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ISA 720 The Auditor's Responsibility in Relation to Other Information in Documents Containing Audited Financial Statements

Proposed 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
April 2007

Executive Summary

ACCA welcomes the opportunity to comment on the proposed International Standard on Auditing ISA 720 (Redrafted) The Auditor's Responsibility in Relation to Other Information in Documents Containing Audited Financial Statements (proposed ISA 720), issued for comment by the International Auditing and Assurance Standards Board of the International Federation of Accountants.

Our comments below are restricted to the changes proposed in applying the Clarity project drafting conventions to extant ISA 720.

We have concerns that the Clarity redrafting has disguised changes to the scope of the ISA and to the auditor's responsibilities towards misstatements in other information. Such changes will add costs to audits that will fall disproportionately on smaller entities.

Scope

Change from extant ISA 720

We are concerned that the Clarity redrafting has resulted in an extension of the scope of proposed ISA 720 that will add unnecessary costs to audits, which will fall disproportionately on smaller entities.

Paragraph 1 of extant ISA 720 states that:

‘The purpose of this International Standard on Auditing (ISA) is to establish standards and provide guidance on the auditor's consideration of other information, on which the auditor has no obligation to report, in documents containing audited financial statements. This ISA applies when an annual report is involved; however, it may also apply to other documents, such as those used in securities offerings.'

Although the paragraph itself has some ambiguities (for example, in the interpretation of the words ‘on which the auditor has no obligation to report ‘) it has generally been interpreted as restricting the scope of the ISA to annual reports. Such documents are well defined and readily identifiable as such, although their actual content varies considerably in nature.

Proposed ISA 720 has altered the emphasis and treats annual reports as just an example of documents containing audited financial statements. Paragraph A6 gives examples of information that is not within the definition of other information. Some of these are so far away from the annual report that auditors are drawn to the conclusion that the boundaries of ‘other information' are now much more widely drawn.

The impact of the change will be to cause auditors to seek to identify and carry out procedures on all ‘other information' that might be subject to the requirements of proposed ISA 720.

It may be that this change in emphasis was not intended, in which case we suggest rewording the scope accordingly.

We have little doubt that the development of corporate reporting, especially non-financial reporting, and the increasing availability of information to investors has increased the risk that the credibility of financial statements is undermined by information outside the traditional annual report.

However, at this stage of the Clarity project, and given that proposed ISA 720 is being redrafted and not fully revised, we question whether it is appropriate to make some changes in scope without a full consideration of how the thinking behind the ‘core ISAs' should be implemented in this ISA.

The meaning of ‘other information in documents containing audited financial statements'

In connection with the change in scope from extant ISA 720, we are concerned that there is imprecision in the term ‘other information in documents containing audited financial statements'.

Other information is defined as:

‘Financial and non-financial information (other than the financial statements or the auditor's report thereon) which is included, either by law, regulation or custom, in a document containing audited financial statements, that is provided to owners on the same terms, and at the same time, as the financial statements.'

Proposed ISA 720 provides no definitions of ‘documents' or ‘audited financial statements'. As such, each term takes its natural meaning.

We believe that this promotes uncertainty in the scope of proposed ISA 720. For example, what is the significance of the words ‘in a document'? Does information have to be part of a composite document to be within the definition? The application of extant ISA 720 was confined to circumstances where ‘an annual report is involved' (although it was permitted to apply more widely). Clearly an ‘annual report' containing audited financial statements and other statements is a single document. But what if the statements are issued together but without an overall ‘wrapper' of an annual report? For larger entities this may happen when a sustainability report is issued at the same time as, but not forming part of, the annual report containing audited financial statements. For a smaller entity, a detailed income statement may be issued to some users but in a way that makes it clear that it is not part of a composite document.

A second example of imprecision, is the exclusion by paragraph A6 of ‘information contained on the entity's web site' , which is too sweeping as an exemption. Many web sites present sustainability reports and other investor-related information that auditors versed in the ‘core ISAs', ought not to exclude from their considerations of inconsistency.

We believe that proposed ISA 720 should include a clear statement of its scope and that at present it should continue to focus on the annual report.

Securities offerings

A specific question is asked in the Explanatory Memorandum is whether to retain the existing reference in proposed ISA 720, or whether it would be preferable to delete the few references to securities offerings in it and other ISAs?

In our view it would be better to exclude such references. We agree with the argument, put forward in the Explanatory Memorandum, that ISAs have not been developed to provide the basis for engagements in connection with prospectuses. Moreover, the responsibilities of auditors and reporting accountants in engagements relating to securities offerings are properly determined by national law and regulation.

Objective

Although the objective is acceptable, it gives the impression that the efforts of the auditor are directed towards reducing an ethical threat. We suggest elimination of the reference to ‘ being associated with other information that may undermine the credibility of the audited financial statements '[emphasis added].

This would necessitate redrafting the sub-paragraphs, which we suggest could then be better presented in terms of the desired outcomes rather than summarising the procedures.

Application of the Clarity Drafting Conventions

Definitions

Paragraph 5(c) provides a definition of ‘misstatement of fact'. This draws on the requirement in extant ISA 720 paragraph 16 (referring to material misstatement of fact) and guidance in paragraph 15 explaining that ‘For the purpose of this ISA, a “material misstatement of fact” in other information exists when such information, not related to matters appearing in the audited financial statements, is incorrectly stated or presented.'

The new definition assumes that the extant guidance was intended to remove considerations of materiality rather than simply confine misstatements to those other than in relation to matters in the financial statements (which are ‘inconsistencies') and explaining that misstatement can arise either from incorrect statement or incorrect presentation. We do not agree with the interpretation in proposed ISA 720 as it goes against the extant requirement. If the intention of extant ISA 720 had been to require all misstatements to be considered, however trivial, it would not have used the words ‘material misstatement of fact'.

We strongly suggest that the extant requirement be reintroduced so as to focus the auditor's attention on misstatements of fact that are important. It should also be observed that the needs of due process in relation to a document described only as ‘redrafted' require an explicit reference to proposed revisions in the Explanatory Memorandum.

Requirements

Paragraphs 11 to 13

As explained more fully under the heading ‘Definitions', we do not agree with the changes made to extend these requirements to all misstatements however trivial.

Smaller entities

Guidance is provided in paragraph A4 on the likelihood of smaller entities issuing documents containing audited financial statements.

In our comments above on the scope of proposed ISA 720 we stated that ‘We are concerned that the Clarity redrafting has resulted in an extension of the scope of proposed ISA 720 that will add unnecessary costs to audits, which will fall disproportionately on smaller entities.'

Auditors of smaller entities that do not issue an annual report would have concluded that extant ISA 720 was not relevant because its scope paragraph clearly excluded them. In contrast, proposed ISA 720 is potentially relevant to all auditors as it is only through consideration of the various matters that might be considered to be ‘other information' that its relevance can be established.

Auditors of smaller entities may well consider that material not specifically excluded from its scope should be subject to the requirements of the proposed ISA, for example taxation and statistical returns. A conservative view is also likely to be taken of any form of information that might be termed a ‘management report' as that is mentioned in paragraph A4.

If the change in scope from extant ISA 720, referred to in our comments earlier in this response, is retained, we recommend making paragraph A4 more precise as the term ‘management report' is capable of many different interpretations.

We further recommend extending the list of matters that are outside the definition of other information (paragraph A6) so that it includes those relevant to smaller entities.

The ‘core' ISAs are: ISA 300 Planning an Audit of Financial Statements , ISA 315 Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement and ISA 330 The Auditor's Procedures in Response to Assessed Risks .

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