In an audit, effective and timely two-way communication is essential to ensure that the auditor and the client’s board of directors have a common understanding of significant audit issues and a constructive working relationship to address those issues.
The primary objective of an audit is to express the auditor’s opinion on whether the client’s financial statements are presented in conformity with an applicable set of accounting standards. This may be fine for the ultimate users who intend to rely on those financial statements, but those charged with governance within the client’s organization – board members, for example – need to know much more about the audit process and its findings to fulfill their fiduciary responsibilities in overseeing the financial reporting process.
Because of the importance of effective two-way communication, auditing standards require auditors to formally communicate certain audit-related matters to those charged with governance. The auditor’s communications have three primary purposes:
1. To provide an overview of the scope and timing of the audit and describe the responsibilities of the auditor
2. To obtain information that may be relevant to the audit
3. To provide observations that may be relevant to the oversight of the financial reporting process
Auditors communicate their responsibilities to close any expectation gap that may exist. They will describe their responsibility for expressing an opinion about whether the financial statements prepared by management with the oversight of the board are fairly presented. They will explain that the audit doesn’t relieve management or the board of their responsibilities.
Auditors will also communicate about matters for which they are not responsible. These include the concepts of materiality and reasonable – as opposed to absolute – assurance, their limited consideration of internal control over financial reporting, and their limited responsibilities related to the detection of illegal acts, fraud and other matters that do not materially misstate the financial statements.
Often the auditor communicates these matters in an engagement letter, which management executes. The engagement letter should, but may not, be provided to the board because management may not always appreciate the significance of the communications to the board.
Communications about the planned timing and scope of the audit are useful in helping:
- All involved to develop an understanding of the areas of heightened risk of material misstatement of the financial statements, whether due to error or fraud
- The board to better understand how the audit impacts their oversight activities
- The auditor to better understand the client and the client’s environment
Specifically, the communications may include how the auditor approaches areas of higher risk, how much the auditor intends to rely upon internal controls in significant audit areas and whether the client’s internal audit function will be used. The extent of the auditor’s communication must not compromise the effectiveness of the audit, especially when some board members also are involved in management.
While these communications are useful in planning the audit, the auditors’ sole responsibility is to determine the nature, timing and extent of procedures necessary to obtain sufficient appropriate evidence to support their opinion.
In the course of an audit, auditors may consider a number of “significant findings” that may be relevant to the oversight of the financial reporting process.
The first potential type of significant finding deals with the qualitative aspects of the client’s significant accounting practices. Management exercises judgment about which accounting policies, accounting estimates and financial statement disclosures are appropriate in the circumstances.
The audit process is valuable in assisting the board to improve the quality of accounting practices by obtaining the auditors’ objective views on those practices. When the auditors have concerns about the appropriateness of any of these judgments, they should explain their reasons to the board and point out that their effect on current and future financial statements, if not changed, will be evaluated as the auditors form their opinion on the financial statements.
Other findings may involve:
- Difficulties encountered during the audit
- Uncorrected misstatements and their effect on the auditor’s opinion
- Disagreements with management about accounting matters that could be significant to the financial statements or auditing matters that could be significant to the auditor’s report
- Management’s significant consultations with the auditor or other accountants
These communications provide useful insight to board members as they exercise their oversight responsibilities. But studies have shown that auditors are not always good about providing these required communications. The board may have to read between the lines and ask probing questions to bring important matters to light.