Value of audit: Toronto

The importance of the audit profession sticking to the basics and doing the fundamentals well was a
major theme at the fourth economia Value of Audit roundtable in association with KPMG, which took
place in Toronto earlier this month. Chaired by economias editor-in-chief, Richard Cree, and hosted by
KPMG Canada, the discussion included input from senior local and international KPMG staff, as well as
representatives of all the other major stakeholders in the audit debate, including CFOs and other
directors, audit committee chairmen, investors and regulators

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Strongly influenced by the risk-averse US market, the Canadian profession is more cautious than other markets that
have hosted discussions (you can find all discussions here) and there was a less open reception for ideas such as
expanded auditor reporting or offering assurance over forward-looking elements of the corporate report.

If the auditors start to get into areas they're not skilled, capable or trained to do, they're
going to dilute the real value of the system, which is integrity of the financial statements
Head of audit for KPMG Canada, John Gordon, explained the local context, saying that while Canada may not have
been at the heart of recent events, neither was it immune from the pressures that they have created: While there are
major trends or events that have led to discussions, like this, around the world, Canada wasnt at the epicentre of
them. But nor are we immune. Whether thats the financial crisis or some responses to it, like audit reform in EU, we
are hearing audit committees and management ask what it means. They are asking about the role of auditors,
whether it could be broader, given the skills and experiences we have and the information we have access to.
Former KPMG partner and audit committee chairman, Axel Thesberg, concurred: Canada is unique. Were close to
the US and a lot of regulation is patterned off the US. But we approach issues and opportunities differently. We get
regulators, firms and clients sitting together to talk through these questions. We ask what can the profession do in
Canada to enhance financial reporting or audit. That has led to discussion on whether you can do much about the
value of audit, unless you ask questions about the relevance of financial reporting.
For Stan Magidson, president and CEO of the Institute of Corporate Directors, this made in Canada approach has
led to a good corporate governance structure. We have a healthy state of corporate governance, by global
standards. Im a believer that regulation for the sake of regulation is a result of the failure of capital markets to work
effectively.
Talk of extending the role of audit caused concerns, with many agreeing with Ian Bourne, board director and audit
committee chairman for some of Canadas largest organizations, who said: I think the real value of audit is in
ensuring the system has got the integrity and is functioning. My sense is that if the auditors start to get into areas
they're not skilled, capable or trained to do, they're going to dilute the real value of the system, which is integrity of the
financial statements.
As chief accountant of the Ontario Securities Commission, Cameron McInnis was clear his priority was protecting
investors: My fundamental concern is making sure the system is reliable and that investors can rely on the audit
report, he said. Its interesting to hear talk about other activities auditors detracting or diluting the value of the audit,
from an investor standpoint. Investors rely on the auditor as an important gatekeeper, to make sure financial
statements are sound and that they can rely on the report. The further we get into other areas, I worry about
detracting from that focus. It is such a fundamental piece of decision-making for investors. Sometimes there is too
much focus on forward-looking information. This information is based on the historical aspects of the business, and
making sure that information is valid, means you can build the forward-looking information. Another investor
representative present was Scott Lawrence, managing director and head of relationship investments, at the Toronto
Office of the Canadian Pension Plan Investment Board. He concurred on the importance of the fundamentals of
audited historical financial statements:
Trust in the system and financial statements is absolutely essential. Investment decisions shouldnt be made solely
on forward-looking information. Its easy to project all kinds of hockey stick financials. Those who ignore history are
doomed to repeat it. If you dont look back and see how a company generates cashflow, if you don't have trust in the

