m924-kaars sijpesteijn_336762

8/12/2019 M924-Kaars Sijpesteijn_336762

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The value relevance of auditorscommunications

Financial statement users understanding of the messages in the audit report


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Masters research Accounting, Auditing and Control -$he %alue rele%ance of auditors communications

April , "/


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"reface

)n the pu0lic de0ate on the causes, the accounta0ilit1, and the solutions concerning the glo0alfinancial crisis, the role of the auditor has 0een 2idel1 discussed and criticied: -4here 2erethe auditors5

$he glo0al financial crisis 2as not prompted 01 an audit failure, ho2e%er the auditor 2as atthe center of the financial meltdo2n, and failed to fulfill its social responsi0ilit1 to pro%ide aclear and ade6uate clarification on the financial statements of financial corporations,

especiall1 on the uncertainties concerning the %aluation of financial assets.

$he %alue of the audit report, and the demand for audit ser%ices depend on pu0lic confidencein the independence and integrit1 of auditors.

$his masters research 2as aimed at understanding the effecti%eness of auditorscommunications, that is, the -%alue rele%ance of the audit report. $his research assessed theeffecti%eness of the audit report in communicating on the audit process, the auditors

responsi0ilities, and the nature of assurances pro%ided.

$his masters thesis is the result of a research project, 2hich has 0een performed as a part ofthe Masters degree program -Economics and +usiness, master specialiation -Accounting,Auditing and Control of the Erasmus School of Economics.

$he main personal goal in 2riting this thesis 2as to learn to accomplish such a long'term

i h ll diffi l i hi id d l i i h l h


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Ta#le of $ontents

8ist of a00re%iations.................................................................................................................. . )ntroduction...........................................................................................................................9

. +ac7ground.....................................................................................................................9 ." 0jecti%es........................................................................................................................; .3 Structure........................................................................................................................

". $heoretical frame2or7 for auditing....................................................................................3". $heories of auditing.......................................................................................................3 ".. 8impergs $heor1 of )nspired Confidence.............................................................3 ".." $he information theor1..........................................................................................= "..3 $he insurance theor1..............................................................................................= "..= $he agenc1 theor1..................................................................................................> "..> $he assurance theor1..............................................................................................!

"." ther theories.................................................................................................................;

".".


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..= $he audit opinion.................................................................................................../ ..> $he auditor and auditors responsi0ilities..............................................................

.. Clarified )SAs ......................................................................................................3 ..! Changes or additions to the audit report................................................................=

." Anal1ing the research results .....................................................................................> .". Audit report ' general.............................................................................................> ."." $he nature and scope of the auditors 2or7 ..........................................................> .".3 $he audit opinion................................................................................................... .".= $he auditor and auditors responsi0ilities..............................................................! .".> Changes or additions to the audit report................................................................9

.3 Summar1.......................................................................................................................; !. Conclusions.........................................................................................................................!/

!. &ecapitulation...............................................................................................................!/ !." Comparison 2ith prior studies......................................................................................!

!.". European Commission reen 9# audit report ....... ......9" )llustration 3: )SA (DK and )reland# !// (re%ised#.............................................................9> )llustration =: controle%er7laring 0ij een jaarre7ening (Standaard !//#.............................9!

Appendi ": 6uestionnaire on )SA !// un6ualified audit reports ..........................................9;A di 3 l f h i i //


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%ist of a##reviations

AAA American Accounting Association

AAF& Australian Accounting &esearch Foundation

A)C


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&' Introduction

$his chapter introduces the research topic: -the %alue rele%ance of the auditorscommunications. $his chapter descri0es the 0ac7ground of accounting and auditing anddefines the o0jecti%es and the pro0lem definition of the research. )n addition, this chaptercontains a recapitulation of the research methodolog1 and an o%er%ie2 of the outline of theresearch.

&'& (ac)ground

$his paragraph descri0es the 0ac7ground of accounting and auditing and introduces researchtopic -the %alue rele%ance of auditors communications.

Financial accounting

Financial accounting is a process in%ol%ing the collection and processing of financialinformation to assist in the ma7ing of %arious decisions 01 man1 parties eternal to theorganiation (eegan and Dnerman, "//, 3"#.

$he process of financial accounting leads to the generation of financial reports: financialstatements. $he principal classes of users of financial statements (financial statement users#are in%estors, 0an7 lenders, trade creditors, emplo1ees, financial anal1sts, go%ernments andthe pu0lic.

$he )nternational Accounting Standards +oard ()AS+#, an independent accounting standard'

F k f th ti d t ti f fi i l t t t


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Auditing and the audit report

)n a decision'ma7ing process, decision ma7ers rel1 upon information, financial statements, as

prepared and presented 01 the management of an entit1. $he possi0ilit1 that the informationupon decided on is inaccurate is called the -information ris7.

Elder et al. ("//, ;# state that the most common 2a1 for users to o0tain relia0le information(reducing the information ris7# is to ha%e an independent audit performed. $o enhance thedegree of confidence of the intended users in the financial statements, a financial statementaudit 2ill 0e conducted. ecision ma7ers use the audited information on the assumption thatit is reasona0l1 complete, accurate, and un0iased.

+ased on an audit, an audit report 2ill 0e issued. $he audit report represents the auditorscommunications of findings to financial statement users. $he audit report containsinformation a0out the audit, including its scope, and an opinion regarding the fair presentationof the financial statements.

Value relevance audit report

Financial statement users rel1 on the auditors report to pro%ide assurance on the compan1sfinancial statements. ne important 6uestion hence is 2hether auditor communicationscommunicate the appropriate information. )s the audit report effecti%e in communicatingimportant information a0out, for eample the audit process, the auditors duties and -goingconcern or do in%estors need more (0etter# information to facilitate their in%estmentdecisions5

Concerning the information content and the effecti%eness of the auditors communications,


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)t is not clear'cut that 2hen deciding on in%estments, financial statement users consider the

audit report. Misunderstanding of information 0eing communicated 01 means of the auditreport ho2e%er, can lead to unintended in%estments, misallocation of resources and J or lossof confidence in the audit function.

$he purpose of this research is to in%estigate the %alue rele%ance of the auditorscommunications. -@alue rele%ance implies the a0ilit1 of auditors communications, i.e., theaudit report, in communicating effecti%el1 a0out the audit process, the responsi0ilities of theauditor, the nature of assurances pro%ided 01 the auditor and other items, 2hich could 0eimportant in a decision'ma7ing process.

-@alue rele%ance 2ill 0e esta0lished 01 assessing users understanding of messages ascontained in the audit report and identif1ing users needs and re6uirements regarding topics2hich should 0e attended to (more etensi%el1# in the audit report.

&', "ro#lem definition

$he main 6uestion hence is:

What is the value relevance of the auditors communications, i.e., does the audit report

enhance the financial statement users understanding of the auditors duties, the audit

process, assurances provided and other important topics, or is additional and / or other

information required in facilitating a decision-making process?


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$he pro0lem in this research could 0est defined as an eplanator1 pro0lem. $he purpose of

the research is to esta0lish and to demonstrate the causal character of the association 0et2eenthe form and the content of the auditors communications and users understanding of certaintopics, li7e the audit process, auditors duties, assurances, going concern, and other topics thatcould 0e important in a decision'ma7ing process.

)n order to esta0lish the %alue rele%ance of the auditors communications, 0oth a literaturere%ie2 and an empirical research 2ill 0e conducted.

$he main purpose of a literature re%ie2 is to pro%ide an o%er%ie2 of significant literature aspu0lished on the topic of auditors communications. $o ac6uire an understanding of theresearch topic, in 2hich 2a1 this topic has 0een researched, and 2hich 7e1 issues ha%e 0eenfound, theoretical literature as 2ell as empirical research literature 2ill 0e identified ande%aluated.

)n this stud1, the research 6uestion is focusing on financial statement users: the population.

@arious groups of sta7eholders (see chapter . -+ac7ground# could 0e distinguished. )norder to realie a 2ell'founded portrait of users opinions, each class of financial statementusers, or the majorit1 of users classes, has to 0e in%ol%ed.

Considering the 0readth and the di%ersit1 of the target population, it 2ill not 0e possi0le toselect un0iased or random su0sets of indi%idual financial statement users. $his research hasnot the intention to 0e accuratel1 representati%e of its populationH appl1ing a 6ualitati%eresearch strateg1 2ill 0e satisfactor1.


