By Eric Turner
Illustration: Geneviève Côté
 NEW SECTION 5751 IS DESIGNED TO CLEAR UP CONFUSION SURROUNDING AUDITOR COMMUNICATIONS
Audit committees, auditors and management are critical to the efficient functioningof the capital markets. While auditors play a key role, strong and effective corporate boards and audit committees are also vital. A recently issued standard of the Assurance Standards Board (ASB) is designed to respond to developments in Canada and worldwide in the area of auditor communications and corporate governance. The project to develop new Assurance Section 5751, "communications with those having oversight responsibility for the financial reporting process," began in 2001. At the time, the US was working on guidance on auditor communications with audit committees to improve the quality of financial reporting. Also, the 1999 US Blue Ribbon Committee report, Improving the Effectiveness of Corporate Audit Committees , followed by the work of the Joint Committee on Corporate Governance in Canada, was changing the roles and responsibilities of audit committees. The ASB wanted assurance standards to stay abreast of these changes. The result is the new section issued in May, which is applicable for audits of financial statements for periods ending on or after December 15.
The ASB believed that much of the guidance in existing Assurance and Related Services Guideline AuG-11, "Communications with audit committees [or equivalent]" was still appropriate, but it had some concerns. First, the developments in the corporate governance area increased the importance of auditor communications with audit committees. To reflect this, the ASB believed the guideline should be upgraded to the level of a standard. Second, although AuG-11 was meant to apply more broadly than just to entities with audit committees, there was anecdotal evidence that auditors were confused about their responsibilities for communication when an entity does not have an audit committee. Consequently the scope of the new standard needed to be clear.
The ASB also noted concerns about the quality of financial reporting, one being that audit committees needed a better understanding of the quality of the accounting principles chosen by management in preparing the financial statements. The ASB believes a discussion with the auditor may help the audit committee make judgments about the quality of the entity's financial reporting. It also believed auditors needed guidance to effectively engage audit committees in this type of discussion.
In 2001, the ASB embarked on a project to harmonize its standard on fraud and error with the US International standards on Auditing and standards in the US. It recognized that the new standard would require improved communications of fraud with the audit committee, and wanted the new standard to be consistent with the new requirements.
The title of the standard refers to communications with those having responsibility for the financial reporting process. It is intended to make clear it applies not only to audits and reviews of entities with audit committees, but also where there is no formal committee by that name. The application of the standard depends on the ownership and corporate governance structure of the entity. For entities with public accountability, as defined in the section, the auditor would follow all the section's requirements. The need for communication with the audit committee will be affected by such factors as the industry it operates in and its regulatory environment. For example, the focus of an auditor's communications with the audit committee might be different for a young, rapidly expanding high-tech firm than for an established, highly regulated utility. For this reason, the section allows scope for use of professional judgment in deciding how to meet these requirements.
When an entity does not have public accountability, the section allows more flexibility to recognize that such entities can have a variety of corporate structures. In a large private group of firms, the entity may have a governance structure similar to that of a public company. Here, the auditor would consider communicating as if the entity had public accountability. With a small owner-managed business, the owner may already know of certain matters that the section requires the auditor to communicate (the owner-manager may be aware of the audit and nonaudit services the auditor is providing to the entity). In this situation, the auditor would only communicate other matters required to be communicated by the section, such as those arising from the audit.
The ASB believes that the practitioner's communication responsibilities in an audit would not be significantly different from those in a review. For example, all other things being equal, the practitioner reviewing the financial statements of a large manufacturing concern would communicate findings the same way as the auditor. However, the ASB recognizes that because of the different scope of a review, compared with an audit, the practitioner may not identify all matters to communicate with the audit committee as wouldbe identified in an audit. Therefore, to the extent that the practitioner becomes aware of matters in performing a review, the practitioner would communicate with the audit committee as required by Section 5751.
This section requires the auditor to communicate with the audit committee his or her professional judgments on the qualitative aspects of accounting principles used in the entity's financial reporting. The intent of this communication is to assist the audit committee in its review of the financial statements prepared by management. The guidance in the section is consistent with similar guidance in the US. Because there are no specific criteria on which to assess the quality of accounting principles, the section provides examples of items that might be considered for communication to the audit committee.
AuG-11 was amended in August 2000 to require the auditor to discuss with the audit committee matters that bear on the auditor's independence. This requirement has been carried forward into the new section, with some minor amendments. First, the section makes it clear that it applies not only to audits but also to reviews. Second, a new requirement has been added when the entity is publicly accountable as defined in the section. The auditor must disclose to the audit committee in a letter the total fees for audit and nonaudit services during the previous year. The auditor would agree with the audit committee how best to break down these amounts in the letter. Some audit committees would like this information within various dollar ranges; others would like it by type of service provided. The ASB believes this new requirement will provide more useful information to assist the audit committee when it considers matters that bear on the auditor's independence.
Until recently, there was no clear distinction in the Assurance Handbook between the roles and responsibilities of management and the audit committee. In March, changes to Section 5090, "Audit of financial statements — an introduction," were made, to clarify "management," "those with oversight for the financial reporting process" and "those charged with governance." The ASB also distinguishes between the auditor's responsibilities for communications and management from responsibilities for communications with those charged with oversight of the financial reporting process. It amended the scope of Section 5750, "communications of matters identified during the financial statement audit," so it deals only with communications with management. Previous guidance in that section dealing with communications with the audit committee has been moved into Section 5751.
The ASB is monitoring developments in corporate governance worldwide so it can respond to the need for further guidance for auditors. It believes strengthening the role of the audit committee and improving the relationship between auditors and committees are key to restoring public confidence in financial reporting, auditing and corporate governance. It also believes this new guidance will enhance the trust investors and other stakeholders place in the effectiveness of the audit process. Threats to that trust cannot be taken lightly. New Section 5751 should lead to improved communications between auditors and those having oversight responsibility for the financial reporting process. This will benefit auditors, by improving understanding of the entity they are auditing, and audit committees, by helping them fulfil their responsibilities. Better communications between auditors and audit committees should lead to improved reporting.
Eric Turner, CA, is a principal in the CICA's Assurance Standards department.
Technical Editor: Robert T. Rutherford, FCA, Vice-president, Standards, CICA. |
