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Delivering the value of the audit

New insightful audit reports
January 2015

An overview of the
new global auditor
reporting model
 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

New insightful audit reports PwC • Contents

 Auditor reporting

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 effective 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 S
 exton
Vice Chairman, Global Assurance

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 Auditor reporting

The key changes

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.
“This innovation in auditor reporting
is radical, a step-change as some have The intent is to introduce into auditor’s reports a bespoke description of key areas of focus in the audit – in a sense, a
called it. It makes the auditor’s work window into what kept the auditor up at night. This won’t supplant the auditor’s opinion on the financial statements
more transparent and relevant to users. It as a whole, which investors value, but it expands the report by asking auditors to describe what the significant issues
stimulates public debate and analysis on were, why they were significant, and how they addressed them.
what auditors’ reports are most helpful.”

Arnold Schilder,
Transparency
Chairman, The main proposals to enhance transparency are to introduce an explicit statement regarding the auditor’s
IAASB 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).

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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 effect 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

Key audit matters – in detail

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
“A good report is one where you can cover attention “often relate to areas of complexity and significant management judgement in the financial statements”.
the name of the company and still be able These are, therefore, the areas that, “often involve difficult or complex auditor judgements”.
to tell what industry the company is in Figure 1. Selecting key audit matters
and maybe even which company it is”
Starting population: all matters communicated
UK investment professional with those charged with governance

The determination of matters that required significant

auditor attention in performing the audit
Key audit matters
The determination of which of those matters were of the most
significance (the population of “key audit matters”)

Permission to carve out

Carve out in extremely rare circumstances
“sensitive matters”

Key audit matters to be

described in the auditor’s report

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 Auditor reporting

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 effect 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.

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 Auditor reporting

Describing key audit matters

The new ISA requires the auditor to: describe each key A learning curve – variation expected
audit matter; include a reference to related financial
statement disclosures, (if any); and address why the As auditors implement the new style reports, there will
matter was considered to be one of most significance be an element of experimentation. It’s almost certain that
in the audit and how it was addressed in the audit. the resulting reports will vary in wording, tone and depth,
While the amount of detail is a matter of professional at least in the beginning. Clearly, there is a balance to be
judgement, the ISA notes that this might include: struck: auditor’s reports need to respond to the spirit of
• Aspects of the auditor’s response or approach that the standards, with a user focus in mind. And auditors
were most relevant to the matter or specific to the should be brave in confronting the cultural norms of
assessed risk. boilerplate and overwhelming caution.
• A brief overview of procedures performed. But forcing the pace of change might have adverse
“Investors do not want a list of procedures. • An indication of the outcome of the auditor’s consequences – especially in litigious environments – and
They want to know what the key risks procedures. this could result in a retreat back to boilerplate. Patience
are, why they are key risks, how the • Key observations with respect to the matter. may be needed as the auditing world grapples with how
auditor responded to them and what to achieve informative and appropriately focused reports.
the auditor found.” How far should auditors go in describing Already, we have come a long way.
findings?
Figure 2. What descriptions of key audit matters will include
UK investment professional
Most of the UK reports in year 1 identified the risk,
explained why it was important and described how the Why the
audit addressed it. While shareholders have welcomed matter May describe the
is considered to most relevant aspects
that insight, many said that they found the descriptions be of the most How the of the response, brief
incomplete without the auditor going further to describe significance matter was overview of procedures
addressed in performed
the findings or outcome. There are questions around the audit
how this can be done meaningfully. For example, might Reference
the auditor’s view (which will inevitably be subjective to related
disclosure(s) May also
to a certain degree) end up supplanting management or if any include an indication
directors’ judgement – and should it? of the outcome of the
procedures, or
Or whether there is a need for some sort of ‘safe harbour’ any key observations
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.

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 Auditor reporting

Illustrations of key audit matters in UK audit reports

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

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 Auditor reporting

Reactions
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.

