‘The art of conversation: the expanded audit report’ – a practitioner view

My background is as a professional auditor with EY, and my entire professional career has been auditing large, multinational companies, listed both in the UK and in the US. So as my time is spent auditing UK-listed companies that are also Foreign Private Issuers, I am affected both by Key Audit Matters (KAMs) and Critical Audit Matters (CAMs). It is very interesting for me to be able to contrast them and study the differences between the two.

In terms of audit quality that Minutti-Meza (2021) mentions, I think there are two areas, certainly in the UK, where changes have caused a significant improvement in audit quality. The first was the mandatory rotation of audit firms, the rule that came in a while ago, where essentially in the UK a company has to re-tender its audit at least every ten years and an auditor cannot be appointed for more than 20 years. In other countries in Europe that period is shorter. That has made a substantial difference to audit quality because for the first time we have seen firms now compete on quality. That is very obvious in terms of how the audit profession works now, where we are very clearly competing with each other on quality; and part of the way that we do compete on quality is through our extended audit reporting, which is the second area of significant change.

For me, there is a very substantial difference between the UK and US audit reports. In terms of the informational value and the new information that investors are getting from the extended audit report in the UK, I think they are getting very substantial additional information. But this is not so much the case with the US report.

The genesis of the extended audit report came from the Financial Reporting Council in the UK, and from the Codes & Standards Committee, of which I was a member at the time. The initiative was led by the then Chairman, Nick Land, and the technical director Marek Grabowski. They had spoken to investors, as we spent a lot of time doing, and the view that we got from investors is that they wanted to get a lens into the discussion that goes on between the auditor and the audit committee. That is how the extended audit report really started, and that is how the KAMs came about.

If you look at the UK audit report, and if I take Shell as an example, the UK report runs to some 16 pages, whereas the US report that is attached to the SEC Form 20-F of Shell runs to 3 pages. So there is a very big difference between the two reports, and a very big difference in the information that is contained in the two reports.

Minutti-Meza (2021) refers to the fact that the additional information that the market is getting, that investors are getting, is perhaps just a known set of issues. I would disagree with that, because what a UK user is getting is a detailed description of the significant risks and areas of audit emphasis that the auditor has focused on in his or her audit; a detailed description of materiality, and what the various materialities are, and how the auditors arrived at their materiality number – which is something that they have never had before, and certainly do not get in the US report; and then there is scoping, where investors get very detailed information on how the audit is scoped, where the focus is and what components are focused on, and whether it is a full audit or what type of audit is carried out on those particular locations or components. So investors get very significant new information that they would not have had otherwise in terms of risks, areas of audit focus, scope, and materiality. When you get to the KAMs, the definition of the KAMs is certainly broader, in my view, than the US CAMs, and that is certainly illustrated by the wider number of KAMs that you find in UK opinions versus what you see in SEC Forms 10-K and 20-F.

The other big difference that Minutti-Meza (2021) correctly mentions is that you get told why a risk is considered an audit risk, you then get told in quite a lot of detail how the auditor addressed that risk, and then what you get in the UK report, and based on the international standard as well, is what conclusions the auditor communicated to the audit committee regarding that risk – which you are not getting in the US opinion. So I think that there are some very big differences, and I think the informational value of a UK and International Auditing and Assurance Standards Board (IAASB) international opinion is considerably greater and broader than the US opinion.

It is very interesting how few CAMs there are in the US opinions. The research that I saw recently was that the average is 1.8. When I did a rough survey, just picking at random sets of accounts, generally there were one or two, maybe the odd one with three CAMs in it. If you take ExxonMobil, for example – once, not so long ago, the largest company in the world – they only had one CAM, and so I do not agree with the idea that the investor is getting this great insight or information from the CAMs that you see in US audit opinions, as compared to the KAMs that you see internationally under the IAASB standard and under the UK standard.

The other big change in behaviour that has come about through the extended audit report, certainly in my experience, is that the conversation that auditors are now having with the audit committee tends to be a lot richer, for some reason, than it used to be. The documentation of the communications with the audit committee throughout the year and the way that they are conveyed is, in my view, certainly enhanced. This is because the auditor has one eye on the fact that what is communicated is going potentially to end up in their audit opinion as a KAM, so auditors really now have to focus on how they present their findings and conclusions and what issues you discuss with the audit committee, because they will potentially flow through to the audit report. So I am finding that I am having a much richer, better documented conversation with audit committees.

The other change that I have observed is that KAMs have now also, in a sort of reverse way, improved the quality of audit committee reports. Because auditors are now setting out in their reports the key issues and their findings, and the key issues which were addressed during the year, these tend to flow back into the audit committee reports, and I am finding that you are getting much richer audit committee reports as a result of the KAMs; so that is, in my view, another substantial benefit of the extended report, and also specifically KAMs, because you now find the audit committee is actually discussing much more in their report, and in much more detail.

We do not necessarily put into our audit reports everything that the audit committee has in their report, because we may decide that it is not a KAM, but certainly you are getting much richer audit committee reports, in my experience.

The other area that I would mention, and which Minutti-Meza (2021) raises, is the trust deficit between the profession and society. This is a huge issue that the profession is facing at the moment. One of the ways that we are able to address this deficit is through our extended audit report. I think the quality of the report, certainly what I am seeing in the UK, is improving remarkably. It is not just boilerplate; people are taking it very seriously.

An important differentiator between the UK and the US is that the auditor puts his or her name to the report, so I sign the audit report in my name, personally, whereas that is something that the US has not yet adopted. The fact that I am signing that report in my name personally may not sound like a big thing, but for me it is a big deal, because it is my name that is going on the report and therefore, apart from a sense of pride, you get a much greater feeling of professional responsibility in the fact that your name is going on the report. And when we say that we compete on quality, one of the things where we compete on quality, certainly, is having my name on the report; I want investors to be able to judge me if they see my report, and hopefully that also has an impact in terms not only of how investors view firms, but also how investors view individual partners.

Moral courage is another area, just to end off, that has become an important factor, and that is also something which auditors have had to focus on. In addressing key audit matters in an expanded report, auditors are finding that they really need to face up much more to the moral courage that is needed to be able to deliver difficult messages to the audit committee. We tend to underestimate the fortitude required for auditors to take a stand. The extended audit report helps them do this.

Disclosure statement

No potential conflict of interest was reported by the author(s).