ISA 260 - Communication with those charged with governance
Proposed revised and redrafted International Standard on Auditing issued for comment by the International Auditing and Assurance Standards Board of the International Federation of Accountants
Comments from ACCA
February 2007
Executive Summary
ACCA welcomes the opportunity to comment on the proposed International Standard on Auditing ISA 260 (Revised and Redrafted) Communication with Those Charged with Governance (proposed ISA 260), issued for comment by the International Auditing and Assurance Standards Board (IAASB) of the International Federation of Accountants (IFAC).
ACCA commented on a March 2005 exposure draft, which has subsequently resulted in a finalised 'close-off' document. Our comments below are restricted to the changes proposed in applying the Clarity project drafting conventions to that document.
We have concerns that:
- The objectives and requirements are out of step with each other.
- The Clarity drafting conventions have not produced clear definitions or requirements.
- There is insufficient justification for many of the proposed requirements.
Objectives
Restriction to the general case
The Introduction notes that 'particular considerations apply where all of those charged with governance are involved in managing an entity, and for listed entities'. These circumstances give rise to conditional requirements (in paragraphs 10 and 15).
The objectives deal only with the general case where the particular circumstances mentioned in the Introduction do not arise. For example, objective 5(a) refers to the 'responsibilities of the auditor' but makes no mention of communication of auditor independence, which is required, for listed companies, by paragraph 15.
The objectives are vitally important because they are used to 'judge whether, having complied with the requirements of the ISAs, sufficient appropriate audit evidence has been obtained in the context of the overall objective of the auditor.' We consider that the wording in the Introduction is not sufficient, therefore, to explain why the objectives deal only with the general case.
The resolution of this comment will be relevant to other Clarity project exposure drafts.
Other disparities Between Objectives and requirements
Objective 5(a) refers to communicating the 'scope and timing of the audit' whereas requirement paragraph 13 refers to 'an overview of the planned scope and timing' . The objective could be interpreted as a continuous obligation (including post-planning) involving greater detail than in an overview. We recommend changing the objective to refer to 'an overview of the planned scope and timing' .
Objective 5(b) is to 'Obtain from those charged with governance, information relevant to the audit;' , but there is, rightly, no related requirement. An ISA should not implicitly impose a general requirement on those charged with governance to provide information. The objective should be rewritten to accord more directly with the need to assess and respond to the adequacy of the communication process.
Application of the Clarity Drafting Conventions
Clear Presentation of Requirements
We do not find the requirements sections of proposed ISA 260 easy to understand. There are three main reasons for this:
- explanatory material is interspersed with the requirements,
- the wording of requirements makes no distinction between essential procedures and basic principles, and
- the requirements are not constructed in a simple fashion.
We do not agree with including explanatory material in the requirements section. In our experience, the first process a user carries out is to highlight all uses of the word 'shall' so as to discover which parts of the text are requirements. Rather than improving clarity, explanatory material adds unnecessary length and detracts from the reader's understanding.
We recommend transferring all explanatory material to the Application and Other Explanatory Material section. For example, paragraphs 11 and 20 could be wholly transferred.
The bold type in extant ISAs identifies basic principles and essential procedures. These are substantially different in nature, but the Clarity project has combined the two as 'requirements'. We do not agree with this approach, which leads to confusion, as auditors may attempt to treat a principle as an action, or vice versa.
For example, paragraph 62 of the close-off document states: 'Communications with those charged with governance should be on a timely basis.' This is a principle - that on which communications are most effective. As paragraph 18 of proposed ISA 260, it is written as an action but one that cannot actually be executed.
The corresponding and perhaps greater danger is that auditors who correctly interpret some of the 'shall' statements as principles will treat as principles some that are intended as active requirements. We recommend separating the principles with which the auditor is required to comply from the required procedures and other actions.
We do not find the requirements easy to understand because they are not always drafted in a simple fashion. Requirements with multiple conditions precedent are particularly difficult to understand when written in prose. For example, paragraph 14 (a) of proposed ISA 260 includes a requirement that the auditor shall request changes. This action is necessary only if:
- the auditor considers it necessary (which begs the question as to why it is a 'requirement' at all),
- the auditor considers the accounting practice not to be appropriate,
- the accounting practice is significant (this condition does not refer to the significance of the requested change itself), and
- the auditor is communicating with those charged with governance concerning significant qualitative aspects of the entity's accounting practices (some users may decide that this is not a condition in itself).
