Financial Reporting

Auditing Disclosures in Financial Statements

The issues of auditing disclosures have been recently considered by the International Auditing and Assurance Standards Board (IAASB)^[1]. Various factors such as developments in Indian Financial Reporting Standards (IFRS) requirements, increased level of complexity and subjectivity involved in the preparation of information to be disclosed in financial statements, facilitated the consideration of issues of auditing disclosures. Auditing disclosures means the opinion expressed by the auditors on the financial statements as a whole. For expressing his opinion, an Auditor must obtain sufficient and appropriate proof concerning the disclosures made in financial statements.

The object of audit disclosures is to enhance the requirements in various International Standards of Auditing (ISAs), to make changes in the auditor’s approach and improve consistency in practices especially when it comes to addressing qualitative disclosures. Further, audit disclosure also clarifies the auditor’s work regarding disclosures, by providing additional guidance to assist auditors in applying the requirements relating to disclosures.

What was the need for IAASB to revise ISAs to address audit disclosure?

• The change in the needs of users of financial statements has led to the evolution of financial reporting. The widespread use of fair values and other estimates involving complex and judgmental measurements has resulted in financial reporting requirements and practices requiring more detailed disclosures like assumptions, models, alternative measurement bases, and sources of estimation uncertainty to provide more decision-useful information.
• The information in these disclosures is both qualitative and quantitative which has made it challenging for the preparers, investors, auditors, etc.
• To ensure that the ISAs address and recognize the auditor’s expected effort concerning disclosure is essential to attain high-quality auditing.

What revision has been made to the ISAs and how has it affected audit disclosure?

• ISA 200- Overall Objectives of the Independent Auditor and the Conduct of an Audit under International Standards on Auditing

Revision under this ISA has been made to the definition of financial statements. The revision specifies that the financial statements include related notes which ‘comprise a summary of significant accounting policies and other explanatory information’. As required by the IFRS, the notes to the financial statements contain both qualitative and quantitative disclosures. Some examples are given below: 

1. Qualitative Disclosures:
   • Descriptions of accounting policies and areas where critical accounting judgment has been exercised, and the rationale behind any changes in accounting policies.
   • Confirmation that the going concern assumption is appropriate, or discussion of significant doubt over going concern.
   • Explanation of impairment losses declared in the year.
   • Information on related parties, and related party transactions.
   • Discussion of areas of risk relating to financial instruments.
2. Quantitative Disclosures
   • Analysis of the segregated data on balances and transactions included in the financial statements, such as property, plant, and equipment, intangible assets, provisions, lease obligations, and financial instruments.
   • For listed companies, Quantitative Disclosure may include segment-wise analysis of revenue, profit, certain other items, and information about major customers.
   • Summarized financial information concerning associates and joint ventures.

• ISA 210- Agreeing on the terms of Audit Engagements

Revisions made under this ISA were regarding new application material by encouraging management to provide information for disclosures earlier in the audit process.

• ISA 240- The Auditor’s responsibilities relating to fraud in an Audit of Financial Statements

The revision under this ISA was regarding the consideration of intentional misstatement of disclosures that may constitute fraud in the new application material.

• ISA 260- Communication with those charged with Governance

Revision under this ISA relates to the communication regarding financial statements and disclosures in the audit process with those charged with governance.

• ISA 300- Planning an Audit of Financial Statements

Revision under this ISA relates to encouraging auditors to consider disclosures earlier in the audit process.

• ISA 315- Identifying and Assessing the risks of material misstatement through understanding the entity and its environment

Revision under this ISA pertains to the enhanced requirements highlighting the need for attention to the information in disclosures, obtained from outside the general and subsidiary ledgers in the planning process. Further, assertions have to be revised to integrate the audit procedures for disclosures with account balances and transactions. Further, enhancement was to emphasize that the understanding of this ISA includes relevant aspects of that system and relevant information disclosed in the financial statements, obtained from within or outside general or subsidiary ledgers.

• ISA 320- Materiality in Planning and performing an audit

This revised the introductory and application material by emphasizing that materiality needs to be considered for qualitative disclosures.

• ISA 330- The Auditor’s Responses to assessed risks

This revision has strengthened procedures regarding the reconciliation of the financial statements and the adequacy of the presentation and disclosures in the financial statements. It includes information from within or outside of the general and subsidiary ledgers and consideration of the classification and description of financial information and the underlying transactions, events, and conditions and the presentation, structure, and contents of the financial statements.  

• ISA 450- Evaluation of Misstatements identified during the audit

This revision emphasizes on accumulation and evaluation of misstatements in disclosure.

• ISA 700- Forming an opinion and reporting on financial statements
  This revision enhances the audit procedures performed by auditors while evaluating financial statements. The enhancement in the requirements for the evaluation of the financial statements relates to:
  • Accounting policies requiring auditors to consider the relevance and understand the accounting policies.
  •  The relevance, reliability, comparability, and understanding of the financial statement have been enhanced by requiring auditors to consider completeness, classification, aggregation and disaggregation, and characterization of the information.

What are the challenges faced by Auditors in audit disclosure?

Following are the challenges faced by Auditors in Audit Disclosure:

• Risk of irrelevant disclosures and determining materiality
  The auditors often prefer to provide detailed disclosure of the information for arriving at a decision. Even the companies prefer the auditor to provide detailed information as it will provide transparency. However, the IAASB considers that too much information makes the readers difficult to focus on important matters due to information overload. Further, it will become difficult to apply materiality to disclosures, especially of quantitative nature.
  IAASB also considers giving additional guidance to auditors to guide them on how to determine whether qualitative disclosure is material or not. A preliminary determination at the planning stage of the audit of those disclosures that could reasonably be expected to influence the economic decision of users would help the auditor better identify disclosure material by their nature or their monetary value and assist in planning appropriate audit procedures.
• Sources of information
  One of the key issues is that the information included in the notes of the financial statements may be derived from systems and processes that are not a part of the general ledger system. This may give rise to problems faced by the auditor and other respondents involved in the consultation. When the system or process from which information is derived is outside the normal accounting process, there might be internal controls to assure the completeness, accuracy, and validity of the information. This might lead to higher audit risk. As per IAASB, this is the most challenging aspect of preparing and auditing disclosures. 
• Timing considerations
  Many times the disclosures are prepared by management very late in the audit process which prevents the auditor to plan the audit of disclosures until late in the audit process. This increases the risk of audit as there remains only a little time to assess the risk relating to disclosures and to perform the necessary audit procedures. The risk increases in cases of complex disclosures.

Conclusion

Auditing disclosures have indeed increased the reliability of financial instruments however, the process of audit disclosure remains difficult. IAASB has from time to time proposed additional guidance to provide auditors with practical guidance and also reduce the risk of audit. IAASB continues to monitor whether further amendments to the ISAs or any other form of non-authoritative guidance are needed.

Also Read: Scope of Reporting of Auditors in Audit Report as per MCA