The recent financial downturn and continuing economic global crises have caused some users of financial statements — investors, lenders or financial analysts — to question if auditors’ reports could tell more of the story and alert users earlier to looming problems.
“Everybody wants to minimize investment risk. They figure the more that they know, the better equipped they are going to be to make decisions,” says Carolyn H. McNerney, CPA, director of Assurance Services at SS&G.
Now, standard setting agencies are considering what disclosures need to be added to auditors’ reports.
Smart Business spoke with McNerney about expectations for revised auditor reporting.
What are the responsibilities of management versus the auditor for financial statements?
Management is responsible for preparing the financial statements, including required footnote disclosures in conformity with generally accepted accounting principles (GAAP) or other reporting framework. The auditors’ responsibility is to express an opinion on the financial statements based on their audit, which involves performing tests and procedures to obtain evidence about the amounts and disclosures in the statements.
Many, if not most, auditors would argue that disclosure should come from management and an auditor’s responsibility is to ensure the ‘numbers’ are fairly stated. Most also acknowledge that the complexity of required disclosures combined with the multitude of new financial instruments, including derivatives, has increasingly complicated reporting. This complexity is a primary driver in the call for more information in auditors’ reports.
What new disclosures are being discussed?
New disclosures are currently being addressed by the International Auditing and Assurance Standards Board (IAASB) as well as by the Public Company Accounting Oversight Board (PCAOB), which sets the U.S. professional reporting standards for auditors of public companies.
Proposed additions include discussion of matters of audit significance that would be in a separate auditors’ commentary or discussion and analysis section of the auditors’ report. The focus would be on key audit areas, which typically require the use of significant management judgment in determining the amounts reported and auditor judgment for the audit approach.
Will the benefits of expanded disclosure be offset by a lack of comparability?
Standard setters are still deciding what should be disclosed and in how much detail. There is a concern that many financial statement users will be confused by detailed disclosures of audit risk and auditors’ responses thereto. A ‘clean’ auditor’s opinion often takes only one page. Some proposed new example reports go on for many pages.
The question is: Will users be able to interpret and compare auditors’ reports that contain a varying amount of disclosures and are significantly different in length? Sophisticated financial analysts may find this additional information useful, others may find it confusing or misinterpret what the disclosure is intended to convey.
Does the additional cost of potential new disclosures outweigh the benefit?
Additional disclosures in the auditors’ reports will require more time of both auditors and management, resulting in additional costs. In the U.S., expanded disclosures are currently being proposed only for public companies.
In the private company world, financial statement users have access to management and, perhaps, even the auditor, should they have questions. For this reason, additional disclosures for private companies are not currently being proposed.
What should owners look for in the future?
It seems very likely that there will be some kind of revised, expanded auditor reporting standards for public companies over the next several years. The IAASB has publicly discussed a desired timetable for the issuance of new reporting standards while the PCAOB has not. Certainly, both of these organizations are keeping a watchful eye on each other’s activities and proposals with respect to auditor reporting. However, even private business owners invest in the public company marketplace and receive annual reports of investments.
Carolyn H. McNerney, CPA, is director, Assurance Services, at SS&G. Reach her at (330) 668-9696 or CMcNerney@SSandG.com.
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The Financial Accounting Standards Board (FASB) has not-for-profit financial reporting on its horizon. The board is expected to propose new guidance on non-profit financial reporting standards in the second half of 2013.
“It’s exciting because the FASB is actively working to make the financial statements more understandable for the user and more comparable across the varying types of not-for-profit organizations, which will allow these organizations to better tell their story to donors.” says Liz Dollar, a partner in the Not-For-Profit and Government group at Moss Adams LLP.
Smart Business spoke with Dollar about how these changes originated and what they could mean for the not-for-profit world.
What is the FASB’s Not-For-Profit Advisory Committee?
This 17-member committee was established in 2009 to act as a standing resource for the FASB. The various users and preparers of not-for-profit financial statements now have a formal process to give input that guides the FASB on the impact of the current standards, and provides feedback on proposed updates. The committee also can assist in outreach activities to the sector.
How is the committee filling a need in the not-for-profit world?
The most impactful financial reporting standards for not-for-profits were statements on Financial Accounting Standards 116 and 117, but these standards were written almost two decades ago in the mid-90s. The committee has focused on determining whether these standards still make sense in the current financial environment. The committee also considers overall financial trends such as the convergence of international and U.S. standards as well as increased emphasis on reporting and transparency of financial information.
What has the committee recommended to FASB?
The committee and its three subcommittees, Reporting Financial Performance, Liquidity and Financial Health, and Telling a Story, recommended:
- Focusing transparency on operating and non-operating activities in the statement of activities.
- Suggestions for improving the cash flow statement, better linking it to the operating measures.
- Reducing the net asset classes from three to two — unrestricted and restricted — in an effort to make financial statements easier to prepare and use, while adding some subcategories into the new net asset classes. Streamlining and improving the footnote disclosures, which have gotten long and can be unclear to many users.
- Requiring some sort of management discussion and analysis in the financial statement that tells a story of what happened during the year. This could enhance the understanding of donors about the financial health and performance of the organization.
What is the FASB doing with these recommendations?
The FASB is currently working on a project entitled Not-for-Profit Financial Reporting: Financial Statements, which is focused on net asset classifications and the information provided in the footnotes about liquidity, financial performance and cash flow. An exposure draft is expected in the second half of 2013. After the comment period, changes likely would be implemented around 2015.
The FASB also added a research project looking at other financial communications, which could include requiring a management discussion and analysis in the financial statements.
Why should not-for-profit organizations be excited about these potential changes?
Not-for-profit organizations often need an audited financial statement because of a donor, statutory or lender requirement. However, they will tell you that most people don’t look at or understand these financial statements. When using a document to tell a story and solicit funds, the 990-tax form is often a more useful tool and something that is comparable among all not-for-profit organizations. The hope is that with the current project the FASB changes will simplify the financial statements, making them in turn more user friendly and useful to the reader.
What does this mean for business owners?
Not-for-profit financial statements typically are very different from for-profit financial statements. So, someone from a public company who serves on a not-for-profit board or who is a potential donor could have trouble reading the statement. With potential changes to the net asset classifications, focus on liquidity and streamlined disclosures, the not-for-profit financial statements should more clearly reflect an organization’s financial position and be more usable to those with a for-profit background.
Liz Dollar is a partner, Not-For-Profit and Government group, at Moss Adams LLP. Reach her at (415) 677-8247 or email@example.com.
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