Auditors who need to know when this requirement applies, and when it does not, have to be very diligent and analytic readers. We recommend rewording all requirements so that there is no doubt about the meaning of the various 'shall' statements. This should be done using a structure that clearly shows:
- any conditions precedent
- on whom the requirement is placed
- the action required, and
- the object of that action.
Definitions
The definitions are unnecessarily extended. In the close-off document there is no separate place for application material and so explanation is mixed with definition. In the clarified document, interpretive guidance is best put in the Application and Other Explanatory Material section. This would also remove the need for footnotes to the definitions.
Growth in Number of Requirements
There seems to be no external economic or social justification, suddenly to increase the degree of specificity of ISAs; nevertheless, proposed ISA 260 exhibits a substantial growth in the number and detail of specific requirements. For each new requirement we consider whether the 'elevation' from a present-tense statement in the close-off document is appropriate. Our detailed analysis concludes that hardly any of the changes are justified. We recommend that the proposed requirements be reconsidered on an individual basis and that each remains as a requirement only if a strong case can be made for that.
The following proposed elevations to requirements are not appropriate for the reasons stated:
Paragraph 8
This paragraph should not be a requirement. It is guidance for paragraph 7 which already requires the auditor to determine the appropriate person(s) within the entity's governance structure with whom to communicate. This paragraph merely advises on the best course of action in unclear circumstances.
If retained as a requirement, it should be rewritten to place an obligation only on the auditor. It is not appropriate for an ISA to seek to impose a requirement on the 'engaging party' to agree something with the auditor. This issue was addressed in the 'basis for conclusions' document in relation to two-way communication where it was concluded that '. . . an ISA cannot mandate two-way communication (because it cannot require those charged with governance to communicate with the auditor) . . .' .
Paragraph 9
This paragraph should not be a requirement. It is application guidance for paragraph 7, which already requires the auditor to determine the appropriate person(s) within the entity's governance structure with whom to communicate. This paragraph merely advises on the best course of action in unclear circumstances. The requirement does not satisfy the criterion that it is necessary to achieve the objective stated in the Standard.
The sentence 'In some circumstances, the auditor may also need to communicate with the governing body.' is presumably explanatory material. Its inclusion here is potentially misleading. Transfer of the whole paragraph to the Application and Other Explanatory Material section would improve clarity.
Paragraph 12
The first part of paragraph 12 is the requirement from the close-off document. The bullet points only illustrate responsibilities and should be presented as Application and Other Explanatory Material. Including the bullets in the requirements section will potentially deter auditors from communicating their other responsibilities. Had the two matters been of overarching significance then the close-off document would have included them as requirements.
The sentence 'This communication is often included in the engagement letter or other form of contract that records the agreed terms of the engagement.' is just guidance and should be presented as such in the Application and Other Explanatory Material section.
Paragraph 14(a)
The following wording should not be included in the requirement: 'When applicable, the auditor shall explain to those charged with governance why the auditor considers a significant accounting practice not to be appropriate and, when considered necessary, shall request changes.'. Auditors identify inappropriate accounting policies as one of the causes of uncorrected misstatements. The wording duplicates the requirement in proposed ISA 450 to communicate uncorrected misstatements. If it is considered necessary to emphasise this aspect in proposed ISA 260, that may be done in the Application and Other Explanatory Material.
The wording earlier in paragraph 14(a) requires the auditor's views to be communicated. The italicised wording above is dangerous as it suggests that explanation of the auditor's views is unnecessary except in the restricted circumstances to which it refers. It would be better to present such material in a more balanced way in the Application and Other Explanatory Material section.
Paragraph 19
Paragraph 19 includes the requirement in paragraph 65 of the close-off document and part of the guidance from paragraph 68 of the close-off document. The guidance from paragraph 68 is best read as a whole and it should be presented, therefore, within the Application and Other Explanatory Material section.
The requirement has been changed from that in the close-off document by the addition of the text emphasised below:
'The auditor shall evaluate whether the two-way communication between the auditor and those charged with governance has been adequate for the purpose of the audit. If it has not, the auditor shall take appropriate action to address the effectiveness of the communication process .'
This change is unnecessarily restrictive on the range of actions the auditor is prompted to take. It is either unclear as to the meaning of 'address' or (to the extent to which 'address' is intended to mean 'improve the adequacy of' ) seeks to impose a requirement that is not achievable unless those charged with governance cooperate.
We recommend deletion of this added text.
Paragraph 15 of the Preface to the International Standards on Quality Control, Auditing, Review, Other Assurance and Related Services (amended September 2006).