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Audit Committees and Auditors reporting

Audit committees' and auditors' reports - Mike Metcalf:

MM Thank you, Brian, and good afternoon, everyone.



Rather unusually, for our financial reporting seminars, this session now isn't about a technical accounting matter. We're going to cover a governance topic, audit committee reports, and for the first time ever at these seminars, audit reports, not because we want to change the focus of these seminars, but because these developments may lead to much more focus from investors on interesting accounting issues at individual companies, so what we're going to do is we're going to look at the major changes that became applicable from September 2013 year-ends onwards, and where it might lead.


So to begin with, as you know, a listed company’s annual report now has to describe how the audit committee addressed the key issues, the key accounting issues, and I'm sure that you’ve noticed that auditors’ reports have become much longer and much more company specific, dealing with those same accounting issues.


We published a survey of these sets of reports, back in January, and we've been tracking developments since then, so I thought, well, we'd start with a few survey statistics.


A frequent question is, well, how many issues are these reports dealing with? Well, the answer is that both of them are covering about four issues on average, and that hasn't changed since January. What's interesting, though, is the range. It's wide, and become wider. In January we saw up to seven issues in the reports, and now we're seeing up to ten. So, I think that's a good thing. It means that companies and auditors aren't targeting some kind of arbitrary fixed number: you must report four; you must report five. So audit committees, for example, are reporting whatever they think they need to say, whether that runs to three, five or eight issues.



In doing this, we also notice some interesting timetable statistics. So, the Companies Act requires a company to publish its annual report on its website as soon as reasonably practicable after it's been signed off. We found a huge range of reasonably practicable, from zero days to 78 days. I can't help wondering whether that's one of the lesser-known requirements of the Companies Act.

Another rule, another requirement that doesn’t seem to be universally known is in the disclosure and transparency rules. It requires that a listed company make an RNS announcement when it's published its accounts on the website, but just under 10% of companies don't do this at all.


Obviously these days there really is a complicated overlapping mass of regulation, and it is easy to overlook things, but if in the past you’ve overlooked either of these you might want to make a mental note for next year-end.


Now, statistics are all very interesting, but you might be asking, well, what about the qualitative aspects of audit committee reporting, audit committee statements. As I said, audit committees are now required to explain how they address the specific accounting issues applicable at the company. The FRC’s financial reporting lab published a guide explaining what investors would value in those statements and I've summarised it in the graphic here on this slide.


So, those are the qualitative characteristics that investors are said to be looking for, so, for example, if you want to look at summary of actions, you can find audit committee statements that explain how they have received and considered reports from management about impairment. For conclusions and outcomes you can find audit committee statements such as, we agree with management that there was no impairment.


As a great example of providing reasons, explaining the approach, and also using active language, I'd just like, for a moment, to quote from the audit committee at a financial institution, and they say, I quote, “through the year the company committee requested and received information on specific names in industries based on its, the audit committee’s, assessment of the external environment and developments in footprint markets”, close quotes.


I think that's a really good example of an audit committee showing that it's engaged and active on behalf of shareholders, and really adding value to the governance of the company.



Not all audit committee reports are like that, though. There's a real mixture. Some are at the opposite end of the spectrum, confine themselves to saying that they received, reviewed and agreed with the report from management.


I was talking to a broker recently, who told me that in their view many audit committee statements aren't useful. I also think that at some point the investment community is going to ask whether the passive style of audit committee reporting is actually a symptom of a passive audit committee. Now, I don’t think that would be true, as a rule, certainly not, however, I imagine that some of you here today probably work closely with your audit committee chairs when they're drafting their audit committee statements, so you might want to prompt your audit committee chair next year, you know, you perhaps need to think about refreshing the style, in order to dispel any doubt that might arise; dispel doubts before they arise.


What about auditors’ reports? Well, this is what it used to look like in the old days. That’s about nine months ago. It was a binary pass/fail opinion, accompanied by a generic explanation of an audit, and it was comparatively short. Not any more. Here's just one page from my firm’s new reports for the same client. That's one page of four, so it’s comparatively long. It's even got graphics in it. There's lots of specific description of the particular audit, for example, we give the materiality figure.



