Auditing and Assurance Services: ISA 701 vs AS 3101, Reporting Changes

This report provides a comprehensive comparison of the International Auditing and Assurance Standards Board (IAASB)'s ISA 701 and the U.S. Public Company Accounting Oversight Board (PCAOB)'s AS 3101, focusing on the key changes in audit reporting. It highlights the similarities and differences between the two standards, particularly in the context of Key Audit Matters (KAM) and Critical Audit Matters (CAM), respectively. The report explores the motivations behind these changes, including the desire to enhance investor protection and improve the informativeness of audit reports. It critically examines the implications of these changes on audit practices, including potential impacts on auditor liability and the role of the audit committee. The analysis covers the differences in how the standards address ethical requirements, auditor responsibilities, and the disclosure of KAM/CAM in various audit opinion scenarios. The report concludes by summarizing the key findings and implications of these changes for both auditors and users of financial statements.

AUDITING AND ASSURANCE
SERVICES

Table of Contents
INTRODUCTION...........................................................................................................................1
Key changes to audit report, similarities and differences between PCAOB and IAASB............1
Reasons/motivations for the change with critical examination...................................................3
Outlining likely impact of audit reporting on audit practice........................................................4
CONCLUSION................................................................................................................................4
REFERENCES................................................................................................................................4

