by Ashutosh Pedneker, DFK AAC Chairman, MP Chitale & Co
Dear Fellow DFKians,Future of Audit and Assurance
I read the Discussion Paper of the Federation of European Accountants (FEE) of its Strategic Debate on the Future of Audit and Assurance. The FEE had initiated the discussion in 2014 and after obtaining responses to it, the matters were discussed at its audit conference in June 2015. The findings are quite relevant to all of us who render audit and assurance services. With the ever growing expectation from varied stakeholders and the economic society at large, our reporting on financial statements has over the past few years acquired a different perspective.
The old debate of audit standards and documentation taking away the flavour of professional judgement based on appropriate professional skcepticism has been discussed nicely in this paper. The paper recognises that synergies exist between good corporate governance, good corporate reporting and good audit. And good audit is a product of the people, culture, knowledge and competence, integrity and independence, and tone t the top.
The main drivers that will affect the future of audit and assurance were shortlisted as:-
- Enhanced engagement with stakeholders needs. Auditor communication is one key area for achieving this
- Harnessing the benefits of technology. Key challenge identified as innovation of I and the auditors skill set development required to use technology
- Education of future generation of auditors
One of the aspects covered in enhanced engagement was for the auditor to be more open with stakeholders on the work performed, judgements taken, and the reasoning behind conclusions reached. For this, apart from the traditional modes of communication with various stakeholders, very interestingly one of the tools suggested is “Social media listening or social media monitoring”. It is a process of identifying and assessing what is being said about a company or a brand on the internet. Within DFK International, our Marketing Committee has always stressed upon the role of social media as a brand awareness tool of our skills. Now FEE suggests looking at it as an enabler for audit communication. it was also felt that open and enhanced communication will result in entities and stakeholders consider audit not as merely a compliance service.
The paper also deals with SMEs where audits are not compulsory in many jurisdictions. It has identified a usefulness matrix of financial statements by applying the needs of various stakeholders. The needs range from reliability of financial information reported, more confidence of going concern, appropriate disclosures and risk coverage and the users are shareholders, investors, bankers, lenders, tax authorities, customers, suppliers, employees and trade unions.
In my view, within DFK International we need to recognise these new enlarged expectations of the economic society we cater too. To meet these requirements, as auditors we need to stand up and deliver. One of the tools for this delivery, apart from development of standards is the education of an auditor and the harnessing of technology. Both have been dealt with the discussion paper.
Process mining and data mining is considered as an important tool for harnessing of technology. The paper also urges professional bodies, firms and other bodies to educate and train auditors to upscale their technology skills. However, the paper states with conviction that technology should not override the human factor; physical presence is still important to fully understand a client’s business and its processes and to remain fully relevant.
The paper mentions that besides technical competence an auditors skill set required are as under:-
- Ethics and values
- Professional behaviour, including independence
- Professional judgement and skepticism
- Ability to understand the business environment and related business risks
- Risk management – different types of risks and areas of expertise
- Business skills
- Soft skills, such as leadership, problem-solving attitude, management, communication
- Ability to understand the behavioural characteristics of an organisation/directors
- Technical skills and knowledge on accounting, auditing, mathematics, statistics
- Analytical skills and critical thinking
- IT knowledge and skills
This paper is available on the FEE website, http://www.fee.be/library/list/32-audit-assurance/1557-pursuing-a-strategic-debate-the-future-of-audit-and-assurance.html I feel that the paper has rightly captured the dilemma of an auditor of how to make his services more relevant. Reliability of our services has always been there; relevancy is the new mantra that auditors need to address. Considering the demographic profile of a large number of our member firms, I feel that within DFK International each of one us could commence introspection of where we are placed on this scale of the desired skill sets. It would perhaps be a good insight if we pick up one or two factors identified by the paper, say manner of harnessing a particular technological skill and educating a future auditor on couple of the desired skill sets and then survey our member firms of how they have gone about implementing it or are thinking of implementing. Such cross sharing of knowledge would, perhaps, lead to better performance by all of us.