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Chapter three introduces auditing and assurance ser%ices and discusses the usefulness ofperforming audit ser%ices. $his chapter includes an introduction to the audit report, an

o%er%ie2 of t1pes of audit reports, and a description of the e%ol%ement of audit reports. )naddition, chapter three pro%ides a description of the form and the content of the standard auditreport and highlights fre6uentl1 heard criticisms concerning the standard audit report.

Chapter four pro%ides a description of prior studies on de%elopments in the standard auditreport and its effecti%eness in communicating important messages. Earl1 in%estigations of the%alue rele%ance of the audit report date 0ac7 to the /s and !/s, for eample &oth (;;# andthe Cohen Commission (;!9#. Su0se6uent studies can 0e classified to periods ;99';;3(adoption of the long form audit report#, ;;3'"//= (long form report under 6uestion#, and"//= up to no2.

Chapter fi%e continues 2ith a description of the empirical part of this research. )n this chapter,the research methodolog1 and the design of the research 2ill 0e descri0ed. )n chapter si,research findings and anal1ses of the results 2ill presented.

Chapter se%en concludes 2ith the ans2er to the main 6uestion of this research and contains anoutline of the limitations of the research. )n addition, this chapter contains a description ofrecommendations concerning further research.


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*' Theoretical frame0or) for auditing

$his chapter pro%ides an o%er%ie2 of the eisting, eplaining theories on accounting andauditing. Auditing theor1 helps eplain 2h1 societ1 needs auditing: the role and purpose ofaudit ser%ices in communication 0et2een a compan1 and its en%ironment.

*'&Theories of auditing

$his paragraph presents some of the theories on the demand concerning auditing. $he agenc1

theor1 is the most prominent of the eisting theories. 8ess significant audit theories are the-policeman theor1 and the -lending credi0ilit1 theor1.

$he policeman theor1 claims that an auditor is responsi0le for searching, disco%ering, andpre%enting fraud. $he focus of the audit ho2e%er, has mo%ed to2ards the %erification of thetruth and the fairness of the financial statements and the pro%ision of reasona0le assurance.$he policeman theor1 is not a0le to eplain full1 the role and the purpose of auditing.

According to the lending credi0ilit1 theor1, the primar1 function of the audit is to addcredi0ilit1 to the financial statements. Audited financial statements increase the financialstatement users confidence in the financial figures and the faith in managementsste2ardship. $he lending credi0ilit1 does not eplain other functions of performing auditser%icesH this theor1 is limited in eplanator1 po2er.

*'&'& %impergs Theor. of Inspired $onfidence


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)n de%eloping his $heor1 of )nspired Confidence, 8imperg (8imperg )nstitute, ;9>, #

descri0es the auditors function J responsi0ilit1 as follo2s: B$he auditor'confidential agentderi%es his general function in societ1 from the need for epert and independent eaminationand the need for an epert and independent opinion 0ased on that eamination. $he functionis rooted in the confidence that societ1 places in the effecti%eness of the audit and in theopinion of the accountant. $his confidence is conse6uentl1 a condition for the eistence ofthat functionH if the confidence is 0etra1ed, the function, too, is destro1ed, since it 0ecomesuseless.

ne important citation concerning the $heor1 of )nspired Confidence (8imperg )nstitute,;9>, 9# is the net. B$he normati%e core of the "heor of #nspired $onfidence is this: theaccountant is o0liged to carr1 out his 2or7 in such 2a1 that he does not 0etra1 theepectations 2hich he e%o7es in the sensi0le la1manH and, con%ersel1, the accountant ma1 notarouse greater epectations than can 0e justified 01 the 2or7 done.According to the citation could 0e concluded that $he $heor1 of )nspired Confidence does not

prescri0e definite rules a0out the 0eha%ior of the auditor in each particular caseH the principle'

0ased approach, signaled 01 Carmichael ("//=, ";#.

B.. $he theor1 epects from the accountant that in each special case he ascertains 2hatepectations he arousesH that he realies the tenor of the confidence that he inspires 2ith thefulfillment of each specific function (8imperg )nstitute, ;9>, ;#.According to the $heor1 of )nspired Confidence (8imperg )nstitute, ;9>, 3#, changes in theneeds of the communit1 and changes in the auditing techni6ues result in changes in the


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*'&'- The agenc. theor.

)n -$heor1 of the firm: managerial 0eha%ior, agenc1 costs and o2nership structure (;!,3/#, M.C. Nensen and 4.*. Mec7ling refer to the firm 0eing a -0lac7 0o, operated so as tomeet rele%ant marginal conditions 2ith respect to inputs and outputs, there01 maimiing

profits, i.e., present %alue. $he authors signaled that no theor1 eists, eplaining the 2a1 in2hich the conflicting o0jecti%es of indi%idual participants 2ill 0rought into e6uili0rium tosucceed in %alue maimiation.

Nensen and Mec7ling (;!, 3/9# define an agenc1 relationship as a contract under 2hich oneor more persons (the principal(s## engage another person (the agent# to perform some ser%iceon their 0ehalf 2hich in%ol%es delegating some decision'ma7ing authorit1 to the agent. $heauthors notice that if 0oth parties are utilit1 maimiers (opportunistic 0eha%ior#H a goodreason eists to 0elie%e that the agent 2ill not al2a1s act in the 0est interests of the principal.

According to Nensen and Mec7ling (;!, 3/9# di%ergence eists 0et2een the agents

decisions and those decisions 2hich 2ould maimie the 2elfare of the principal. 4ithin thisprincipal'agent relationship, o2ners ha%e an interest in maimiing the %alue of their shares,2hereas managers are more interested in -pri%ate consumption of firm resources and firmgro2th.

Costs that arise 0ecause of the delegation decision'ma7ing authorit1 from the principal to theagent, 2hich is due to the -separation of o2nership and control in modern corporations, arereferred to as -agenc1 costs. Nensen and Mec7ling (;!, 3/9# define as the sum of the


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Figure : Agenc1 $heor1 %er%ie2 (Eisenhardt, ;9;, >;#

$he -model of man underl1ing the Agenc1 $heor1 is that of a rational actor 2ho see7s tomaimie his or her utilit1 2ith the least possi0le ependiture. +oth agents and principalssee7 to recei%e as much possi0le utilit1 2ith the least possi0le ependiture. $hus, gi%en the


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eegan and Dnerman ("//, "># notice that 2ithin the agenc1 theor1 literature, the firm

itself is considered to 0e a -neus of contracts. $hese contracts are used 2ith the intention ofensuring that all parties, acting in their o2n self'interest, are at the same time moti%atedto2ards maimiing the %alue of the organiation.

According to onaldson and a%is (;;, >/#, a major structural mechanism to restrictmanagerial opportunism is the 0oard of directors, 2hich pro%ides a monitoring of managerialactions on 0ehalf of the shareholders. $he authors assert that an un0iased re%ie2 2ill occurmore full1, 2here the chairperson of the 0oard is independent of eecuti%e management.

a%is et al. (;;!, "3# further mention that the application of agenc1 control does not impl1that all managers decisions 2ill result in increased 2ealth for principalsH it implies onl1 thatmanagers 2ill stri%e to attain outcomes fa%ora0le for the principals. According to a%is et al.,there are man1 reasons other than poor moti%ation for agents failing to deli%er high

performance, e.g. lo2 a0ilit1, lac7 of 7no2ledge and poor information.

Agency theory and the role of auditA principal'agent relationship arises 2hen principals engage another person as their agent to

perform some ser%ice on their 0ehalf. elegation of responsi0ilit1 is helpful in promoting anefficient and producti%e econom1, ho2e%er delegation also means that the principal needs to

place trust in an agent to act in the principals 0est interests.

+ecause of information as1mmetries 0et2een principals and agents and differing moti%es,principals ma1 lac7 trust in their agents and ma1 conse6uentl1 need to put in place


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)ndi%iduals responsi0le for ma7ing 0usiness decisions see7 assurance ser%ices to help impro%ethe relia0ilit1 and rele%ance of the information used as the 0asis for their decisions.

Follo2ing Elder et al. ("//, ;#, one categor1 of assurance ser%ices pro%ided 01 auditors is-attestation ser%ices.


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*'*ther theories

)n this paragraph, the


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$o compensate themsel%es for the -agenc1 ris7, the epectation that the agents self'interest2ill di%erge from the principals interest, in%estors 2ill re6uire a higher rate of return, i.e.,

the1 2ill pa1 less for the shares than their intrinsic %alue.

