Value of audit: Time for a change | KPMG | PL

Value of audit: Time for a change

Value of audit: Time for a change

For many years the audit of historical financial statements conducted by certified auditors in its current format has been a very important element in communication between companies and their investors as well as other stakeholders.

1000

Partner, Head of Financial Services Audit, Head of Financial Services in Poland and CEE

KPMG in Poland

Contact

Related content

Beyond meeting legal and regulatory requirements, audit derives its value from the quality of its process, independent verification, probing and a sceptical approach required of auditors, as well as from the trustworthiness of its results.

Historically speaking, conservatism has been a strength of the audit profession. Auditors have been requiring of management a cautious approach. However, today auditor profession is widely perceived as having fallen behind the rapid economic, technological and cultural changes. Recent years have seen many changes in financial markets, the business environment and shareholders’ expectations. Nevertheless, despite the constantly improving quality of audit, the essence of audit has not changed for over 100 years. In many cases financial statements no longer provide sufficient insights into companies’ changing fortunes because of the changes in value creation by companies and changes in how investors judge them.

Even though it was not the quality of audit that contributed to the economic crisis in recent years, it has become clear that the outside world expects the audit profession to communicate more about audit results, both individually and systemically. As a response to these changing expectations on financial markets, we saw stronger regulatory oversight and standards introduced, including the bundle of new EU regulations on the reform of the audit market, adopted in May 2014.

The events of the last decade have shown that the time has come for a change and a revolution in how auditors think and how they go about auditing financial statements.

What is the value of audit today?

In the most general sense, audit helps companies to lower the cost of capital. This cost is higher for entities which do not have their financial statements audited. An additional dimension, which is more difficult to place a precise value on, is related to public interest. Presumably, if audits were not useful in those two areas, it would have been abolished long ago as a function in the economic system. However, what would happen if financial statements were not audited? If there were no independent actors who confirm the financial standing of a company presented in its financial statements (in a historical perspective), the level of trust around the business community would be much lower than it is. Therefore, audit plays an important role in giving people comfort and there is massive commercial value in that.
A clean audit opinion means that the company should have at least fair or reasonable standards of corporate governance, management control and internal controls. If financial statements of a company cannot be audited or receive a clean opinion, this fact undoubtedly impacts the stakeholders’ perception of that business. From this perspective, a company with a clean audit opinion should be valued significantly more than one without.

The value of financial statements audit also derives from delivering insights and perspective across a wide array of financial, regulatory, operational and technological aspects. The auditor also gives many valuable recommendations on how to improve various functions and processes in the organisation.
 

Relevance of financial statements

The quality of audit is one thing but the relevance of audited financial information is quite a different thing because, fundamentally, an audit cannot be more relevant than the information that is subject to the audit. We must admit, therefore, that the greatest weakness of audit, in its current format, it is its focus on historical financial data whereas investors today tend to be more interested in factors which shape the current stock prices and the value of the organisation rather than annual reports. And this is the aspect of audit which increasingly undermines its importance for financial markets.

The quality of audit is one thing but the relevance of audited financial information is quite a different thing because, fundamentally, an audit cannot be more relevant than the information that is subject to the audit. We must admit, therefore, that the greatest weakness of audit, in its current format, it is its focus on historical financial data whereas investors today tend to be more interested in factors which shape the current stock prices and the value of the organisation rather than annual reports. And this is the aspect of audit which increasingly undermines its importance for financial markets.

Undoubtedly the audit quality has been improved, to some extent, because of stronger oversight from the regulators but also because the profession has decided that quality is essential for driving efficiency. What has not been addressed so far is the relevance of the audited financial information. In their decisions, stakeholders increasingly rely on information coming from outside financial statements. For instance, bank’s quarterly investor & analysts conferences may shed more light on the way the banks are growing than their financial statements summarising the past year results.

The aforementioned EU regulations, adopted to improve the quality of statutory audits, only challenged the independence of the auditors, while the question as to what financial information should be assessed by that independent auditors has not been addressed.
 

Limitation of the binary pass-or-fail audit opinion

Further concerns are coming over the fact that delivering a binary report is not providing investors with all of the insights that they need in order to make their investment decisions. In July 2013, the International Auditing and Assurance Standards Board (IAASB, ‘the Board’) issued a draft standard concerning an auditor’s report as a proposal to depart from the binary nature of opinions in favour of presenting a descriptive summary of key audit elements. Auditors certainly have the skills to provide more information to the users of financial statements. In the case of more difficult judgemental areas, such as an impairment provision, informing readers of the financial statements about the key assumptions used gives a better idea of the key judgments made during the audit. This exchange of information takes place when discussing audit results at the meeting of a Supervisory Board’s Audit Committee. But it is very hard in a one-way communication to replicate the discussion that goes on in the audit committee meeting. The challenge here is how to determine where the demand is, what type of information is relevant, how to write the report in a way that can go to in vestors and not be misinterpreted. A s a rule, investors make their decisions on the basis of such analytical data as non-GAAP earnings or other non-financial metrics. When making their decisions, they also take into account elements of strategy, sales plans and product development plans made available by banks. Such data may rely on historical financial statements but, per se, are not regulated by accounting standards such as the IFRS and do not need to originate directly from financial statements or a company’s reporting systems. It is those non- GAAP measures, both financial and non-financial, that are driving the market capitalisation of listed companies and do not normally undergo independent attestation. However, it should be expected that markets and investors will demand some form of attestation for such information in future.

The future of audit

For audit to stay relevant, auditors need to start looking at what creates value in a business. This calls for more integrated thinking about expectations towards financial reports in their entirety. Auditors will need to get involved in understanding entities’ real business value drivers so that we can give assurance over these drivers, as this is where market demand is going to take us.

This takes us to the last point, i.e. innovation. Until recently, there have been little momentum for the audit profession to develop. KPMG auditors focus on launching new standards that lead to innovation in the audit process and its results since we know that this is absolutely crucial for this function to remain relevant. Regardless of the legal factors and the responsibility involved, the audit profession must move towards developing new reporting and assurance models that works for tomorrow's business world.

I can see a quantum leap in terms of cost and what we provide: to make use of opportunities offered by Big Data and data analytics. They would allow us to provide our clients with in-depth insights on how well their organisations operate.

To conclude, the audit profession must widen the scope of the information that it offers assurance over in order to give the investor community and other stakeholders what they need. How the profession might do this is a topic f or debate. Read what partners from across the KPMG network of member firms have to say by visiting our website (kpmg.com/valueofaudit), and join in the conversation.
 

Connect with us

 

Request for proposal

 

Submit