The AAC has always been asked by various members whether a software exists that can be used by DFK members. Considering the structure of our association DFK International will never prescribe an audit software to be used. Large firms within our membership either use their own softwares / utilities or rely on off the shelf products, further customised or not. There are member firms within DFK International which have developed their own software and utilities. Three such firms were identified and AAC took it upon itself to do a review of them. Parameters were decided, templates developed and reviewers identified within our committee. Two of the three reviews have commenced. Once all the reviews are done the findings will be shared with our members. We can have a discussion on the same in our forthcoming international conference at Hanoi. This is perhaps, a first within DFK International.
AAC Workshop at Hanoi
Friends, we have commenced preparation for the AAC Workshop that would be held at Hanoi, Vietnam in July this year. As soon as the topics and speakers are finalised we will announce. I request you to please enrol yourself for this Workshop, which has always thrown up some excellent ideas and thoughts on the technical, quality and business side of our profession.
In the meantime, please do share your experiences of implementing accounting and auditing complexities with us. If there are matters of general interest we will certainly share them through our newsletters with our fellow DFKians.
We at the AAC welcome your views on the contents of the newsletter and suggestions to improve it. I can be reached on firstname.lastname@example.org
The current members of the committee
- Ashutosh Pednekar, M.P. Chitale & Co. India
- Michele B. Amato, Friedman LLP, USA
- Rick Bahula, Taylor Leibow LLP, Canada
- Shane Browning, DFK Oswin Griffiths Carlton, New Zealand
- Pier Giuseppe Ferri, DFK Italia, Italy
- Ricardo Gonzalez, DFK Gonzalez y Asociados, Mexico
- Jose M. Hinojal, Abante Auditores, Spain
- Anton Lewis, Levitt Kirson, South Africa
- Xerxes Medora, J.K. Medora, Singapore
- Andreas Vogl, PSP, Germany
Italy – changes to Financial Statements – March 2016
From 2016 the companies’ balance sheets in Italy change shape. The main changes that will be introduced by the new Directive are:-
- Simplification (see article “From the 2016 New Balance – Part 1”)
- Basis of preparation (see article “From the 2016 New Balance – Part 1”)
- Introduction of Cash Flows
- Exclusion from income statement items relating to extraordinary income and expenses and disclosures in the Notes (see article “From the 2016 New Balance – Part 2”)
- Capitalization of the voices of “research costs Exclusion” (see article “From the 2016 New Balance – Part 2”)
- New reporting formats (see article “From the 2016 New Balance – Part 2”)
Some aspects are described here:-
The Directive aims mainly to introduce the important “simplifications” especially for certain categories of entrepreneurs and legal entities (including on consolidated accounts). It wants to create a mostly informative stratification of financial statements according to company size, reducing the severity of compilation for small and medium-sized enterprises, in particular for micro-entities.
groups also are divided into three size categories (small, medium and large) based on the parameters set for the same categories of businesses. The effort of the Directive is to create an important reference point in setting, the distinction between micro, small, medium and large enterprises.
Basis of preparation
The Directive confirms the existing general principles of financial statement preparation, expanding the list and providing that the disclosure and presentation of items in the income statement and the balance sheet take into account the substance of the transaction . The authority has the right to grant exemptions for some businesses. This is not an absolute novelty, because our legislature had already implemented this requirement in 2003. This standard had somehow intended to bring the accounting policies of some items of the financial statements to international accounting standards (IAS / IFRS) in line with the general approach of evaluation which tends to abandon the policy of “historical cost” in favor of a criterion based on the fair value (or “fair value”). This will enable companies who prepare their financial statements in accordance with statutory provisions and those who prepare in accordance with IFRS to be on an equal footing. The impact would be in accounting of leasing, factoring and the “repo” (the latter as financial transactions and not as securities trading).
It is easy, then, to imagine that Italy does not transpose (converge or adopt) in an absolute sense because the convergence / adoption would involve the rewriting of many laws (including the tax), not counting that should, perhaps, in contrast to a guiding principle of our legal system that sees the property and possession as two “domain situations” where the property is a formal legal situation in which the owner has the full power provided by law on the things that belong to him, while the possession not as a formal situation but as a state of affairs in which they exercise the powers typical of the properties of certain objects.
This distinction is also reflected in the way in which the facts are recorded (with administrative significance). In fact in the balance sheet assets (assets) are only those assets (tangible or intangible) of which the company has a formal domain situation regardless of whether the asset itself carries its own economic function (ie helps to generate profits for the ‘ enterprise).