Financial reports (pu0lic disclosures# 2hich gi%e an account of the agents performance ha%eadopted as 0eing a monitoring mechanism. $o reduce further the agenc1 ris7, principals couldappl1 for an independent audit of these reports. $he %alue of an audit 2ill 0e recognied if thecosts in%ol%ed are less than the agenc1 costsH the increase in the cost of the compan1s sharecapital if no audit 2as conducted (Cosserat, "//;, =3#.

*'*'* %egitimac. theor.

According to eegan and Dnerman ("//, "!#, legitimac1 theor1 asserts that organiationscontinuall1 see7 to ensure that the1 are percei%ed as operating 2ithin the 0ounds and norms oftheir respecti%e societies, that is, the1 attempt to ensure that their acti%ities are percei%ed 01outside parties as 0eing -legitimate.

8egitimac1 theor1 relies upon the conception of a -social contract 0et2een the organiationand the societ1 in 2hich it operates. B$he concept is used to represent the multitude ofimplicit and eplicit epectations that societ1 has a0out in 2hich 2a1 the organiation shouldconduct its operations (eegan and Dnerman, "//, "!#.

eegan and Dnerman ("//, "!"# assert that legitimac1 from societ1s perspecti%e and theright to operate go hand in hand. Societ1 allo2s the organiation to continue operations to theetent that it generall1 meets their epectations. 8egitimac1 theor1 predicts that management


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onaldson and a%is (;;, >"# pretend that ste2ardship theor1 focuses not on moti%ation ofthe CE 0ut rather facilitati%e, empo2ering structures. Contrar1 to the agenc1 theor1,

ste2ardship theor1 holds that fusion of the roles of CE (eecuti%e management# and chair ofthe 0oard of directors 2ill enhance effecti%eness and produce superior returns to shareholdersthan separation of the roles of CE and chair.

BAgenc1 theor1 pro%ides a useful 2a1 of eplaining relationships 2here the parties interestsare at odds and can 0e 0rought more into alignment through proper monitoring and a 2ell'

planned compensation s1stem (a%is et al., ;;!, "=#. According to the authors ho2e%er, toeplain other t1pes of human 0eha%ior, additional theor1 is needed.

Follo2ing a%is et al. (;;!, "#, in ste2ardship theor1, the model of man is 0ased on aste2ard 2hose 0eha%ior is ordered such that pro'organiational, collecti%istic 0eha%iors ha%ehigher utilit1 than indi%idualistic, self'ser%ing 0eha%iors. $he ste2ardship theor1 definessituations in 2hich managers are not moti%ated 01 indi%idual goals. $he1 are rather ste2ards2hose moti%es 2ith the o0jecti%es of their principals are aligned.

BSte2ardship theorists assume a strong relationship 0et2een the success of the organiationand the principals satisfaction. A ste2ard protects and maimies shareholders 2ealththrough firm performance, 0ecause, 01 so doing, the ste2ards utilit1 functions aremaimied (a%is et al., ;;!, ">#.

Ste2ards are moti%ated 01 intrinsic re2ards, such as reciprocit1 and mission alignment, ratherthan solel1 etrinsic re2ards. $he ste2ard, as opposed to the agent, places greater %alue oncollecti%e rather than indi%idual goalsH the ste2ard understands the compan1s success as his


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)n ans2er to the 6uestion: -i%en the ad%antage of ste2ardship to principals, 2h1 isnt thereal2a1s a ste2ardship relationship5 a%is et al. (;;!, "# eplain that 2ithin the go%ernance

contract 0et2een o2ners and eecuti%es, o2ners must decide ho2 much ris7 the1 are 2illingto assume. &is7'ad%erse o2ners conse6uentl1 2ill percei%e that eecuti%es are self'ser%ingand 2ill prefer agenc1 go%ernance prescriptions.

Stewardship theory and the role of the audit

$he agenc1 model assumes a principal'agent relationship in 2hich differing moti%es andinformation as1mmetr1 lead to concern a0out the relia0ilit1 of information. 4ithin the agenc1theor1, the role of the audit is to reinforce trust and confidence in financial reporting.Dnli7e the agenc1 theor1, the ste2ardship theor1 holds that no inherent, general pro0lem ofeecuti%e moti%ation eists. $he model of man is 0ased on a ste2ard 2hose 0eha%ior is pro'organiational and collecti%istic.

Follo2ing the 0asic thoughts of ste2ardship theor1, there is no need of implementingmonitoring mechanisms. $here is no need of engaging audit ser%ices in order to secure the

relia0ilit1 of information. *o2e%er, 2ithin ste2ardship theor1 an audit could 0e of %alue as ameans of assisting the eecuti%es ste2ardship.

According to ste2ardship theor1, the eecuti%e manager places greater %alue on collecti%erather than indi%idual goals. $he eecuti%e is moti%ated to 0e a good ste2ard of corporateassets and an audit could help to epress good ste2ardship. ispla1ing audited financialstatements, the ste2ard epresses truth and fairness of financial and non'financial

performances.


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,' The contents of auditing and the audit report

$his chapter introduces auditing and assurance ser%ices and discusses t1pes of audit reportsand the de%elopment of the standard audit report. $his chapter includes a description of theform and the content of the audit report and presents the main criticisms concerning thestandard audit report.

,'&Auditing and assurance services

$his paragraph introduces the nature and content of performing auditing and assuranceser%ices and descri0es the t1pes of audit ser%ices. )n addition, this chapter 0riefl1 discussesthe audit process and attends to the European Commission reen


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,'&', The audit process

)n planning a com0ination of audit o0jecti%es and the e%idence that need to 0e accumulated tomeet these o0jecti%es, the auditor 2ill follo2 an audit process. Elder et al. ("//, # definethe audit process as a 2ell'defined methodolog1 for organiing an audit to ensure thee%idence gathered is sufficient a competent and that all audit o0jecti%es are met.

$he audit process has four specific phases. )n -planning and designing an audit approach(phase )#, the clients 0usiness strategies and processes are studied. $he auditor assesses theris7 of misstatements in financial statements, and e%aluates internal controls and theireffecti%eness (Elder et al., "//, "#.

)n phase )) of the audit process, tests of controls and su0stanti%e tests of transactions areconducted. )n phase ))), anal1tical procedures and tests of details are performed. $he auditorassesses 2hether account 0alances or other data appear reasona0le and performs procedures totest for monetar1 misstatements in account 0alances. )n phase )@ at last, e%idence is com0inedand an o%erall conclusion concerning the financial statements is formulated (Elder et al.,

"//, 3#.

Audit ser%ices ha%e 0een changing rapidl1 since the earl1 ;;/s. Audit practices ha%e 0eene%ol%ing in response to gro2ing pu0lic epectations of accounta0ilit1 and to the compleitiesin economic and technological ad%ances implemented in 0usiness organiations. $he maingoal of a financial statement audit ho2e%er, is still to reduce the information ris7H the ris7 thatthe financial statement information ma1 0e inaccurate, incomplete or 0iased.


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Elder et al. ("//# distinguish four t1pes of audit reports:

Standard unqualified4hen the financial statements presented are free of material misstatements and arerepresented fairl1 in accordance 2ith the enerall1 Accepted Accounting


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)n de%eloping its standard audit report ("//=#, the )nternational Auditing and AssuranceStandards +oard ()AAS+# intended to increase the understanda0ilit1 of the auditors role and

of the auditors report. $he understanda0ilit1 of the auditors report should 0e impro%ed 01using simple language and 0eing concise, 2hile still aiming to 0e informati%e ()SC, "//;,=#.

4ith the implementation of )SA !//, effecti%e in 0ehalf of reports dated on or after ecem0er3, "//, the )AAS+ intends to pro%ide Bne2 2ording concerning the auditors report that

0etter eplains the respecti%e responsi0ilities of management and the auditor. $his updates thedescription of the audit process and the clarification of the scope of the auditors

responsi0ilities 2ith respect to internal controls ()AAS+, "//=#.

$he DK-s first auditing standard on auditor reporting 2as issued in ;9/ and re6uired theauditor to epress an opinion concerning the -true and fair %ie2 of the audited financialstatements.

After its formation in ;;, the Auditing


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+ecause of the -Clarit1 project, a project to impro%e the clarit1 of )SAs, completed inFe0ruar1 "//;, clarified )SAs ha%e released among 2hich )SA !// (&edrafted#, Forming an

)pinion, and *eporting on Financial (tatements.