INTRODUCTION
IAASB is the leading accounting standard setting body that set high quality standards
satisfying public interest. It issued ISA 701 with respect to audit report, while, PCAOB is a
private body that protect investors right by overseeing companies audit. Recently, it had
proposed several changes in the audit reporting requirement of companies in AS 3101. The key
purpose of the assignment is to identify key changes and examine similarities and differences
between ISA 701 and AS 3101. Moreover, it will critically examine the key issues and reasons
behind proposing such changes in the standard along with its potential implication on audit
practices.
Key changes to audit report, similarities and differences between PCAOB and IAASB
Recently, in May 2016, US Public Company Accounting Oversight Board (PCAOB)
release AS 3101 for auditors reports (in case of unqualified opinion), as per which, auditors need
to disclose areas, considered as high audit risk in his report. However, IAASB (International
Auditing and Assurance Standards) revised its audit reporting standards in January, 2015.
Following are the key changes introduced by PCAOB in AS 3101:
 Limiting communication of CAM in the audit report to the audit committee
 Incorporating materiality element in the CAM
 Revised definition on CAM covering challenging, subjective and complex judgment of
auditor
 Require publishing only the principal consideration in determination of whether a matter
is CAM or not
 Expanding communication requirements by including description of how CAM has been
addressed during audit
The main difference between both the standards is PCABO is based on critical audit
matters (CAM) whereas ISA, 701 focuses on key audit matters (KAM). Here, CAM comprises
all the matters that arisen from the auditing of company’s financial statements such as
materialistic information to the accounts & disclosure and challenging & subjective judgments
need to be conveyed to audit committee (Arens, Elder & Mark, 2012). However, KAM are
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auditor’s professional judgment that is considered as most significance in auditing annual
accounts. In order to determine whether a matter is CAM or KAM, both ISA 701 and AS 3101
follows same two-step principle based procedure of judgment-based framework. Although, both
standards approach different concepts (CAM & KAM), still, both have same intention to
communicate a complete set of information in auditor report to assist investors and other
stakeholders in rationalized decisions. As per ISA 701, paragraph 13, auditor must include KAM
in his report which comprises details about why the particular matter is considered extremely
significant and how it was addressed by him during audit (William, Glover & Prawitt, 2016).
However, AS 3101, paragraph 14 stated that for each CAM, auditor must provide details of the
matter, present principle consideration, mention how it was addressed along with the related
statement & disclosure (Summary Comparison between the IAASB and US PCAOB Standards,
2017).
Considering IAASB and PCABO, both of these need presentation of opinion section of in
the audit report. However, under basis for opinion section, ISA 701 identifies ethical requirement
and responsibilities of auditor (affirmative statement), in contrast, AS 3101 require audit
compliance with US federal Security Law and US SEC (Security Exchange and Commission)
law. If company auditor modifies his or her audit opinion, then as per IAASB standard, such
modification needs to incorporated in basis for opinion, while, in accordance with AS 3101, it
needs to be shown in opinion section. Although both need disclosure of KAM/CAM for the
qualified opinion of auditor and it is not required in case of disclaimer (Hayes, R., Wallage, P., &
Gortemaker, 2014). According to ISA701 requirement, IAASB need KAM when auditor
expresses his adverse opinion while considering PCAOB standards no such disclosure of CAM
is necessary to be given by the auditor.
According to ISA 701 paragraph 9, necessary documentation is required for such matters
which need significant attention of the auditor and also a clear rationale needs to be presented for
KAM. AS 3101, on the other hand, requires communicating report to the audit committee for
CAM (challenging, subjective & complex) and materialistic accounts & disclosure. Although,
both the standards have different nature of documentation, still, the similar point is that both
need proper communication of significant judgment in determining whether a matter is subject to
CAM/KAM. Besides this, auditor’s tenure is not necessary to disclose in IAASB while statement
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for auditor’s tenure needs to be publish accordance with PCAOB. In despite of this, both follows
similar principles for addressing issues regarding the concept of going concern, still, ISA 701
need some specific disclosure for the managerial and auditor responsibility in such area,
however, as per AS 3101, these can be reported in explanatory paragraph and CAM section only.
Reasons/motivations for the change with critical examination
According to Carmichael (2014), PCAOB introduced changes with the intention to
maximize auditor’s liability by highlighting all the necessary details about high risky aspect.
Board believed that by introducing such changes, it will be able to satisfy investor’s interest by
enhanced communication. It will protect their interest and leads to maximize public interest in
preparing accurate, highly informative and independent audit report. Thus, the key reason for
such changes is to make report more informative as well as relevant for stakeholders, especially
shareholders.
As per PCABOB’s proposal, auditor need to follow four level reporting for CAM,
comprising currently adopted reporting model of audit, related CAM, CAM considered as high
risky issue and required financial statement. Gimbar, Hansen & Ozlanski (2015), said that such
disclosure serves as a warning indicator for the users and seen as a “disclaimer” for the liability
of auditor for identified high risky areas. Similarly, Cassell & et.al. (2016), called CAM as
“forewarning” for different users of the financial statement which provide them details about
issues in the annual report result in lower liability, but, it is only true when recognized issue is
perceived as easy for the audit.
PcW, Deloitte, Earnst & Young LLP agreed with reproposed standard on audit report,
while SEC secretary provided adverse viewpoint and commented that usefulness of the audit
report could not be necessarily improved by extensive disclosure. It is because, Sonu, Ahn &
Choi (2017), proposed changes could diminish the importance of CAM disclosure and resultant
significant level of cost for both the auditors and issuers. As per the view of Glover, Hansen &
Seidel (2016), disclosure of CAM would change auditor’s role. Moreover, audit committee may
not be interested in having a direct conversation with the auditors, because, discussion among
them might result in presenting sensitive information which may not be of materialistic nature
for the investors.
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Likewise, Cipriano, Hamilton & Vandervelde (2016), considered the amendments as
boilerplate as in some way, it overlap other aspects i.e. critical accounting policies. It also results
in duplication because auditors as have to disclose CAM, similarly, issuers also need to repeat
the same discussion in their own reports.
Outlining likely impact of audit reporting on audit practice
The new standard AS 3101 will apply for all audit which is conducted following PCAOB
standards. It will make audit report more informative for the investors because, in this, auditor
will need to present additional insight about the key judgments. Thus, by this way, it minimizes
information asymmetry between auditor and investors as well as managers and investors about
the financial performance of the organization. Moreover, it is in line with the international
standard. It will improve format and content of the audit report highly informative and relevant
for the users. It will require some change in the audit practices as in this, determination o matters
whether it is a CAM or not needs to follow a principle based framework along with facts &
circumstances based analytical framework. In the determination procedure, auditor will follow
two pronged test, in the first, it is essential that matter it must be an material element of account
or disclosure of financial statement, however, in the later, significant deficiency in the internal
control mechanism followed by the firm is recognized.
CONCLUSION
From the discussion, it become clear that AS 3101 has received favorable opinion of
PcW, Deloitte, Earnst & Young LLP as they commented that it will make report more
informative for all the users of financial statement. However, at the same, it has been criticized
as it will result in high cost occurrence, change auditor role and unnecessary disclosure of
sensitive information in the discussion.
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REFERENCES
Arens, A. A., Elder, R. J., & Mark, B. (2012). Auditing and assurance services: an integrated approach.
Boston: Prentice Hall.
Carmichael, D.R. (2014). Reflections on the establishment of the PCAOB and its audit standard-
setting role. Accounting Horizons. 28(4). pp.901-915
Cassell, C.A. & et.al. (2016). Does the Timing of Auditor Changes Affect Audit Quality?
Evidence from the Initial Year of the Audit Engagement.
Cipriano, M., Hamilton, E. L., & Vandervelde, S. D. (2016). Has the lack of use of the qualified
audit opinion turned it into the “Rotten Kid” threat?. Critical Perspectives on
Accounting. 14(3). pp.18-63.
Gimbar, C., Hansen, B., & Ozlanski, M. E. (2015). Early Evidence on the Effects of Critical
Audit Matters on Auditor Liability. Current Issues in Auditing, 10(1), A24-A33.
Glover, S. M., Hansen, J. C., & Seidel, T. A. (2016). The Informational Value of the Audit
Report Date and the Effect of SFAS No. 165. 15(3). pp.12-36.
Hayes, R., Wallage, P., & Gortemaker, H. (2014). Principles of auditing: an introduction to international
standards on auditing. Pearson Higher Ed.
Sonu, C. H., Ahn, H., & Choi, A. (2017). Audit fee pressure and audit risk: evidence from the
financial crisis of 2008. Asia-Pacific Journal of Accounting & Economics. 24(1-2).
pp.127-144.
William Jr, M., Glover, S., & Prawitt, D. (2016). Auditing and assurance services: A systematic
approach. McGraw-Hill Education.
Online
Summary Comparison between the IAASB and US PCAOB Standards. (2017). [PDF]. Available
through: http://www.hesabras.com/Content/media/filepool3/2017/8/569.pdf. [Accessed
on 2nd October 2017].
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