As is well known, the lease has the distinction of being the combination of contracts (leasing, financing and sale with reservation of ownership) where the lessee does not have full power over the detainee well, albeit often plays a role important in the formation of the tenant’s income. Think of an important machine in the production process of a company (the press to a news organization, the pasteurizer for food companies, etc.) Purchased with leasing agreements, this good would not find its enhancement in the assets of the balance sheet of the lessee’s balance sheet (except the eventual payment of the maxi as a prepaid expense) if not for his share of the economic utilization of business costs (value of the lease and financial costs) in the statement of income (more properly in B.8 “costs for use of third party assets”).
This procedure, however, not shared by the international accounting principles (see IAS 17), provides for the commitment assumed and detection of the original value of the acquired good only in the memorandum accounts, omitting the indication in the balance sheet. Since we know that, unfortunately, there are still many companies that do not give due weight to the correct indication of the memorandum accounts, it is clear that such an approach creates distortions and errors of assessment of the economic results and capital and financial structures of the lessee companies , with the effect of distorting the reading of some indices (ROI, ROE, financial acrobatics, etc.) and their interpretation.
For this reason it was said that the directive in question could constitute an opportunity to give precedence in some cases, the substance over form, and give the correct interpretation and informative value to the budgets of our businesses, eventually forming a prodromal factor to transparency and openness financial markets also to SMEs.
– Pier Giuseppe Ferri, DFK Italia
USA – That’s Material?
This year may see a new definition for an old concept: Materiality. The parameters around what constitutes a material disclosure in financial statements will be impacted, and some onlookers say the new meaning will give more discretion to companies, which may lead to less information being provided.
It was 1976 when the Supreme Court decided material would be defined as an omission of factual information (i.e., disclosures). The definition was effectively expanded to cover misrepresentations of fact in a 1988 decision of the Court, and generally applied to both disclosure misstatements and matters of measurement. These definitions were subsequently adopted as part of Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, which prohibits any act or omission resulting in fraud or deceit in connection with the purchase or sale of any security.
Accountants have traditionally used the definition given in Statement of Financial Accounting Concepts No. 8, Conceptual Framework for Financial Reporting (CON 8), which was released in 2010. CON 8 states, “Information is material if omitting it or misstating it could influence decisions that users make on the basis of the financial information of a specific reporting entity.” Concept Statements describe fundamental concepts that are intended to provide guidance on financial accounting practices.
In 2015, the Financial Accounting Standards Board (FASB) proposed to amend CON 8 to eliminate the inconsistency, recognizing that materiality is a legal, rather than an accounting, concept. The inconsistency lies in the fact that one definition uses the word would, while the other uses the word could. Determining whether an omission would have influenced an investor is more difficult to prove than whether such omission could have influenced the investor. However, both are very subjective and not likely to have much impact on the judgments of preparers or auditors.
Since Concept Statements are non-authoritative, the FASB proposed an Accounting Standards Update (ASU), Assessing Whether Disclosures Are Material, to amend the Accounting Standards Codification Topic 235, Notes to Financial Statements, at the same time. The main provisions in the amendment not only refer to materiality as a legal concept, but state specifically that “omitting a disclosure of immaterial information would not be an accounting error.” According to the ASU, “Each Accounting Standards Codification Topic would state that an entity shall provide required disclosures if they are material.”
In January 2016, the SEC’s Investor Advisory Committee voted to request the FASB revise its proposals due to concerns that the new definition of materiality may reduce the amount of information provided to shareholders. However, in February 2016, the AICPA’s Financial Reporting Executive Committee (FinREC) submitted a comment letter to the FASB in favor of its proposals.
Small businesses are putting their reputation at risk by underestimating the impact of cyber-attacks, new research has found.
KPMG UK and the UK Government’s Cyber Streetwise campaign has found an overwhelming majority (93%) of small businesses think about reputation frequently or all the time but are not considering how a cyber breach could impact it.
Moreover, only 29% of surveyed small companies that have not experienced a cyber or data breach are mindful of the damage one could cause.
The report, entitled Small Business Reputation and the Cyber Risk, surveyed 1,000 senior leaders at small businesses and 1,000 consumers across the UK.