Gational standards in the Getherlands are 0ased on )nternational Standards on Auditing. )nconse6uence of the re%ision of )SA !//, also national standard !// (*&A# had to 0ere2ritten. As from ecem0er >, "//, the audit report is called -controle%er7laring. $hisne2 title should 0etter reflect the nature of the 2or7 performed 01 the auditor, i.e., the-controle%er7laring as a resultant of the audit of financial statements.

$he ne2 form audit report contains the heading: -independent auditors report(controle%er7laring %an de onafhan7elij7e accountant#. $he addition of the 2ord-independent affirms that the auditor has met all of the ethical re6uirements regardingindependence and, conse6uentl1, distinguishes the independent auditors report from reportsissued 01 others.

,'- Form and contents standard audit report

$his paragraph continues on the standard audit report 01 descri0ing its form and contents,reflecting on 0oth the Dnited Kingdoms and the Dnited States latest issuances of )SA !//.

)SA !// is designed to esta0lish a ne2 form of the audit report, 2hich see7s to appro%e theeplanations on auditors responsi0ilities and the tas7 and scope of the audit. 4ith theimplementation of )SA !//, effecti%e for reports dated on or after 3 ecem0er "//, the)AAS+ intended to increase the understanda0ilit1 of the auditors role and of the auditors


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0# states that the financial statements ha%e 0een auditedHc# identifies the title of each statement that comprises the financial statements, for

eample a 0alance sheet, an income statement, a statement of changes in e6uit1 and acash flo2 statementHd# refers to the summar1 of significant accounting policies and other eplanator1

informationH ande# comprising the financial statements specifies the date or period co%ered 01 each

financial statement comprising the financial statements.

$anagement%s responsibility for the financial statements

$his section of the audit report descri0es the responsi0ilities of those in the organiation thatare responsi0le for the preparation of financial statements. $he audit report uses the term, foreample -management or -those charged 2ith go%ernance, that is appropriate in the contetof a particular legal frame2or7.

$he audit report descri0es managements responsi0ilit1 for the preparation of the financialstatements: -the preparation and fair presentation of financial statements. $he description

includes an eplanation that management is responsi0le for the preparation of the financialstatements in accordance 2ith the applica0le reporting frame2or7, and for such internalcontrol as it is necessar1 to ena0le the preparation of financial statements that are free frommaterial misstatement.

Auditor%s responsibility

$he audit report states that the responsi0ilit1 of the auditor is to epress an opinion on thefinancial statements 0ased on the audit and refers to the conduction of the audit in accordance


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Auditor%s opinion

Epressing an unmodified opinion on the financial statements, the auditors opinion is that the

financial statements are prepared, in all material aspects, in accordance 2ith Lthe applica0lereporting frame2or7. )f the reference to the applica0le reporting frame2or7 is no to)nternational Financial &eporting Standards ()F&S#, the auditors opinion identifies the

jurisdiction of origin of the frame2or7.

Other reporting responsibilities

)f the auditor addresses other reporting responsi0ilities in the audit report on the financialstatements, these other reporting responsi0ilities need to 0e addressed in a separate section in

the audit report.

Signature of the auditor

$he auditors signature is either in the name of the audit firm, the personal name of theauditor or 0oth, as appropriate for the particular jurisdiction.

&ate of the audit report

$he audit report is dated no earlier than the date on 2hich the auditor has o0tained sufficientappropriate audit e%idence on 2hich to 0ase the auditors opinion on the financial statements.

Auditor%s address

$he audit report names the location in the jurisdiction 2here the auditor practices.

$he latest %ersion of )SA !// as pu0lished 01 the A April "//;. See


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,'/ Shortcomings standard audit report

Concerning the form and contents of the audit report, as also the information content andeffecti%eness of auditors communications, se%eral studies are alread1 eplored (see chapter-re%ie2 of empirical research literature#. ne important 6uestion is 2hether the audit reportis effecti%e in communicating important information a0out for eample the audit process,auditors duties and -going concern and does satisf1 users information needs.

,'/'& Earl. criticisms short form audit report

$his section descri0es some of the earl1 criticisms regarding the effecti%eness of auditorcommunications.

Roth and 'est ()*+,-

)n ;9 N.8. &oth, chairman of the Committee on Auditing


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A#./A ()*,0-

Alread1 in ;!9, an earl1 indication of concerns a0out the effecti%eness of the audit report asa communication de%ice 2as epressed in a report of the Commission on Auditorsresponsi0ilities (CAH the -Cohen Commission (A)C


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$he audit report 2as criticied 0ecause of its ina0ilit1 ade6uatel1 communicate to its users theauditors function, the nature of the auditors 2or7 and auditors responsi0ilities. Go2ada1s,

concerns a0out the audit epectation'performance gap are still ali%e.

&egarding the form and the contents of the audit report, the %alue rele%ance of auditorscommunications, %arious studies ha%e alread1 0een eplored. )n the net chapter, se%eralstudies concerning the %alue rele%ance of the audit report 2ill 0e commented in more detail.


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-' "rior research on development audit report 1&435 6 *7742

$his chapter pro%ides an o%er%ie2 of the eisting empirical research literature concerning the%alue rele%ance of auditor communications.

-'& Value relevance standard audit report

Follo2ing the Cohen Commissions (;!9# recommendations for impro%ed communications0et2een auditors and financial statement users, the Auditing Standards +oard (AS+# of theA)C


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SAS Go. >9 introduced an epanded audit report, 2hich included:

a paragraph eplaining that the financial statements are the responsi0ilit1 ofmanagement and that the auditors responsi0ilit1 is to epress an opinion on thosefinancial statementsH and

a 0rief eplanation a0out the content of the audit process, and the limitationsconcerning this process.

)n response to the issuance of SAS Go. >9, a num0er of studies 2ere designed to in%estigatethe etent to 2hich the long form audit report met its o0jecti%es. $he re%ision of the auditreport, epanding 2ith additional paragraphs, led to concerns a0out the audit report 0ecominglong, comple, and less understanda0le.

)n ;;3, the )nternational Auditing


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)n order to test users perceptions regarding the auditors responsi0ilit1 (phase ))#, participants2ere gi%en a second 6uestionnaire. $he 6uestionnaire re6uired each participant to indicate the

nature of the change in the le%el of responsi0ilit1 that the auditor assumes 0et2een the oldreport and the SAS Go >9 report. $he 6uestionnaire included an audit report opposite to thereport the su0jects recei%ed in phase ) (Kell1 and Mohr2eis, ;9;, ;#.

$he authors found that 0an7ers and in%estors reading the ne2 report tended to agree thatmanagement 2as responsi0le for the presentation and disclosure in the financial statements.+ased on their research findings, the authors further conclude that the ne2 report enhancedusers understanding of the purposes of the audit.

Kell1 and Mohr2eis (;9;, ;># state that attention ma1 0e focused on impro%ing the message0eing communicated a0out the auditors responsi0ilit1. $he authors found participants to 0euncertain as to the nature of the auditors responsi0ilit1.

7ermanson et al8 ()**)-

)n -oes the ne2 audit report impro%e communication 2ith in%estors5 (;;#, &.*.

*ermanson, 9, *eports on audited financial statements. *ermanson etal. (;;# de%eloped a 6uestionnaire in order to determine 2hether the -ne2 audit reportimpro%es communication 2ith financial statement users. *ermanson et al. (;;, 3"#


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. a1 and 9 *eports on audited financial statements(;99#.

According to a1 and Schelluch (;;3, 3#, the o0jecti%e of the auditing standards 0oards in

0oth countries is to narro2 the differences 0et2een users and auditors %ie2s of the auditorspart in the financial reporting process. B$he ne2 long form audit report attempts to achie%ethis 01 ma7ing eplicit reference to the auditors role and responsi0ilities, the audit processand the le%el of assurance pro%ided 01 the audit.

