Who watches the watchers? – auditor edition

Earlier this month, the FMA released its auditor regulation and oversight plan for 2016. The FMA’s plan sets out the new style of audit report issued by the XRB, intended to provide better information to investors.

The new auditor’s report includes new standards for listed entities – an auditor will be required to communicate key audit matters, and their report will include the name of the engagement partner. The auditor will report on significant matters in the audit of the financial statements, explaining why the matter was significant and how the matter was addressed by their audit work. This, the FMA says, is expected to improve the information available for investors.

The new auditor’s report also gives auditors the opportunity to explain their work and to provide additional information, and the FMA expects reporting that reflects the uniqueness of each business.

FMA’s workplan

The oversight plan notes that, over the next three years (to 30 June 2019), the FMA will focus on three main areas:

• Improving audit quality: The FMA states that it aim to perform audit quality reviews of registered audit firms once every three years. This is designed to ensure that key stakeholders, including audit firms, are informed about developments in audit quality, and any potential areas of improvement. (It also stated that its areas of focus for the reviews have not significantly changed compared to previous years and are aligned with what audit regulators are doing internationally).

• Monitoring changes in the new standards for auditor reporting: A new standard for auditors’ reports, including more comprehensive information, will be required for all New Zealand listed issuers with a reporting period ending on or after 15 December 2016, and can be used earlier. For other FMC reporting entities considered to have a higher level of public accountability, the effective date will be periods ending on or after 31 December 2018.

• Monitoring how it performs audit quality reviews: These were previously done by ICANZ on behalf of the FMA, but will be performed by the FMA (using FMA staff and independent contractors) from 1 July 2016 to align with international practice.

Improving audit quality – areas of focus

Under the new standard, the auditor will be required to communicate ‘key audit matters’ (those that, in the auditor’s professional judgement, were most significant in the audit of the financial statements for the current period.) The auditor will be required to report why each matter was considered to be significant, and how the matter was addressed in the audit. The FMA notes that this will provide users of financial statements with previously unavailable information.

During its audit quality reviews, audit firms’ internal quality control and the quality of individual audit files will also be assessed. The FMA has also signalled that it has selected the following focus areas based on issues identified by international audit regulators and its own findings from its most recent reviews:

• Auditor independence – particularly in the case of firms that provide significant non-audit services to FMC reporting entities.

• Audit quality control systems and supervision – especially where the FMA’s review picks up matters not detected in the firm’s own quality review procedures.

• Professional scepticism – particular emphasis will be placed on documenting:

o significant judgements on accounting estimates and fair value calculations;
o reliability of data provided by management or directors;
o management and directors’ representations;
o impairment calculations and recoverability of assets; and
o changes in accounting treatments / use of unusual treatments.

• Audit evidence – concentrating on ensuring audit firms obtain sufficient evidence in the following areas:

o going concern;
o revenue recognition; and
o the completeness and accuracy of related-party transactions.

• Understanding the issuer and its environment – demonstrating an understanding of the FMC reporting entity’s business model to cover all key risk areas in the audit strategy.

• The auditor’s responsibilities relating to fraud – the auditor must identify and assess the risks of material misstatement of the financial statements due to fraud. The FMA review the auditors’ assessment of this risk, and whether they adequately performed the procedures used to address this risk (including an increased focus on the review of journal entries and other specific fraud procedures).

• Use of experts – requiring the auditor to assess the competence and objectivity of any experts relied on.

• Audit fees and audit performance – the FMA says it will focus on those audits that have a very low audit fee or where audit fees do not reflect the complexity of the business, to assess whether sufficient work has been completed.

Comments

In recent years the auditing of financial statements has undergone a major sea change, requiring auditors of FMC reporting entities to be registered and individual auditors licensed by the FMA.

The changes heralded by the XRB’s new standard and the focus on ‘key audit matters’ (requiring the auditor to report why each matter was considered to be significant and how the matter was addressed in the audit) are expected to raise a number of complex issues. In the first instance, the audit profession and users of financial statements will likely be guided by the FMA, as frontline regulator. However, a quick glance at developments overseas would also indicate that there will be adjustment period by both FMC reporting entities and the audience for the financial statements.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.