It seems not a week goes by without auditors and company reporting being in the spotlight. The emphasis given to narrative disclosure in company reporting continues to increase, as does the pressure on auditors to provide assurance outside of the traditional financial statements.
As we enter a new chapter of company reporting, there is a clear call from investors and regulators for clearer disclosures on a company’s health and the need to build on the comfort users already derived from the audit process.
In the aftermath of the financial crisis, demands have grown for clearer explanations of a company’s key risks. Management is increasingly encouraged to use the front half of the annual report to tell shareholders about these and the past, present and future story of the business.
A recent research project published by The Institute of Chartered Accountants of Scotland (ICAS) on user views on external assurance and management commentary cites that users find management commentary to be valuable, but many are concerned that it is susceptible to ‘spin’ and distortion which blunts its usefulness.
The report also highlighted that users of annual reports find management commentary useful and would welcome external assurance on the content – but limited confidence in the current external audit report would undermine the credibility of assurance.
Both investors and non-investors believe that external assurance should be provided on management commentary to curb excessively optimistic directors’ statements and identify inconsistencies between the narrative and the audited figures. Views on providing assurance on statements about future prospects were less positive, partly because users perceive the auditors may report in ‘softer’ terms or hedge their bets in relation to whether directors’ judgements are reasonable.
There is a high level of consensus that the current audit report has limited value. The research report found that users wished to see a radically enhanced audit report incorporating more company-specific information and explaining audit judgements. Those interviewed during the research stressed there was a need for auditors to ‘reconnect with investors’.
There is a clear desire from users of financial reports for external assurance on management statements. Something similar to the current audit report would fail to reassure users of the integrity of the directors’ commentary.
Two years on from the financial crisis, it is time to replace reflection with urgent action so that reporting and auditing can grow and change with the evolving needs of the market.
This brings a challenge to the auditing profession, investors and regulators to work towards corporate reporting and assurance that can more fully explain the key judgements on a company’s risks and uncertainties. We need an outcome with a happy ending, one not open to misinterpretation. Then maybe we can all sit comfortably.
Ian Fraser is a Professor of Accounting at the University of Stirling and one of the authors of the ICAS study, ‘Meeting the needs? User views on external assurance and management commentary’. A second stage of this project considering auditor views on these issues is currently in progress.