$o esta0lish the impact of the re%ised audit report on users perceptions regarding the role ofthe auditor, the nature of the audit and the financial reporting process, a1 and Schelluch

(;;3# conducted a research among sophisticated users, shareholders and -reasona0l1intelligent non'in%estors. 9/ financial statement users too7 part in the research, including /senior 0an7'lending officers, selected from three national 0an7s, / in%estors, and / non'in%estors 2ith 0usiness 0ac7grounds. +oth in%estors and non'in%estors 2ere selected fromM+A students at Monash Dni%ersit1. Su0jects 2ere as7ed to read an eample of an auditreport and respond to a series of 6uestions 0ased on their understanding of the reports.

a1 and Schelluch (;;3, ;# concluded that the re%ised audit report has changed users


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$he Auditing # learned that financial statement users are in fa%or of aneplicit statement in the audit report of the auditors assessment of the -going concern status


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ifferent categories of sta7eholders met separatel1. # found that focus group participants

generall1 did not assume an un6ualified audit opinion indicates an1thing a0out the 6ualit1 ofinternal controls. Some focus groups ho2e%er, recommended that the 6ualit1 of the internalcontrols 0e eplicitl1 included in the auditors report.

Moc7 et al. ("//;, # call attention to the o%erall usefulness of the un6ualified audit report.&esearch results epressthat not all focus groups consider the audit report 2hen percei%ing acompan1s performance. +esides, 2hen eamining focus group results in detail, Moc7 et al.

0ecame conscious of a serious disconnect 0et2een 2hat auditors ma1 0elie%e the1 arecommunicating in an un6ualified auditors report and 2hat users infer from that report.

/orter et al8 (;


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9old et al8 (;


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Moc7 et al. ("//;, # recommend to define clearl1 the message the profession 2ishes tocommunicate 01 issuance of an un6ualified audit report and the le%el of assurance intended to

communicate in regard to the audit and the associated financial statements.

Concerning -epanded disclosure, the disclosure of matters found to 0e important to financialstatement users, Moc7 et al. ("//;, "# mention t2o topics to 0e 2orth1 of consideration:-materialit1, seeing that the le%el of assurance is confused 2ith the concept of materialit1 and-independence. Further research, for eample, should eamine the impact of disclosingadditional information on issues that ma1 potentiall1 affect user perceptions of auditorindependence and the corresponding le%el of assurance pro%ided 01 the audit.

Moc7 et al. ("//;, !# call attention to the importance of reporting on certain 0usiness ris7s,including the potential effect on the financial statements of significant ris7s and eposures anduncertainties that are disclosed in the financial statements. BSuch information could 0e ofinterest to financial statement users and should 0e eamined as to the usefulness to financialstatement users and the impact of such disclosures on users perceptions of the le%el ofassurance pro%ided 01 an un6ualified auditors report.

+ased on their research findings,


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Smieliaus7as et al. ("//9, ""# state that the audit report should communicate the results of anaudit process to 0est reflect the auditors state of 7no2ledge at the time the audit report is

dated. $he1 argue that the current 2ording of the standard audit report is deficient and that itsepression, -true and fair %ie2, is operationall1 defecti%e.

$he concept of ris7: -accepta0le ris7 of material misstatement as proposed in this article("//9, "=#, incorporates audit ris7s as 2ell as accounting ris7s. Accounting ris7s areassociated 2ith ma7ing predictions in estimates used in appl1ing AA


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$he Commission ("//, # notes that the statutor1 audit has e%ol%ed from su0stanti%e%erification of income, ependiture, assets, and lia0ilities to a ris7 0ased approach. $he

Commission 6uestions 2hether this creates an epectation gap and 2hether a -0ac7 to 0asicsapproach 2ould 0e desira0le.

According to the Commission ("//, 9#, the auditors responsi0ilities to communicate ma1 0ere%isited in order to impro%e the o%erall communication process. $he reen


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"he American Accounting Association

$he Auditing Standards Committee of the Auditing Section of the American Accounting

Association (AAA#, notes that the compleit1 and estimation uncertaint1 inherent in financialstatements ha%e changed dramaticall1 o%er the past fe2 decades. *o2e%er, the format offinancial statements, the nature of assurance pro%ided for accounting estimates, and content inthe auditors report ha%e changed %er1 little. 4ithout re%isions to the audit report, and thefinancial reporting models, the epectation gap 2ill 7eep increasing.

According to the AAA, more non'financial indicators, such as customer and emplo1eesatisfaction, should 0e audited and included in the financial reports. Auditors can use

nonfinancial measures to assess the reasona0leness of financial performance and, there01,help detect financial statement fraud.

"he '3A

$he G+A: the utch rnst ? @oung

)n discussions and interactions 2ith in%estors, Ernst T Roung lo0al 8imited, the central


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-'- The :!e ;it committee report 1


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/' utline of the empirical research

$he purpose of this research is to in%estigate the %alue rele%ance of the auditorscommunications. -@alue rele%ance implies the a0ilit1 of the auditors communications, i.e.,the audit report, in communicating effecti%el1 a0out the audit process, the responsi0ilities ofthe auditor, the nature of assurances pro%ided 01 the auditor and other items 2hich could 0eimportant in a decision'ma7ing process.

Effecti%eness 2ill 0e esta0lished 01 assessing users understanding of messages as containedin the audit report and identif1ing users needs and re6uirements regarding topics 2hich

should 0e attended to (more etensi%el1# in the audit report.

$his chapter pro%ides an outline of the empirical research. &esearch approach, t1pe ofresearch and the research strateg1H the research characteristics, are depicted. $his chapter alsodefines units of anal1ses and descri0es strategies of sample selection and data collection. Atlast, this chapter reports on the design of the 6uestionnaire (research instrument# and dataanal1sis.

/'&$haracteristics of the research

Research approach

Empirical research deri%es its data 01 means of direct o0ser%ation or eperiment. ata is usedto ans2er a 6uestion or to test a h1pothesis. $2o generall1 accepted approaches eist as to thedesign of an empirical research: 6ualitati%e research and 6uantitati%e research.


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"ype of research

According to +a00ie ("//!, 9!#, three of the most common and useful purposes of research

are eploration, description and eplanation. Eplorator1 studies are conducted to -eplore atopic. Eplorator1 research helps determine the 0est research design, data collection method,and selection of sample items. $he eplorator1 approach t1picall1 occurs 2hen a researchereamines a ne2 interest or 2hen the su0ject of the research itself is relati%el1 ne2.

)n eploring descripti%e research, the researcher o0ser%es and then descri0es 2hat haso0ser%ed. $he purpose of descripti%e studies is to identif1 patterns or trends in a situation, 0utnot the causal relationships 0et2een different elements. escripti%e studies help in generating

h1potheses on 2hich further research can 0e 0ased.

escripti%e studies ans2er 6uestions of 2hat, 2here, 2hen and in 2hich 2a1, eplanator1studies of 2h1. Conducting eplanator1 research, the researcher goes 0e1ond merel1descri0ing characteristics, to anal1e and eplain 2h1 and in 2hich 2a1 something ishappening. $he purpose of eplanator1 studies is to identif1 and measure causal relationshipsamong phenomena.

$he nature of this research could 0est 0e descri0ed as -eplorati%e. $he purpose of theresearch is to learn a0out financial statement users conception and understanding of certainmessages in the audit report, i.e., to identif1 and descri0e the %alue rele%ance of )SA !//un6ualified audit reports.

Research strategy

@erschuren en oore2aard ("//!, # distinguish fi%e main research strategies:


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A financial statement audit is conducted to enhance the degree of confidence of intendedusers in the financial statements. ecision ma7ers use the audited information on theassumption that it is reasona0l1 complete, accurate, and un0iased. +ecause the audit reportrepresents the auditors communications of findings to financial statement users, such a reportis considered an essential tool in e%aluating companies performances and creating in%estmentdecisions.

Concerning the purpose of this research, and considering the information 0efore, is decided

that -in%estors 2ill form a major part of the sample. @arious groups of financial statementusers 2ill use and anal1e the audit report from different points of %ie2H conse6uentl1, it isessential to engage different sta7eholders. )n forming conclusions, in%estors, as 2ell as

0an7ers and financial anal1sts, practice different ideas and perspecti%es.

/',Sampling and data collection

)n paragraph >.", units of anal1ses ha%e 0een identified. $his paragraph descri0es in 2hich2a1 different target groups 2ill 0e approached and eemplifies the sampling method andsample sie.

$arget group -in%estors, the pro%iders of ris7 capital, is considered to 0e the principal class offinancial statement users. )n%estors could 0e institutions, e.g., insurance companies and

pension funds, or pri%ate in%estors. )n%estors 2ill 0e addressed through -professionalrepresentati%es, li7e fund managers (asset management#, pension funds and insurance


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)n this research, determining the actual sie of the population (financial statement users# 2ill

0e practicall1 impossi0le. Conse6uentl1, it is not possi0le to select random samplesHpro0a0ilit1 samples of different groups of financial statement users. $he actual selection ofsample elements 2ill 0e non'random.

