Comment Letter to Auditing and Assurance Standards Board on Changes to the Audit Report

Introduction

In overseeing the financial reporting process, including the work of the external auditor, audit committees play a vital and integral role in the financial reporting of public companies. As the organization that represents the interests of those directors on Canada’s audit committees, the Institute of Corporate Directors (ICD) thanks the Auditing and Assurance Standards Board (AASB) for the opportunity to comment on the proposal to adopt as Canadian Auditing Standards (CASs), the recent changes to auditor reporting standards issued by the International Auditing and Assurance Standards Board (IAASB).

The ICD is a not-for-profit, member-based association with more than 10,000 members and eleven chapters across Canada. We are the pre-eminent organization in Canada for directors in the for-profit, not-for-profit and Crown Corporation sectors. 

The specific requests for comment regard only the timing and process of implementation in Canada of the IAASB changes. Given that this is the first opportunity many stakeholders will have had to comment on these changes, we have broadened our submission to offer our views on the merits of the proposal. These views are informed by feedback received from hundreds of directors, audit committee members and other interested capital markets stakeholders at cross-country consultations over the past four months. As well, we offer commentary on other avenues that the AASB and collaborators in this space may wish to explore to improve financial reporting.

The ICD Position

Background

In fulfillment of our mission to foster excellence in directors to strengthen the governance and performance of Canadian corporations and organizations, the ICD organized a series of cross-Canada town hall events in collaboration with the Chartered Professional Accountants of Canada (CPA Canada) and the Canadian Public Accountability Board (CPAB) to gain the perspective of our members on a number of emerging audit committee issues, including the IAASB’s changes to the auditor report proposed for implementation in Canada.

Between October 2015 and January 2016, we hosted seven events that educated our members on these changes and solicited their feedback and guidance. It is these insights from Canada’s corporate director community – including many audit committee members of listed companies - that largely inform our comments below.

Process 

Following an introduction to and overview of the proposed changes, as well as a panel discussion with CPA Canada, CPAB, and a leading audit committee member from a major issuer, participants at our events were asked to work in groups of 8-10 to deliberate over the following questions:

1. Has your impression been that changes are required to Auditor Reporting in Canada? Why?

2. What are your reactions to the proposed changes? Are there opportunities or challenges that you would highlight?

3. If Canada implements the proposed changes, how could it be done effectively?

One scribe per table was assigned to capture key takeaways from the conversations. We also asked participants to complete a multiple choice survey at the end of each event.
 
Based on the feedback we received at these events, as well as further dialogue with some of Canada’s leading audit committee members, the ICD questions the value of these proposed changes in the Canadian context. Further, we believe the concerns identified by the stakeholders we consulted outweigh the purported benefits.
 
Below we outline these concerns as supported by the key takeaways from our town halls:

Lack of need in the Canadian context

While the ICD appreciates the focus of the IAASB and the AASB on improving audit transparency, a key question that emerged from our cross-country consultations is whether there is even demand in Canada for this proposal. Given that the information included in the new auditor’s report is intended to benefit the user of the audit –- it is concerning that many stakeholders involved in Canada’s capital markets who attended our events did not seem to be aware of these potential changes.

Further, participants at the town halls seemed unconvinced that these proposed changes would be of great value to the users of the audit. In response to the statement, “based on what you have learned, the proposed changes to auditor reporting will enhance the value of the auditor’s report to users”, 38% responded somewhat” and 40% responded “not very”. Only 11% responded “very”.

Many at our events asked, “What is the problem we’re trying to fix?”

Key town hall takeaways

• There is some question regarding the degree to which users of the audit in Canada are demanding the changes being proposed

• The lack of awareness about these issues indicated there may not be significant demand for change. (In every city we visited, most participants – audit committee members, CFOs or other sophisticated stakeholders in this space – had never heard of this initiative)

• Relatively speaking, there have not been serious accounting and auditing crises in Canada so it is not clear what problem the changes would solve
• There are different needs and accountabilities in Canada than in other jurisdictions (i.e. Europe) so this may not be appropriate for our market 

Cost

There is concern that the proposed changes, including obligating the external auditor to identify Key Audit Matters (KAMs), will significantly drive up costs to issuers. It is assumed that large cap companies would be in a position to absorb these costs, although it is unclear whether this is value for money considering the audit committee should already be privy to the information the auditor would be required to make public.