I can tell you, from our conversations with investors, that materiality has attracted quite a bit of interest. They're surprised at how large the figures are, really surprised. I heard of one broker who nearly fell off his chair when he read the figure from one of the very early new style reports. So I think that this could provoke a debate about materiality. After all, materiality is about how large a potential adjustment has to be before it would affect the reactions of users, so it’s a bit hard to say that the investment community doesn’t have a legitimate voice in that.


At the same time, lower materiality levels would mean more audit work, and more audit cost, ultimately coming out of the shareholders’ profits, and companies, of course, also have a legitimate voice in any debate about materiality. At the end of the day, it's the materiality of your financial statements, so I think you’ll need to keep a watching brief on this one, and if a debate starts up, participate.


The other new feature of the auditors report, the principal new feature is the description of the key risks and the auditors’ response to them. It's largely factual about the audit. What do we think the risks were, and what audit work did we do about them? I'm pleased to say that in a recent brokers’ research note Citi Research said that in their view, KPMG’s reports contained the most useful analysis of the risks, which was very nice to hear.


In fact, we're hearing, generally, that all types of investors are showing a great deal of interest in audit reports; all types of investors, not just the governance people at the big, well known investment houses, but in fact, you know, for example, buy side analysts, individual fund managers, lots of interest in it.



The increased transparency is giving them a better understanding of the audit and the auditor, but also, in some cases, it's giving them more transparency about the accounting. Now, certainly, our experience has been that the new report has occasioned renewed focus by companies on their own disclosures of significant estimates and judgements, however, that same Citi Research note also suggested that investors think there's still some distance that companies, on the whole, could go.


So, whilst the reforms of the audit reports are about the value of audit, and making that transparent, I think it's also promoting more transparency about the company’s own accounting, and I can't help but suspect that the FRC was hoping for just such a by-product of this reform.


Now, all of that seems like a huge amount of change in a very short time, and it is, but could there be yet more transparency to come?


KPMG, it seemed to us, from the outset, that there was an elephant in the room. The new rules require reporting only on the audit risks and the auditors’ work in response, but not the findings from the auditors’ work. Why? Well, we felt that it was better to talk about this than to pretend that the elephant wasn't there, so with the agreement with three of our clients, and we're really very grateful to them for their commitment to examining and shaping what the future could look like, we did a live field test of exactly this idea. In those three reports we included our findings on, for example, how acceptable were the policies, the estimates, the disclosures, expressed in a graduated way, rather than in binary yes/no, acceptable/unacceptable style.



We did this to promote debate, though we've also found recently that the forthcoming EU audit regulation might actually make this kind of reporting mandatory, from about 2016, so, if you go to the Restoring Trust pages of our website, just type “KPMG Restoring Trust” into Google, and it will take you straight there, you'll find that we've uploaded some materials explaining this idea about reporting findings, giving extracts from the reports, and pointing to some of the pros and cons.


Our web pages also have the facility for you to vote on the idea, and to upload a comment.


The result so far is that investors, perhaps not surprisingly, are very positive about this, but the companies are among the more cautious in terms of their reaction. The caution isn't wholly about the transparency itself; it's also a concern that it's coming from the auditor, rather than from the company or its audit committee.


Our view is that we'd be ready to deliver this, if that's the consensus, but the consensus isn't for auditors to decide. Whatever is the way forward is, subject to that question of the EU regulation that might make it mandatory, whatever is the way forward is what shareholders, the investment community, and companies can agree on, implemented in auditing standards.


So, if you’ve not already visited our Restoring Trust pages, do go there, have a look, perhaps even vote and upload a comment.



So, to close, I think that the prospect of engagement by the investment community on accounting issues, seeking and reacting to more transparency of accounting estimates and judgements, and about audit, for example, materiality, has never been higher. Companies should make sure they're watching what's going on, and if and when any debate starts, participate. After all, accounts and audit are about facilitating stewardship, the relationship between shareholders and the company, so it's important that the companies voices, yours, are heard.


Thank you very much.

Audit committees' and auditors' reports - Mike Metcalf