Go pro0a0ilit1 sampling is an1 sampling method 2here the pro0a0ilit1 of the selection cannot0e accuratel1 determined. $he sampling method in this research that could 0est 0e applied is-a%aila0ilit1 sampling (con%enience sampling#. A%aila0ilit1 sampling is a method ofchoosing sample'elements 2ho are a%aila0le or eas1 to find.

)n gathering compan1 information and addressing potential sample participants, the data0aseof $ompan.info2ill 0e used.

$o 0e a0le to address research data in a 6uantitati%e manner, and to perform statisticalanal1ses, it is decided to o0tain 6uantified data. According to e @ocht ("//;, ">#, astatistical sample includes a num0er of o0ser%ations of minimal 3/.

Forming a sample, as much as possi0le potential participants should 0e approached. Mostpro0a0l1, a great part of the participants as gathered in the first instance 2ill not actuall1participate (non'response#.

/'->uestionnaire design and data anal.sis

)n eamining respondents opinions and interpretations regarding messages in the audit


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+ased on the completed 6uestionnaires, especiall1 the response to the statements on audit

reports, 6uantitati%e data 2ill 0e o0tained. uantitati%e data 2ill 0e anal1ed using a6uantitati%e statistic program (S


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3' Research results and anal.ses

$his chapter presents the results of the empirical part of this research. $he first paragraphcontains an outline of the 6uestionnaire results (appendi 3#. $he second paragraph pro%ides a6ualitati%e assessment of the research results.

3'& The results of the ?uestionnaire

$his paragraph pro%ides an outline of the sample results concerning financial statement usersunderstanding of the messages contained in the audit report. A schematic o%er%ie2 of theresearch results per 6uestion is presented in appendi 3.

3'&'& The research respondents

$he research 2as conducted among different groups of financial statement users, i.e.,institutional in%estors, 0an7 lenders, and financial anal1sts.

@arious user groups ha%e different approaches in processing information and economicdecisions. $he role of the financial statements and the accompan1ing audit report di%ergeaccording as the nature of decision'ma7ing, for eample, in%estment decisions, lending ris7assessments, and %aluation. ifferent perspecti%es la1 the foundation in forming conclusions.

espite of the purpose of using financial statement information, all of the intendedrespondents are professional users 2ho rel1 on financial statements to help them in theirdecision'ma7ing. +ecause it represents the auditors communications of findings 2ith respect


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Ta#le 3'& (ranch of industr.

Fre6uenc1


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Ta#le 3'- (ranch of industr. vs' (ig - report preference

+ig = report preference

$otalRes Go

+ranch of industr1 Asset management > 9 3

)nsurance compan1 " " =


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;/Q of the respondents (3!Q agree and >3Q strongl1 agree# affirm the statement: -$heun6ualified audit report implies that the audited financial statements present a true an fair

%ie2 of the compan1s financial position as at ecem0er 3, "/U and of its financialperformances and cash flo2s for the 1ear then ended.

Figure 3'* audit report 6 general

&esearch results sho2 that respondents are in disharmon1 2hen percei%ing the statement ongoing concern. Figure ." sho2s that a third of the respondents 0elie%e that an un6ualified


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$a0le .> re%eals respondents responses to the going concern statement 01 comparison 2ith0ranches of industr1. $he greater part of the asset managers do not agree 2ith the statement

on going concern.3'&', The nature and scope of the auditors 0or)

Figure 3', the nature and scope of the auditors 0or)


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report in communicating on audit procedures and the application of auditing standards.

3'&'- The audit opinion

$he un6ualified audit report concludes on the financial statements to present a true and fair%ie2 of the financial position of the reporting entit1 and of its financial performance. $heauditors responsi0ilit1 is to perform the audit to o0tain reasona0le assurance a0out 2hetherthe financial statements are free from material misstatement

Almost 9!Q of the respondents disagree or strongl1 disagree 2ith the follo2ing statement:

-$he audit report implies that the audited financial statements are free of material error.

$he research results further epress that 93Q of the respondents agree or strongl1 agree thatthe audit report clearl1 indicates the le%el of assurance pro%ided concerning the audit opinionon financial statements. &espondents interpreted the audit report as to eplain that an audit2as designed to pro%ide reasona0le, 0ut not a0solute assurance, that the financial statementsare free of material misstatements.

Ta#le 3' #ranch of industr. versus #asis of audit opinion

$he audit opinion: 0asis of the audit opinion is clearl1

communicated in the audit report

$otal

Strongl1

agree Agree

Geither agree

nor disagree isagree

Strongl1

disagree


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Figure 3'- the audit opinion

)t appears that respondents are dou0tful concerning the role of judgment in the formation ofan audit opinion. Almost half of the respondents disagrees that the audit report clearl1indicates the role of judgment in the formation of the audit opinion.

$a0le .9 presents the comparison of respondents responses to the statement on professionaljudgment, in comparison 2ith 0ranches of industr1.


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Ta#le 3'4 #ranch of industr. versus auditors responsi#ilities in relation to fraud

$he audit report clearl1 communicates the auditors

responsi0ilities in relation to fraud

$otalAgree

Geither agree

nor disagree isagree

Strongl1

disagree

+ranch of

industr1

Asset management / 3

)nsurance compan1 " " / / =


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3'&'3 $larified ISAs

Figure 3'3 clarified ISAs

)n the Getherlands, as from ecem0er >, "//, the audit report is called -controle%er7laring.$his ne2 title should 0etter reflect the nature of the 2or7 performed 01 the auditor, i.e., the-controle%er7laring as a resultant of the audit of financial statements.


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3'&' $hanges or additions to the audit report

Figure 3' revision of the audit report 6 :going concern

As is sho2n in figure .!, 9/Q of the respondents agree that the audit report should contain aneplicit statement of the auditors assessment of the -going concern status of the client.Almost =Q of the respondents neither agree nor disagree the audit report to contain astatement on the going concern status of the client, and Q disagree 2ith this assertion.


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39Q of the respondents agree that the auditor should report the etent to 2hich he relied onthe internal controls. Another great part of the respondents (3>Q# neither agrees nor disagrees2ith the statement on internal control. $he respondents do not ha%e an opinion on, or do notunderstand the role of internal control in the practice of auditing.

3'* Anal.Bing the research results

$his paragraph contains the 6ualitati%e anal1ses of the research results, presented in paragraph.. )n this paragraph, the research results 2ill 0e interpreted. $his part of the research isaimed at understanding the respondents understanding of the audit report, and their %isions

concerning the contents of the current form audit report, and possi0le changes or additions tothe audit report.

3'*'& Audit report 8 general

As is presented figure ., respondents do agree that the audit report enhances the credi0ilit1of the financial statements. )n addition, the greater part of the respondents is of the opinionthat in the audit report the purpose of the audit is clearl1 communicatedH conse6uentl1, therespondents are ac6uainted 2ith the role and the purpose of the audit. $he respondentssupport the rele%ance of the audit report to represent an un6ualified opinion on the financialstatements.

$he greater part of the respondents does not agree 2ith the statement on going concern.&espondents are of the opinion that an un6ualified audit report does not necessaril1 %ouch forthe entit1s a0ilit1 to continue as a going concern. $his ma1 impl1 respondents demand for


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$he remaining part of the respondents 2ho neither agree nor disagree, or 2ho disagree 2iththe statements on the nature and scope of the auditors 2or7 dou0t the understanda0ilit1 of theaudit report. &espondents ma1 re6uire more transparenc1 into the audit process and 2hat theauditor has performed to o0e1 his responsi0ilities. &esearch results here ma1 indicate theeistence of an -information gap 0et2een the information that in%estors need to realieinformed in%estment decisions and the information that is disclosed.

3'*', The audit opinion

$he auditors responsi0ilit1 is to perform the audit to o0tain reasona0le assurance a0out

2hether the financial statements are free from material misstatement. $he greatest part of therespondents understands that the audit report does not impl1 the audited financial statementsto 0e free of material error. +ased on this it could 0e concluded that the audit reporteffecti%el1 communicated the le%el of assurance pro%ided 01 the audit, that is, the auditordoes not guarantee the correctness of the financial statements.