The findings highlight 83% of consumers are concerned about who has hold of their data and whether it is safe, with more than half (53%) saying they would be “discouraged” to use a business again if a breach came to light.
The financial sector is the most likely industry to lose customers because of cyber breaches, with 39% of 599 small businesses surveyed by the same report losing customers this way in comparison to the UK average of 30%.
“Every piece of data in a business can be of interest to a cyber criminal,” KPMG UK cyber security practice partner George Quigley says.
“Even if the business itself may not realise it – and with small and medium sized businesses a key target for this very reason – it’s vital to take steps to protect your data, and with it the trust of your customers and ultimately your reputation.”
In November 2015, Cyber Streetwise held a forum that revealed SME owners are seeking advice from accountants to improve online security. However, the government-backed organisation added in a blog post that SMEs should consider small steps first.
Elsewhere, the report published in Monday by KPMG and Cyber Streetwise highlights that 85% of small businesses store data in their IT systems however one fifth of this number do not consider the material commercially sensitive.
A vulnerable data-system can leave a businesses’ financial and customer information at risk of cyber attacks , the research adds, but again only one in five (19%) small businesses said they would be immediately concerned about competitors gaining advantage if a breach happened.
New products, services and business ideas are included in intellectual property data that 45% of surveyed small business has in their domain, the survey continues. If this information is not protected adequately customers lose trust and reputations are ruined, it explained.
Vice-Chairman for the Federation of Small Businesses, Sandra Dexter, says small businesses need simple and straight forward advice to protect their data.
“Cyber breaches can happen to any business, any size and the repercussions should not be underestimated, leading to damaged reputations, hindered growth and in the worst cases, entrepreneurs being put out of business.”
– Michele B. Amato, Friedman LLP
IAASB Highlights How Expected Credit Loss Models Will Affect Auditors
On March 2, 2016 the International Auditing and Assurances Standard Board released a publication on the issues that will impact audit from the shift to Expected Credit Loss models when accounting for loan losses as IFRS 9, Financial Instruments sets to be implemented by entities with effect from January 1, 2018. The press release of the IAASB is as under:-
IAASB Highlights How Expected Credit Loss Models Will Affect Auditors; Signals Broader Efforts to Strengthen Auditor Efforts on Accounting Estimates
The International Auditing and Assurance Standards Board® (IAASB®) today released a publication highlighting the audit issues arising from the shift to Expected Credit Loss (ECL) models when accounting for loan losses. ECL models are now required, or will soon be required, by some financial reporting frameworks, including IFRS 9, Financial Instruments, which will come into effect from January 1, 2018.
“The adoption and implementation of ECL models will, in many cases, bring significant challenges for auditors, management, those charged with governance (e.g., audit committees), supervisors, and users,” explained IAASB Chairman Prof. Arnold Schilder. “Auditors need to be aware of the changes related to ECL and the implications for audits. Auditors will need to be actively engaged in 2016 and 2017, in particular to understanding how an entity is planning for the adoption and implementation of its ECL models.”
The publication summarizes the audit challenges identified with respect to ECL and sets out initial thinking on how these challenges may be addressed under the current International Standards on Auditing™ (ISA™). The publication has been developed by a task force comprised of IAASB members and technical advisors, representatives from the Basel Committee on Banking Supervision, the International Association of Insurance Supervisors, bank auditors, and an observer from the US Public Company Accounting Oversight Board.
“Our work to date has benefited from input from different stakeholders from around the world,” highlighted Task Force Chair Rich Sharko. “The publication issued today is the result of extensive outreach with regulators, expert auditors from different industries, and others to capture the significant issues that arise in dealing with ECL models, as well as how they may be addressed under the current ISA pronouncements.”
“As a result, the publication is particularly relevant for auditors of financial institutions and other entities that have substantial credit risk exposures through holdings of loans and similar financial assets,” noted Task Force Co-Chair Marc Pickeur.
The publication also discusses how the IAASB’s new standard-setting project to revise ISA 540, Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures, will seek to further address these and other challenges that have been noted in respect of auditing accounting estimates, including in relation to audits of financial institutions.