Positive reaction to tailored UK reports

Reactions to the similarly enhanced auditor’s reports in
Common views heard on the new UK
the UK have been very positive. In fact, many have said
“One benefit of the new reports is the clear that the first year reports exceeded their expectations. As
reports
demonstration that earnings numbers one UK investment professional said, “I think they are • The new reports are now more interesting and
are subject to many assumptions and not only a major step forwards, but actually pretty useful informative.
estimates and that radically different and interesting”. • The most valuable section in the new reports is
numbers could be permissible. That is not the areas of focus (IAASB’s key audit matters).
news to auditors, but it may not be well Importantly, the UK experience reflects the fact that
• Shareholders are keen to hear the auditor’s
understood by many investors.” the UK audit profession embraced the new reports with
perspective on the significant judgements made
enthusiasm. Audit firms issued bespoke reports that
in the entity’s critical accounting policies and
Floyd Norris, provided insight into the key issues addressed in the audit.
estimates.
International New York Times There was motivation to do so, against a backdrop of an
• Shareholders are interested in which risks were
engaged shareholder community, companion changes to
key in the audit and why, and how the audit
audit committee reporting and a competition enquiry that
responded to them – but they also want to hear
promoted greater innovation.
what the auditor found.
That’s not to say that shareholders do not believe there • The best descriptions are tailored to the
is room for improvement – shareholders clearly see some particular audit and entity – ‘boilerplate’ wording
reports being better than others. But it has been a very and generic descriptions are not helpful.
good start.

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 Auditor reporting

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 different jurisdictions around the
“If this just becomes a boilerplate exercise world. For example in the UK, the enhanced auditor’s reports were implemented at the same time as expanded audit
then it would be a setback, rather than a committee reporting requirements. Under the Financial Reporting Council’s changes to the Corporate Governance
step forward. For the standard to really be Code, audit committees are expected to describe significant issues in the financial statements that they addressed.
successful, the challenge is to make sure These complementary reporting requirements provided a shared agenda for auditors and audit committees that may
that the key audit matters are tailored to explain in part why the first year experience in the UK proved to be as successful as it was.
the company and provide useful insight For years, auditors have been required to have standardised reports. Bespoke audit reports are, in a way, counter-
to the various stakeholder groups – and cultural. While there will inevitably be similarities between auditor’s reports for the same company over a number
auditors should primarily be thinking of years, some fear a risk that the new audit reports could evolve quickly to the use of quite standardised wording to
about investors”. 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
Bruce Winter, risk of longer reports with simply more boilerplate language. If that is the case, the new reports will fall well short of
IAASB Member the a
 im.

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 Auditor reporting

Lessons learned so far

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 differ 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.

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 Auditor reporting

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

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 efforts 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.

Figure 5. Overview of auditor reporting timeline

New EU Audit Directive
New UK audit IAASB approves final and Regulation approved
reporting standard auditor reporting April 2014, to be
becomes effective for ISAs September 2014, followed by Member
reports issued after 1 PCAOB Roundtable expect to be released State Implementation
Oct 2013 April 2014 December 2014 by 2016

IAASB Exposure Some auditors in the New style audit reports PCAOB expects to Effective date for
Draft July 2013 Netherlands decide to be required in the consult on a revised the IAASB (and still
PCAOB to issue reports on Netherlands for proposed standard in possible for the PCAOB)
Proposed their Dec 2013 audits 21 Dec 2014 audits of Q1 2015 is the 31 Dec 2016
standard August following the public interest entities reporting period
2013 IAASB proposals (i.e. reports issued
in 2017)

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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

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 Auditor reporting

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 If there is a material uncertainty with respect to going concern, it will now be described in a separate section that
going concern (if any) 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* *The placement of an Other Matter paragraph could be here if it relates to the financial statement audit only, or later in
(if any) 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 The description of management’s responsibilities will be expanded to explain its responsibilities with respect to going
statements concern. It will also now identify those charged with governance (if different 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.

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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 August 2013 June 2013 standard Final approved
standard proposed standard in effect 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 Not required but has been Required where
they may be included included in a few reports relevant

Key audit input judgments, including materiality and group scoping √

Conclusions regarding going concern Enhanced No change to Not required but have No change to
descriptions of extant model been included by some extant model
responsibilities firms

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 √ Not in the auditor’s √
auditor 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

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 Auditor reporting

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.

US
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 effective 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.

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

Diana Hillier Marc Panucci

T: +44 (0) 20 7804 0472 T: +1 (973) 236 4885

E: [email protected] E: [email protected]

Paul Fitzsimon Jamie Shannon

T: +1 (416) 869 2322 T: +44 (0) 141 355 4225

E: [email protected] E: [email protected]
© 2014 PricewaterhouseCoopers LLP. All rights reserved. In this document “PwC” refers to the UK member firm, and may sometimes refer to the PwC network. Each firm is a separate legal entity.
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