Ge%ertheless, it is surprising that such a great part of the respondents is s7eptical as to thecorrectness of the financial statements. &espondents ta7e into account the financial statementsto contain mista7es or misstatements, despite the audit, 2hich ser%es the purpose of addingcredi0ilit1 to the financial statements. $he %alue rele%ance of performing audit procedurescould 0e dou0ted.

$he last phrase of the section -Auditors responsi0ilit1 in the audit report states 2hether theauditor 0elie%es that the audit e%idence as o0tained 01 the auditor is sufficient and appropriateto pro%ide a 0asis for the auditors opinion. +ased on ta0le . could 0e deducted that the


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pposite, the judgmental process in%ol%ed in performing an audit is comple and ma1 notha%e to 0e con%e1ed in detail. +esides, a re6uirement for auditors to pro%ide a narrati%e auditreport, including a description of the 2or7 performed and judgments used, ma1 raise concernsthat audit firms 2ould 0e re6uired to disclose proprietar1 information.

3'*'- The auditor and auditors responsi#ilities

As stated in the audit report, the auditors responsi0ilit1 is to epress an opinion on thefinancial statements. According to the research results, respondents clearl1 understood thisstatement of the audit report. $his statement on auditors responsi0ilit1 ho2e%er, does not

propose an approach concerning the auditors responsi0ilit1 in relation to fraud.

$he audit report pro%ides little information on the auditors responsi0ilit1 in relation to fraud.$he section -Auditors responsi0ilit1 in the audit report states that the audit proceduresselected depend on the auditors judgment, including the assessment of the ris7s of materialmisstatement of the financial statements, 2hether due to fraud or error. Fraud is attended to as

part of the auditors ris7 assessment procedures.

)nternational Standard on Auditing ()SA# "=/ deals 2ith the auditors responsi0ilities relatingto fraud in an audit of financial statements. )SA "=/ states that the primar1 responsi0ilit1 forthe pre%ention and detection of fraud rests 2ith those charged 2ith go%ernance of the entit1and management.

Concerning the responsi0ilities of the auditor, )SA "=/ postulates: -An auditor conducting anaudit in accordance 2ith )SAs is responsi0le for o0taining reasona0le assurance that the


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$he principle of o0jecti%it1 imposes an o0ligation on all professional accountants, amongstothers, not to compromise their professional or 0usiness judgment 0ecause of 0ias, conflict ofinterest, or the undue influence of others.

$he research results re%eal the greater part of the respondents to 0e positi%e concerning theauditors professional 0eha%ior. $he audit report appoints that the auditor 0e re6uired tocompl1 2ith the ethical re6uirements. $he audit report ho2e%er, further does not attend to thecontent and the application of the ethical re6uirements. $he research results ma1 indicate thatrespondents are alread1 familiar 2ith the concept of the auditor independence, and theauditors social responsi0ilit1.

A great part of the respondents trusts the auditor to act in the pu0lic interest, 2hich is animportant solution. According to the hand0oo7 of the code of ethics ()FAC, "//#,independence of mind and in appearance is necessar1 to ena0le the professional accountant in

pu0lic practice to epress a conclusion, and 0e seen to epress a conclusion, 2ithout 0ias,conflict of interest, or undue influence of others.

$he o0jecti%e of the auditH to enhance the credi0ilit1 of the financial statements, could onl1 0erealied if the users of the financial statements 0elie%e the auditor is o0jecti%e and un0iased.)ndependence is fundamental to the relia0ilit1 of the audit report. Audit reports 2ould not 0ecredi0le, and in%estors and creditors 2ould ha%e little confidence in them, if auditors 2ere notindependent in 0oth fact and appearance.

3'*'/ $hanges or additions to the audit report


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)n the -audit opinion ? section of this chapter, it has alread1 0een raised that the audit reporteffecti%el1 communicates the le%el of assurance pro%ided 01 the audit. &espondents correctl1interpreted the audit report as to eplain that an audit 2as designed to pro%ide reasona0le, 0utnot a0solute, assurance that the financial statements are free of material misstatements. $heauditor does not guarantee the correctness of the financial statements.

Although the respondents seem to understand that auditors do not audit e%er1thing to e%er1penn1, the1 ma1 not understand the le%el of assurance related to the concept of materialit1.

Misstatements, including omissions, are considered to 0e material if the1, indi%iduall1 or

ta7en together, could reasona0l1 0e epected to influence the economic decisions of usersta7en 0ased on the financial statements ()SA 3"/#. $he auditor applies the concept ofmaterialit1 0oth in planning and in performing the audit, and in e%aluating the effect ofidentified misstatements on the audit and of uncorrected misstatements, if an1, on thefinancial statements and in forming the opinion in the auditors report.

$hroughout the audit, materialit1 is considered, in particular 2hen )dentif1ing and assessing the ris7s of material misstatementH etermining the nature, timing and etent of further audit proceduresH and E%aluating the effect of uncorrected misstatements, if an1, on the financial statements,

and in forming the opinion in the auditors report ()SA 3"/#.

isclosure of the materialit1 le%els might pro%ide guidance to users of the etent to 2hich thefinancial statements could potentiall1 0e misstated. )t pro%ides the 6uantitati%e contet in2hich the auditor has arri%ed at his opinion that the financial statements present a true and fair


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' $onclusions

$his chapter contains a recapitulation of the research, and pro%ides an ans2er to the mainresearch 6uestion. $he research results are compared 2ith the results of prior research and therecommendations of, and responses to, the European Commission reen


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$his masters research 2as aimed at understanding the effecti%eness of auditorscommunications, that is, the -%alue rele%ance of the audit report. $his research assessed theeffecti%eness of the audit report in communicating on the audit process, the auditorsresponsi0ilities, and the nature of assurances pro%ided.

$he main research 6uestion 2as formulated as follo2s:

What is the value relevance of the auditors communications, i.e., does the audit report

enhance the financial statement users understanding of the auditors duties, the audit

process, assurances provided and other important topics, or is additional and / or other

information required in facilitating a decision-making process?

+ased on the research results could 0e concluded that the respondents did understand the 7e1messages of the audit report:

$he un6ualified audit report implies that the audited financial statements present a truean fair %ie2 of the compan1s financial position as at ecem0er 3, "/U and of itsfinancial performances and cash flo2s for the 1ear then endedH

$he auditors responsi0ilit1 is to epress an opinion on the financial statements 0asedon the auditH

$he auditor does not guarantee the correctness of the financial statementsH and $he auditor o0tained sufficient and appropriate to pro%ide a 0asis for the audit

opinionH

$he results re%eal that the greater part of the respondents do agree that the audit report


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'*'& European $ommission 9reen "aper on Audit "olic.

)n chapter = of this thesis, the -European Commission reen


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Eamining the financial statement users understanding of the messages con%e1ed in astandard un6ualified audit report,


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', %imitations

$he major research limitation of this masters research 2as the failure to collect data that2ould 1ield a 6uantitati%e assessment of the financial statement users interpretation ofcertain messages in the audit report.

$he design of this research is not capa0le for 0ringing up reasona0le pronouncementsconcerning a population. Go pro0a0ilit1 sampling is used to dra2 a population sample. A no

pro0a0ilit1 sample ma1 not represent the population 2ell. Moreo%er, statistical or parametrictests are onl1 meaningful for data, 2hich is sampled from a population 2ith an underl1ing

normal distri0ution (e @ocht, "//;, ">#. $he sample results for all 6uestionnaire statementsdo not approimate to a normal distri0ution.

)t is impossi0le to determine the actual sie of different groups of financial statement usersand conse6uentl1 it is not possi0le to select random samplesH pro0a0ilit1 samples of thesegroups. )nformation a0out the relation 0et2een the sample and population is limited, 2hichma7es it difficult to etrapolate from the sample to the population.

'- Recommendations

Considering the limitations of this masters research, in order to effecti%el1 in%estigate thefinancial statement users understanding of the audit report, and the effecti%eness of the auditreport in communicating on the audit process, the auditors responsi0ilities, and the nature ofassurances pro%ided, further research should 0e performed


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)n cto0er "//, the European Commission launched a pu0lic consultation on audit polic1,see7ing %ie2s from sta7eholders and the 0roader pu0lic on a range of issues related to thestatutor1 audit. $he consultation closed on the 9th of ecem0er, almost !// responses 2ererecei%ed. As the 1ear progresses, it is epected that the Commission 2ill decide on the needfor an1 measures as a follo2'up to the reen


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onaldson, 8. and N.*. a%is (;;#, Ste2ardship theor1 or agenc1 theor1: CE go%ernanceand shareholder returns,'ustralian Cournal of Eanagement, @ol. , Go., pp. =;'>

Eilifsen, A., 4.F. Messier Nr, S.M. lo%er, and .4.


