents:

Appendix 1: Overview of content of the new IAASB reporting model 13

Appendix 2: How the reporting models compare 14

Appendix 3: Developments around the world 15

Appendix 1: Overview of content of the new IAASB reporting model

Opinion

The audit opinion and identiﬁcation of what’s been audited will now be the ﬁrst section of the report.

Basis for Opinion

The Basis for Opinion will directly follow the Opinion section and, in addition to referring to compliance with the ISAs

and referring to the auditor’s responsibilities section, will now include the new assertion of the auditor’s independence.

If the audit opinion has been modiﬁed, the explanation would be here too.

Material uncertainty regarding

going concern (if any)

If there is a material uncertainty with respect to going concern, it will now be described in a separate section that

identiﬁes it as such.

Emphasis paragraphs* (if any)

*An emphasis of matter paragraph may be next if, for example, it is relevant to understanding the ﬁnancial reporting

framework, or it might follow the key audit matters if it relates to a matter also addressed in that section.

Key audit matters

The new section providing insight into the key matters addressed in the audit will be required for audits of listed

companies, but can also be included voluntarily by others.

Other matter paragraphs*

(if any)

*The placement of an Other Matter paragraph could be here if it relates to the ﬁnancial statement audit only, or later in

the report if it relates to other legal or regulatory requirements, or both.

Other information

A new section in the auditor’s report will describe the auditor’s responsibilities for “other information” (e.g., the rest of

the annual report, including the management report) and the outcome of fulﬁlling those responsibilities.

Responsibilities for the ﬁnancial

statements

The description of management’s responsibilities will be expanded to explain its responsibilities with respect to going

concern. It will also now identify those charged with governance (if dierent from management).

Auditor’s responsibilities

The description of the auditor’s responsibilities under the ISAs is now much more comprehensive and includes a

description of the auditor’s responsibilities with respect to going concern.

Date, address and signature

In addition to the signature, address and date, auditor’s reports for listed companies will now also have to identify the

engagement partner’s name.

Auditor reporting

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Auditor reporting

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Auditor reporting

Appendix 2: How the reporting models compare

IAASB US PCAOB UK FRC EU audit regulation

Stage of development

December 2014

standard

August 2013

proposed standard

June 2013 standard

in eect

Final approved

requirements

Auditor’s report element (for listed company audits,)

Prominent placement of the auditor’s opinion and other entity-speciﬁc information

√ √

Key audit matters/critical audit matters/audit risks:

• Identiﬁcation of the matters/risks

√ √ √ √

• Description of how the audit responded to those matters/risks

√ √ √

• Description of the outcomes/ﬁndings

Guidance suggests

they may be included

Not required but has been

included in a few reports

Required where

relevant

Key audit input judgments, including materiality and group scoping

√

Conclusions regarding going concern

Enhanced

descriptions of

responsibilities

No change to

extant model

Not required but have

been included by some

ﬁrms

No change to

extant model

Statement regarding the outcome of auditor’s consideration of ‘other information’

(e.g., the front half of the annual report)

√ √ √ √

Statement regarding the auditor’s independence

√ √

Reference to the

requirement to be

independent

√

Disclosure of the year the auditor began consecutively serving as the company’s

auditor

√

Not in the auditor’s

report but included in

the report by the audit

committee on its work

√

Identiﬁcation of the engagement partner’s name

For listed companies Being addressed in

a separate project

√ √

Appendix 3: Developments around the world

United Kingdom

The UK is heading into year two of its new reporting regime – which shares many features of the IAASB standards, as well as some

further requirements such as materiality and group scoping. Second year reports already issued show continuing innovation by

auditors in response to feedback on the ﬁrst year results. For example:

• Greater insight being provided into the rationale for materiality judgements

• Expanded descriptions of the scoping and approach to group audits

• Descriptions of risks and responses becoming more bespoke and speciﬁc, with some evidence of further experimentation with

how observations and outcomes might meaningfully be provided in the descriptions.

Netherlands

As anticipated, the new style auditor’s reports will be introduced in the Netherlands for December 2014 year-end audits. These

are required for audits of public interest entities, but auditors of other organisations are allowed to adopt it too. The Netherlands

standards use the IAASB’s ISAs as a blueprint but also pick up some of the additional requirements from the new EU audit

regulation – for example disclosing the date of appointment and total uninterrupted engagement. In a nod to the UK model, the

Netherlands report will also require the sections on materiality and the scope of the group audit. Neither is required in the new

ISAs or EU Audit Regulation.

The Public Company Accounting Oversight Board has signalled its intent to re-expose their proposed standard in Q1 2015. This

may enable them to ﬁnalise their ﬁnal standard so that it could become eective at the same time as the ISAs. The PCAOB has also

indicated that they will issue a supplementary request for comment on partner naming and identifying other participants in the audit

in the near term, which is expected to include an option for these disclosures on a new form ﬁled on the PCAOB’s website instead of in

the audit report.

Other countries and regions

While there is evidence of heightened awareness in the marketplace, we haven’t yet seen other signiﬁcant regulatory developments.

It is likely that national standard-setters who adopt the ISAs into national standards will begin that process now that the ISAs are

ﬁnalised. One of the main areas of discussion is whether to limit the new reports to listed companies or extend the scope to audit

reports for all public interest entities and government entities.

Auditor reporting

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For further information please enquire of your usual PwC contact or the investment community engagement team:

Who to contact

Diana Hillier

T: +44 (0) 20 7804 0472

E: [email protected]c.com

Paul Fitzsimon

T: +1 (416) 869 2322

E: paul.ﬁ[email protected]c.com

Marc Panucci

T: +1 (973) 236 4885

E: [email protected]c.com

Jamie Shannon

T: +44 (0) 141 355 4225

E: [email protected]c.com

Please see www.pwc.com/structure for further details

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