systems, if it doesnt hold together, you shouldnt invest. Audit is an integral part of the financial system, so that we
have financials that communicate information for investors to make critical decisions.
Bourne was also vocal on the role played by audit committees. The whole key to success here is that the audit
committee needs to be an active participant in the system of checks and balances, the assessment of the quality of
the audit. Part of this exercise of assessing the value of the audit is making sure were getting what we pay for, that
were not getting stuff we dont need or cant use and that the people doing the work know what that theyre doing.
Glen Fagan, vice-president at Canadian Public Accountability Board, agreed that audit committees are crucial: Were
taking a more holistic approach to regulation. As part of the solution, we see audit committees having a big role to
play. It is important audit committees have a good understanding of audit quality and what that means, and why they
should be concerned about it.
There was less certainty as to what we mean by audit quality and how it is measured. For many, this remains a
continuing difficulty and something the profession has struggled with. Fagan claimed he hadnt ever seen a really
good definition of audit quality, while Karyn Brooks, board director at Financial Executives International Canada and
former VP finance at Bell Canada, denied there was any single measure. I don't think there is a real measure of audit
quality, she said. You get a different answer, depending who you ask. If you ask the management or if you asked
the chairman, youre going to get a different answer about the quality of the audit and who is accountable for it.
Bourne added that audit committees werent good at assessing quality. Its partly because in many cases audit
committees are only now starting to figure out what an audit firm does. Theyve never thought about it. They look at
the fee structure, which is usually negotiated with management. Now were at a point where audit committees have to
satisfy themselves theyre paying an appropriate amount for what theyre getting and that theyve got a basis for
approving it. Which comes back to is the question of whether the audit plan is properly structured in the first place.
Does it display an understanding of the business, are the auditors looking in the right places? If the plans okay, did
they follow it and react to changes?
McInnis raised the difference between the quality of any specific audit and the wider concept of audit quality: Talk
about audit quality gives me a headache, because its been discussed for so long. Is audit quality the same as a
quality audit? A quality audit is fundamental for investors to rely on a set of financial statements. But audit quality
means something beyond that.
On the upside, McInnis added that were getting better at measuring audit quality globally. Oversight bodies are
doing a good job of figuring it out more consistently. Its back to standard setting and execution. Are the standards
clear and robust enough, so that auditors can apply them appropriately? Are they executing well?
Magidson agreed with Bournes point on sticking to a plan: I like Ians focus on getting the right audit plan for a
business and holding people accountable for delivery of that plan. There is clearly a role for audit committees to get
the right outcomes. But I don't think audit committees should be expected to take responsibility for ensuring audit
quality in general is enhanced. Directors have a full-time vocation looking after their business. But if each audit
committee does what it needs to do to get a good quality audit outcome, the macro effect is cumulative.
One obvious answer to the question of how we measure audit quality is the annual reviews of oversight bodies. But
as Brooks suggested one problem here is that they often appear to focus on the negative. Once its issued, the
audience focuses on the negative. Its not a balanced view.
Bourne, who assists in the CPAB review, disagreed, explaining that while the nuance in the report might be lost on
some, the report included specific wording as to the positive state of the audit market in Canada. We actually say the
standard of auditing in Canada is OK. Thats a very important statement, and is not said lightly. There are negatives
picked out, but the core message is you can count on the audit function.
The group dismissed the notion that audit quality would be enhanced by recent EU reforms and increased pressure
for more frequent tendering, or mandatory rotation. Lawrence explained: I would say its a nice academic and
theoretical idea to rotate firms. But there are alternative solutions to changing firms. Additional review, professional
standards and training and increasing the sophistication by which systems are reviewed, there are a whole lot of
other things that I think investors worry about more, in terms of quality of audit, than independence. Its a bit of a red
herring. Its easy to talk about changing auditors, its easily fixed, but I dont think it addresses the root of what
investors worry about.
Fagan expressed concern that the outcome may be worse: Im concerned about simplistic solutions being proposed
to complex problems. It's only a matter of time before there is going to be a failure that occurs just because youve
changed auditors, and thats going to send people scuttering around.
This led back to the idea that improved quality could come from an extended report. Recent changes to the UK
standards, were explained by Mark Vaessen, global head of IFRS at KPMG: The requirement in the UK is that