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)FAC ("//;#, )nternational Standard on Auditing "=/, the auditors responsi0ilities relating tofraud in an audit of financial statements, http0//we!.ifac.org/download/a:19-9:1:-iaas!-hand!ook-isa-96:.pdf

)FAC ("//;#, )nternational Standard on Auditing 3"/, materialit1 in planning and performingan audit, http0//we!.ifac.org/download/a:14-9:1:-iaas!-hand!ook-isa-B9:.pdf

)FAC ("//#, *and0oo7 of the code of ethics for professional accountants,http0//we!.ifac.org/pu!lications/international-ethics-standards-!oard-for-accountants/code-

of-ethics

Nensen, M.C. and 4.*. Mec7ling (;!#, $heor1 of the firm: managerial 0eha%iour, agenc1costs and o2nership structure,Cournal of Financial conomics, @ol. 3, Go. =, pp. 3/>'3/

)SC $echnical Committee ("//;#, Auditor communications: consultation report,http0//www.ifac.org/#''(G/%ro@ect::2A

)CAE4 ("//!#, Auditor reporting paper, http0//www.icaew.co.uk/indeJ.cfm?route>16623:

Kell1, A.S. and 8.C. Mohr2eis (;9;#, +an7ers and in%estors perceptions of the auditorsrole in financial statement reporting: the impact of SAS Go. >9, 'uditing0 ' Cournal of

%ractice "heor, @ol. ;, Go. , pp. 9!';!

8imperg )nstitute, ;3" (;9>#, $he social responsi0ilit1 of the auditor. A 0asic theor1 on theauditors function, 01


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/

S2an0orn,


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Appendi@ &C illustrations on audit reports

Illustration &C comparison of old form and ne0 form 1SAS No' /52 auditreport

M t h A ti A diti d C t l -$h l l f dit i ti


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Illustration *C ISA 77 :Forming an opinion and reporting on financial statements

IN!E"EN!ENT AU!ITRS RE"RT

LAppropriate Addressee

Report on the Financial Statements

4e ha%e audited the accompan1ing financial statements of A+C Compan1, 2hich comprisethe statement of financial position as at ecem0er 3, "/U, and the statement ofcomprehensi%e income, statement of changes in e6uit1 and statement of cash flo2s for the

1ear then ended, and a summar1 of significant accounting policies and other eplanator1information.

Eanagements*esponsi!ilit for the Financial (tatementsManagement is responsi0le for the preparation and fair presentation of these financialstatements in accordance 2ith )nternational Financial &eporting Standards, and for suchinternal control as management determines is necessar1 to ena0le the preparation of financialstatements that are free from material misstatement, 2hether due to fraud or error.

'uditors *esponsi!ilit

ur responsi0ilit1 is to epress an opinion on these financial statements 0ased on our audit.4e conducted our audit in accordance 2ith )nternational Standards on Auditing. $hosestandards re6uire that 2e compl1 2ith ethical re6uirements and plan and perform the audit too0tain reasona0le assurance a0out 2hether the financial statements are free from materialmisstatement.

M t h A ti A diti d C t l -$h l l f dit i ti


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)pinion

)n our opinion, the financial statements present fairl1, in all material respects, (orgive a trueand fair view of# the financial position of A+C Compan1 as at ecem0er 3, "/U, and (of#its financial performance and its cash flo2s for the 1ear then ended in accordance 2ith)nternational Financial &eporting Standards.

Report on ther %egal and Regulator. Re?uirements

LForm and content of this section of the auditors report 2ill %ar1 depending on the nature ofthe auditors other reporting responsi0ilities.

LAuditors signature

Late of the auditors report

LAuditors address

Masters research Accounting Auditing and Control -$he %alue rele%ance of auditors communications


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Illustration ,C ISA 1UD and Ireland2 77 1revised2

IN!E"EN!ENT AU!ITRS RE"RT T TE MEM(ERS F GH "%$

4e ha%e audited the financial statements of (name of entit1# for the 1ear ended ... 2hichcomprise the financial statements, such as the Statements of Financial


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Master s research Accounting, Auditing and Control $he %alue rele%ance of auditors communications

Dnder the Companies Act "//, 2e are re6uired to report to 1ou if, in our opinion:

ade6uate accounting records ha%e not 0een 7ept, or returns ade6uate for our audit ha%enot 0een recei%ed from 0ranches not %isited 01 usH or

the parent compan1 financial statements and the part of the irectors &emuneration&eport to 0e audited are not in agreement 2ith the accounting records and returnsH or

certain disclosures of directors remuneration specified 01 la2 are not madeH or 2e ha%e not recei%ed all the information and eplanations 2e re6uire for our audit.

Dnder the 8isting &ules, 2e are re6uired to re%ie2:

the directors statement in relation to going concernH and the parts of the Corporate o%ernance Statement relating to the compan1s

compliance 2ith the nine pro%isions of the L"// LNune "//9 Com0ined Codespecified for our re%ie2.

LSignatureNohn Smith (Senior statutor1 auditor#for and on 0ehalf of A+C 88


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Illustration -C controlever)laring #i+ een +aarre)ening 1Standaard 772

Koor!eeldtekst !etreft @aarrekening op !asis van "itel 2 Goek 9 GW

$NTR%EVERD%ARIN9 VAN !E NAFANDE%IDE A$$UNTANT

Aan: pdrachtge%er

Ver)laring #etreffende de +aarre)ening

4ij he00en de in dit rapport opgenomen jaarre7ening "/U (of %oor een ge0ro7en 0oe7jaar:

%oor het jaar eindigend op 3/ juni "/U# %an ... (naam entiteit(en## te ... (statutaire%estigingsplaats# gecontroleerd. ee jaarre7ening 0estaat uit de 0alans per 3 decem0er"/U en de 2inst'en'%erliesre7ening o%er "/U met de toelichting, 2aarin ijn opgenomeneen o%ericht %an de gehanteerde grondslagen %oor financiVle %erslagge%ing en anderetoelichtingen.

Verant0oordeli+)heid van het #estuur

*et 0estuur %an de entiteit is %erant2oordelij7 %oor het opma7en %an de jaarre7ening die het

%ermogen en het resultaat getrou2 dient 2eer te ge%en, alsmede %oor het opstellen %an hetjaar%erslag, 0eide in o%ereenstemming met $itel ; +oe7 " %an het in Gederland geldende+urgerlij7 4et0oe7 (+4# . *et 0estuur is te%ens %erant2oordelij7 %oor een odanige interne

0eheersing als het nooda7elij7 acht om het opma7en %an de jaarre7ening mogelij7 te ma7enonder af2ij7ingen %an materieel 0elang als ge%olg %an fraude of fouten.

Verant0oordeli+)heid van de accountant


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Masters research Accounting Auditing and Control -$he %alue rele%ance of auditors communications


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Appendi@ *C ?uestionnaire on ISA 77 un?ualified audit reports

ear participant,

+1 means of this preliminar1 letter, ) 2ould li7e to re6uest 1ou to ta7e part in this researchproject, 2hich is 0eing underta7en as part of the Masters degree program -Economics and+usiness of the Erasmus School of Economics.

$his research project is focusing on the -%alue rele%ance of auditors communications. $he

purpose of this research is to in%estigate the %alue rele%ance of audit reports, that is, thea0ilit1 of audit reports in communicating effecti%el1 a0out the audit process, managementsand auditors responsi0ilities, the nature of assurances pro%ided 01 an auditor and other topics2hich could 0e important in economic decision'ma7ing. )n addition, %alue rele%ance 2ill 0eesta0lished 01 assessing the changes to audit reports that financial statement users consider2ould ma7e the reports more useful.

n the follo2ing pages, 1ou are presented an eample audit report ta7en from )SA !//Forming an opinion and reporting on financial statements. Rou are as7ed to respond to ase%eral 6uestions and statements, 0ased on 1our understanding of the audit report.


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E@ample audit report & 8 IAAS(ISA 77

m924-kaars sijpesteijn_336762

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