Jumpstarting auditor reporting: New U.K. reports spark new life

According to Citi Research (Citi), “U.K. auditor’s reports became (a bit) more interesting this year.”

According to Citi Research (Citi), “U.K. auditor’s reports became (a bit) more interesting this year.” They see the reports sparking new life into auditor reporting, prompting better dialogue between companies and their shareholders about accounting and auditing issues, and potentially resulting in enhanced disclosures, provided auditors fulfill the spirit of the new requirements.

Citi reviewed 88 reports, including 35 FTSE 100 companies. Here are some of the key findings:

  • Reports varied in length from two to seven pages.
  • There was a large variation in quality, which Citi found not altogether surprising in the first year of a new requirement.
  • Some reports added little or no value with largely boilerplate comments, while others contribute significantly to investor understanding.
  • Most reports discuss at least three company-specific risks.

The U.K. requirements require the auditor to provide an explanation of how the auditor applied materiality in planning and performing the audit. This includes specifying the threshold used as materiality for the financial statements as a whole. Citi compared the materiality disclosures for all 88 reports. What they found was significant variability not only in the benchmark measures used, but also in how these are described and the rationale for using them. If investors review the percentages cited in the auditor’s reports across a range of companies they may reach some incorrect conclusions about their comparability.

Citi performed a similar exercise with respect to how auditors dealt with the U.K. requirement to provide an overview of the scope of the audit, which might include the coverage of revenue, total assets and profit before tax achieved. Citi found there was variability in the level of detail provided, particularly the extent to which coverage consisted of a full audit or something less than a full audit.

Another significant Citi finding relates to how auditors deal with disclosures around the risk of fraud in revenue recognition and the risk of management override of internal controls. Because these risks are identified in the auditing standards as present in virtually all entities, some auditors took the position that they needed to include disclosures about these risks in every report, using fairly generic language. Citi does not believe these standard disclosures are helpful to investors and fears that they might be included in the auditor’s report at the expense of more company-specific information.

Citi summarized points of interest from the auditor’s reports of BP, HSBC, Rolls-Royce, and Vodafone. They identified the Rolls-Royce report as the best they have seen to date. This is because the report not only describes key risks in detail, but also explains the auditor’s response and the auditor’s findings, including comments on whether Rolls-Royce management’s judgments and estimates were appropriate or cautious/optimistic. Citi found this very useful.

Citi concludes overall that the new requirements for auditor’s reports are an improvement. However, they go on to provide suggestions on how reports can be more useful going forward. Although these suggestions are given in the context of the U.K. requirements, they give a good sense of what Citi finds useful in an auditor’s report. The U.K. experience will also serve auditors in other jurisdictions as they implement auditor reporting requirements under upcoming new international reporting requirements.

Keep the conversation going…. what is your reaction to the Citi report?

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About the Author

Eric Turner, CPA, CA

Director, Auditing and Assurance Standards, CPA Canada