auditors have to talk about the significant risk areas you see for your audit, and how you have addressed them, in
terms of procedures, and the details. KPMG has gone further with a pilot with some clients, including Rolls Royce,
where we also report findings. And the investor community has responded positively.
Bourne wasnt keen on the idea. The transparency of what went into the audit is important. But if were talking about
more than that, all of a sudden the burden on the company and auditors becomes significant. The liability side of this
is something most of us underestimate until we're in the middle of a lawsuit.
Magidson concurred: I would be careful seeking an expansion of reporting by auditors, precisely for the liability
reason. If youre going to move into this area, it seems to me you would want the benefit of disclaimers and safe
harbours.
Thesberg was concerned what this expanded report was meant to achieve. This question of using the auditor to
communicate something about the company is indicative of companies not communicating themselves. Its the job of
the company to explain to investors their financial position and risks. To use the auditor as a surrogate for information
youre failing to get out is misguided.
McInnis was less concerned than others by this expansion: When the expanded audit report started to be discussed,
I was sceptical of what it would produce. Now Im more open-minded. My scepticism was whether this was just going
to produce more information investors will have to sift through and add to concerns about too much information. Does
anyone really need to know this information about the areas of the audit? But Im open-minded and wait for the
outcomes of how stakeholders react. But I havent fully drunk the Kool-Aid.
Larry Bradley, global head of audit at KPMG International, agreed that the debate is just beginning and cited the
example of the recent Tesco in the UK: The media initially questioned the audit. They looked at the audit report and
it came out that the auditors had warned about this. Then people took management to task. In reality, when you read
the report, it was just a key audit matter and a description of the fact that auditors focused on this. At the end of the
day, it was a clean opinion. But what was reported was that the auditors warned about the situation.
Magidson raised the question as to how expanded reporting has been received in the US. If auditors are more
engaged in commenting on the situation, your exposure will increase, without some safe harbour disclaimers. We
have some litigation here and some of us around the table know about that, but not to the same extent as the US.
Bradley agreed that it has been met with trepidation and a significant amount of caution in the US. Weve
commented publicly on the PCAOB release on enhanced auditor reports. The PCAOB release was talking about a
description of the key audit matters and audit procedures, not moving into a detailed description of findings. Even so,
one of our concerns was over the extent to which we are articulating something that should be articulated by
management. Is that indicative of a deficiency in reporting? In the US, the SEC has a requirement that in the annual
report, management has a responsibility to describe risks. Our proposal is that we should report on managements
report, and providing our assurance or an attestation on what managements is reporting, as opposed to articulating
our own view.
Brooks expressed dismay that over her 40-year career there has been little movement in solving the expectation
gap as to what audit can do. It strikes me as astonishing that 40 years on, were still talking about the expectation
gap when it comes to audit. This is a fundamental issue, because if you dont solve it all these other things are not
going to solve it. Expanding the audit report isnt going to solve the expectation gap.
McInnis countered by saying that whats more interesting now is the debate about the information gap. Investors
want more information, and thats something that happened before the financial crisis, and which became a focus
after it. What do investors need to know about the audit? Theres been movement in that direction and well have to
see what the outcome is and how capital markets respond to this information provided about audit.
For Thesburg, the answer lies in providing assurance. Whats key is the linkage between assurance, audit and the
information a company provides. The profession needs to work with those who are providing information to
stakeholders and figure the appropriate assurance model. I recognise the liability concerns and what you can and
cant say. But investors are looking for more information about risks, uncertainties and measurement uncertainties.
We need to find a way to build assurance into that, and then make sure people understand whats assured, and
whats not, and what level of assurance is, without adding a lot of cost.
Lawrence added that investors primary concern is to make sure that confidence in the primary audit function, namely
testifying to the quality of the financials, remains paramount. You should make sure that you invest all of those
resources to make sure that that promise has been delivered against, and not watered down by other things.
Additional information is useful for investors. The more the better, we cant get enough. But it should be of paramount
importance to stay focused on the core of what were asking auditors to do.

Vaessen added that improvements in the reporting model could be helpful and might address the information gap.
Whether its the disclosure initiative to get rid of clutter, or integrated reporting, I think we should have further debate
about it.
Bradley concluded by pointing out that the profession is at an inflection point with respect to the future. We have an
increase in sophistication of international regulators coming together. We have a debate with respect to enhanced
audit that is not going to go away. And we have the advent of mandatory rotation in the EU, which is a global
phenomenon. All of these events coming together within a few years mean there will be changes. Wed much rather
compete on quality. If were competing on quality, it means were not competing solely on cost. Competing on cost
means theres a race to the bottom. Thats the last place I want to go.
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