“Accounting estimates are becoming more complex and subjective, and are critical to a user’s understanding of an entity’s performance,” noted IAASB Technical Director Kathleen Healy. “The IAASB will consider what revisions are necessary to ISA 540 to promote audit quality in the varied and complex scenarios that arise today, and that are likely to continue to evolve in the future.”
For more information, visit www.iaasb.org/auditing-estimates.
– Ashutosh Pednekar, M.P. Chitale & Co.
Accounting Directive update November 2015
The Directive 2013/34/EU of 26 June 2013 is aimed at amending Directive 2006/43/EC of the European Parliament and of the Council and repealing Council Directives 78/660/EEC and 83/349/EEC. The new Directive was originally going to oblige all EU Member States to bring into force the laws, regulations and administrative provisions necessary to comply with this Directive by 20 July 2015. As at December 2015 12 out of the 28 European Union Members States have implemented it.
The Directive 2013/34/EU introduces new elements and principles related to the preparation of financial statements and to the compliance with new audit requirements to all those companies that are not obliged to adopt the international accounting standard set. The Directive focuses on small and medium-sized entities (SMEs) and pursues the objective of finding the right balance between the need of transparent financial reporting and the related burden of administrative costs compared to the benefits received.
The Directive has established 4 specific categories based on thresholds in relation to the parameters of net turnover, balance sheet total and average number of employees. These categories are micro, small, medium and large. The larger the company the more obligations are imposed.
|In million EUR||Micro||Small||Medium||Large|
|Balance Sheet||< 0.35||< 4 to 6*||< 20||> 20|
|Net Turnover||< 0.7||< 8 to 12*||< 40||> 40|
|Average number of employees||< 10||< 50||< 250||> 250|
*Member States may define thresholds exceeding 4 for Balance Sheet and 8 for Net Turnover. However, the thresholds shall not respectively exceed 6 and 12.
A company moves up a category if it exceeds 2 of the 3 thresholds for 2 consecutive years.
This approach is similar to what has occurred in New Zealand with the advent of the Financial Reporting Act 2013. The effect is a decrease in the obligations in term of audit and financial reporting for small to medium sized entities. We expect this will widen the gap between the different financial reporting requirements of the different categories and lead to increased compliance costs when moving up to higher reporting levels with resistance by management and Directors to full compliance which they will perceive as far more onerous.
Following the introduction of new legislation the number of audits required both in NZ and EU is on the decline with resultant decrease in the number of audit firms and auditors.
Audit reform update
The Audit Directive 2014/56/EU and Regulation 537/2014 is due to be implemented by the EU Member States by 16 June 2016.
Under the new rules the mandatory rotation of auditors for public interest entities (PIEs) will be introduced, requiring such companies to retender at 10 years and change the auditor at least every 20 years. The reforms include a prohibition on the provision of certain non-audit services to PIE audit clients (including tax advice and services linked to the financial and investment strategy of the audit client) and also introduce a cap on the fees that can be earned from the provision of permitted non-audit services to PIEs.
Additionally the rules prohibit the use of restrictive clauses in contracts which limit a company’s choice of auditor in order to promote market diversity.
The rotation and prohibition on the provision of certain non-audit services to PIE audit clients is a step in the right direction to ensure and demonstrate the independence of the auditor and should generate positive reactions from the market. However the periods of 10 and 20 years seems extremely long and could certainly be reduced significantly. The industry and business expertise that auditors need to have should be a factor that the legislators and regulators take into consideration when setting and maintaining the rotation of auditors.
Commission Capital Markets Union Action Plan
The action plan from the Commission Capital Markets Union was published on 30 September 2015. This plan is an ambitious policy package that will aim to foster integration and functioning of the capital markets in the EU.
While the main goals and objectives of the Commission Capital Markets Union Action Plan should be beneficial to SMEs the goal to improve SME access to finance and facilitate their listing seems inconsistent with the reduced quality of financial reporting for SMEs. The access to equity funding becomes much more difficult if there is little exposure to proper financial reporting and auditing.
By reducing the financial reporting requirements applicable to SMEs it will be more difficult for them to adopt a higher level of reporting if access to the share market or an alternate market is needed or if the funding bodies require them to comply with a more stringent financial reporting framework than the one they normally comply with.
– Shane Browning, DFK Oswin Griffiths