At the ICGN San Francisco Annual Conference, KPMG hosted a breakfast session on the roles and responsibilities of audit committees and external auditors.
Scott Marcello, Vice Chair of KPMG US opened the discussion by asking participants for their perspectives on communications between audit committees and auditors, on their challenges, and on the types of information they would find most useful.
Liz Murrall, Director of Stewardship and Reporting at the UK Investment Association, said communications transparency has been a big issue. She explained the FRC in the UK now requires audit committees to report on significant issues addressed and on communications from the auditor to them in their audit committee report – and auditors, in the enhanced audit report, to say whether they felt any information was incomplete, and to provide their assessment of the risk of misstatement in the financial statements, the level of materiality they adopted, and the level of confidence they have in the internal control systems.
Murrall said this added transparency has, “Helped the institutional investor community, so now we’ve got hooks with which we can actually challenge management and these interactions are no longer the black box that they used to be.”
James Andrus, Investment Manager at CalPERS, believes that in the US there is too much boilerplate content. “We don’t know what types of decisions the audit committee makes with regard to the auditor [and] we don’t know what the audit committee actual does,” he said. While investors value the audit report, they want more information.
Peter Butler, Founder Partner Emeritus of Go Investment Partners, added, “The level of transparency we need to get to is a proper debate on the material issues that affect the numbers. If an investor has the ability to understand the arguments…the investor can make his own judgements.” Impediments to this level of transparency include the ability of investors to talk to the auditor.
Transparency is a global challenge. Leonardo Pereira, Chair of the Brazilian SEC, noted, “There is a wide gap in terms of quality, in terms of communications and, as far as the audit committee [goes], how they convey the message.” This gap needs to be bridged, even if it doesn’t happen overnight. “We have to ensure that, 5 years from now when we look back, that we have made some progress. It’s not the auditor that’s responsible. It’s not the investor. It’s everyone.”
Mark Vaessen, Head of IFRS at KPMG International noted that in the Netherlands auditors walk through their audit report at the annual general meeting, giving investors a chance to ask questions.
David Shammai, Senior Corporate Governance Specialist at APG, explained such open communications might not work everywhere, but that, “Anything that you can put out in the open to give investors an idea about audit quality is going to be welcomed … whether it’s through enhanced reporting, or whether through a face-to-face or direct interaction with the audit committee chairman.”
Cindy Fornelli, Executive Director of the Center for Audit Quality, noted that investor concerns go beyond audit quality. “It really is the whole financial reporting process that we need to make sure we don’t lose sight of,” she said. “And that’s harder to do because nobody really regulates that financial reporting.”
Participants discussed how the role of intangibles has grown significantly over time. With how fast things change, intangible value can be wiped out quickly. As a result, assumptions around intangibles must be transparent.
Vaessen asked whether auditors have a role to play when it comes to intangibles. The response was positive, yet cautious – with participants noting that getting there would take time. There is a need to create a connection between investors who try and look forward and accountants who typically look backwards.
Marcello asked what other factors enhance audit quality. When participants answered ‘independence’ and ‘objectivity,’ he asked, “How do you get a lens into how those things are working?”
Butler said it is the independent chairman’s job to balance interactions between the CEO and the board – at least in the UK. In Brazil, where companies often have strong controlling ownership, it’s different. Pereira explained this is why the Brazilian regulator pushes hard for qualified audit committee members. “That is where you have more independence – and [can] mitigate an autocrat chair, CEO or someone still linked to the controlling owner.”
The discussion then shifted to risk analysis and the fact that risk identification has become too boilerplate. Shammai said, “[Investors] read all the risk factors, but what is missing is how each is linked to the information that they need to rely on to make investment decisions.”
One of the participants asked Marcello how audit companies manage risk. Marcello answered that in addition to doing an annual assessment of client acceptance, KPMG “In the audit, constantly re-evaluates the very specific risks relating to that entity and how it should affect the scope of our work…the auditing standards require that and, in fact, just prudent judgement requires that.”
Higher risk assessments do not mean companies are bad, he added. “You invest in certain companies because you want the risk…It’s inherently the risk that you’re attracted to.” The key is balance. Investors need to ask, ‘Do I understand the risks appropriately?’ and ‘When I put a company in my portfolio, how do I think about the up and down risks of it?’
When it comes to risks, investors need to have a transparent view. Andrus noted that technology is a key enabler of transparency.
Marcello agreed. “Over the medium term, technology will not only enable companies, but it’ll enable the auditors to do significantly more.” Marcello highlighted KPMG’s partnership with IBM Watson to pilot cognitive capabilities as one example. But with changes in technology, companies need to think about cyber security and talent management.
The breakfast session ended with agreement that investors have to push for stronger relationships between audit committees and auditors. Pereira summarized this by stating, “From the moment investors are positive and engaged, we put positive pressure on the relationship between the auditors and the audit committee because the audit committees will be more aware of what they’re supposed to do and how important it is.”