More concerning is the impact these increased costs would have on small and mid-cap issuers where significant cost increases could have a material impact, putting them at a competitive disadvantage.

Key town hall takeaways

• The increased work demanded of the external auditor will drive up costs for issuers
• Increased costs will be damaging for small and mid-cap companies

The impact and appropriateness of highlighting Key Audit Matters (KAM) and going concern

Several issues were identified by stakeholders regarding the external auditor publicly highlighting Key Audit Matters and commenting on going concern.

Many participants felt that identifying KAM risked reiterating what should already be in the MD&A, raising the question of utility. Further, it was felt by many that identifying KAMs in the auditor’s report would be done through standardized language, with the external auditor feeling compelled to include every risk possibly associated with a particular industry in an effort to avoid liability. This again raises questions about utility and whether auditor reports would become “templated” and/or be subject to additional boilerplate language.

On the matter of going concern, there was some discomfort over the appropriateness of the external auditor commenting on management’s use of the going concern assumption. Concern was raised, for example, that the auditor risked increasing the likelihood of a negative event by telegraphing it in the report.

Key town hall takeaways

• Risks are already identified in disclosure documents, including the MD&A
• The focus should be on simplifying the MD&A and the financial statements
• Because of potential liability issues, there is a risk that the external auditor will include every and any risk as a KAM
• There is a risk that KAMs could become standardized by industry or across all industries, leading to more boilerplate copy in the audit report 

First mover disadvantage

The AASB has rightly been cautious in its approach to the timing of any implementation.

Participants at our town halls identified as very concerning the scenario of Canada adopting the changed standards before the United States. Given the very large number of cross-listed Canadian companies, any adoption by Canada before the U.S. would put Canada at a disadvantage.

Indeed, 80% of participants agreed that the direction and timing of United States auditor reporting standards for listed entities is important in reaching decisions about the implementation of new auditor reporting standards in Canada.

The ICD believes that if Canada adopts changes to auditor reporting, it should not be before changes are implemented in the U.S. Further, we urge the AASB to monitor the PCAOB process carefully to identify whether any changes issued by that body (if forthcoming) could logically be adapted in Canada.

Key town hall takeaways

• If Canada adopts before the US, we will be at a disadvantage
• If the US does not adopt, Canadian cross-listed companies will follow the PCAOB

Standard

An alternative to increase transparency and improve audit quality

The concerns raised above do not necessarily indicate that financial reporting cannot be made clearer and more transparent for the benefit of the user.

The ICD would welcome further study by the AASB, perhaps in collaboration with other leaders in this space such as CPA Canada and CPAB, into making financial statements clearer and potentially increasing the involvement of the external auditor with the Management Discussion and Analysis (MD&A).

There is also potential value in a project to develop non-GAAP measures in the MD&A. These are documents that investors and analysts rely on and more clarity here would, we believe, likely have a greater impact on improving financial reporting than would the changes adopted by the IAASB.

Focusing on the auditor’s involvement in the MD&A and non-GAAP measures would be a made-in-Canada solution that could realize true value for the user in this market.

Conclusion

The ICD welcomes initiatives that will bring transparency and clarity to Canada’s capital markets but we have concerns that these changes, while perhaps appropriate in other markets, will not achieve those goals in Canada.

First, there are problematic aspects to these proposals that we believe need to be further deliberated before the AASB considers implementation. These include questions regarding the usefulness of these changes in the Canadian context, high cost and an incomplete understanding of how additional information, including KAMs would be communicated effectively in the auditor report.

Second, given the very high number of cross-listed companies in Canada, we believe it would be imprudent for Canada to implement any changes in advance of understanding what changes may (or may not) be implemented by the PCAOB in the United States. We would, therefore, urge the AASB to hold off implementing any changes until this becomes clear.

We do believe that the AASB could work towards greater transparency and clarity in financial reporting by initiating work regarding the role that the external auditor plays in the MD&A and in developing non-GAPP measures.