University of RichmondUR Scholarship Repository

Accounting Faculty Publications Accounting

11-1994

The New Auditor's Report: Have the Benefits ofWording Changes Been Acknowledged Outsidethe CPA Profession?Marshall A. GeigerUniversity of Richmond, mgeiger@richmond.edu

Follow this and additional works at: http://scholarship.richmond.edu/accounting-faculty-publications

Part of the Accounting Commons, Business Administration, Management, and OperationsCommons, Entrepreneurial and Small Business Operations Commons, and the Finance andFinancial Management Commons

This Article is brought to you for free and open access by the Accounting at UR Scholarship Repository. It has been accepted for inclusion inAccounting Faculty Publications by an authorized administrator of UR Scholarship Repository. For more information, please contactscholarshiprepository@richmond.edu.

Recommended CitationGeiger, Marshall A. "The New Auditor's Report." Journal of Accountancy, November 1994, 59-64.

CPE DIRECT

THE NEWAUDITOR'SREPORTHave the benefits of wording changes beenacknowledged outside the CPA profession?

by Marshall A. Geiger

PAs use the auditor's report to communi-cate their opinions of an entity's financialstatements and related disclosures. Con-cerned parties, in turn, use the report toassess the integrity of the financial state-ments and the accuracy of the disclosures.

In 1!I<S8. the American Institute of CPAsauditing standards board established newwording for the standard unqualified auditreport. It also revised the reporting re-quirements and types of audit reports al-lowed (for example, the subject-to reportfor uncertainties and except-for report forconsistency departures were eliminated).The new wording appears in Statement onAuditing Standards no. 58, Reportt^ on Au-dited Financial Statements. (The sidebaron page 61 describes the evolution of theaudit report until SAS no. 58's issuance.)

With these audit reporting changes andmodifications comes the need for CPAs toassess how financial statement users per-ceive the new reports and what impact thewording has had. One question is howusers who continually encounter differenttypes of reports are affected. Have thesechanges been acknowledged by those out-side the CPA profession? If so, have theybeen beneficial?

MARSHALL A. GEIGER. CPA. PhD. /.s mmnateftrofessor of accounting, the, Universitif of Rhode Is-laiul, KitHjaton. He is a mvmher of the. American In-sti.ti.ite of CPAs. ilif Pemisiflvaitia Society of CPAsand the Americaii Accounting A.tMociatioi!.

This article reports on a study of bankloan officers conducted to determine howthis gi'oup of users perceived some of thenew audit reports compared with formerreports. The loan officers generally viewedthe new' standard report similarly to theold one. However, they liked the new modi-fied unqualified consistency report betterthan both the former except-for consisten-

JOURNAL OF ACCOUNTANCY, NOVEMBER 1994 S9

AUDITOR'S REPORT

cy report and the standard unqualified re-port used alone in the event of an account-ing change.

OAUGING USER PERCEPTIONSOne hundred seventy-eight bankers partic-ipated in the survey to assess the impact ofthe new standard unqualified report andthe new modified unqualified consistencyreport on their perceptions of an audit, theauditor and the audit report. It was con-ducted in the fourth quarter of 1989 to de-termine users' initial reactions to the new-reports (SAS no. 58 is effective for all re-ports issued or reissued after January 1,1989). Bank loan officers were chosen forthe survey because of their constant expo-sure to various audit report types and theirfamiliarity with the meaning intended tobe communicated through such reports—new or old.

Participants reviewed a loan applicationfor a medium-sized regional retail grocerycompany {with $51 million in sales) operat-ing at or slightly below industry averages.A marginal applicant was used to allow theaudit report wording a greater opportuni-ty to affect the bankers' perceptions. Theloan request was for $2.2 million, re-payable in equal quarterly installmentsover 10 years. The proceeds were to beused to add inventory to existing storesand to open several new stores. Financialstatements and related footnotes, a de-scription of the company, biographies of itskey executives and a set of calculated fi-nancial statement ratios and cash flowdata were provided to each participant.

Five slightly different scenarios wereused (each loan officer received one set ofapplication matei'ials and evaluated onlyone scenario). Two loan applications pre-

sented the company with no change in ac-counting principle. The applications wereidentical except for the wording of the au-ditor's report; group 1 received the oldstandard report, while group 2 was giventhe new standard report.

The three remaining loan applicationswere similar to the first two, except theyshowed the company had changed its de-preciation method, which resulted in an 8%($2(),00()) aftertax increase in net income.The effect of this change, in accordancewith Accounting Principles Board Opinionno. 20, Accounting Changes, was properlynoted as a separate item on the incomestatement. Referred to as change cases,these last three loan applications wereidentical to each other except for the typeof audit report included.

The first group (group 3) received thenew modified unqualified consistency re-port with the required additional para-graph. Group 4 received the old except-forqualification (due to the principle change);gi'oup 5 received the new standard unqual-ified report with no reference to the incon-sistency. All other information, includingdescriptive footnotes of the change, wasidentical.

The change-case loan applications weredeveloped to test SAS no. 58 reporting re-quirements as well as the ASB's originalposition that the reference to consistencybe eliminated entirely, even for companiesmaking accounting changes. Althoughthere is no such requirement today, it'spossible such a requirement may be adopt-ed in the future.

In evaluating the case materials, bankloan officers were asked individually

• How confident they were the CPAswere inde])en(lent in performing the audit.

EXECUTIVE SUMMARY• IN 1988, THE AMERICAN INSTITUTEof CPAs auditing standards board estab-lished new wording for the standard unquali-fied audit report and also revised reportingrequirements and the types of audit reportsallowed.• RANK LOAN OFFICERS WERE sur-veyed in 1989 to determine how this grouj) ofusers perceived the new audit report. Sur-vey participants reviewed a sample loan ap-plication with five different scenarios.• THE SURVEY FOUND the new stan-dard audit report wording did not appear toaffect significantly bankers' perceptions of

auditors or the integrity of financial .state-ments or their overall satisfaction with thereport. This was the AICPA auditing stan-dards board's intended result when it issuedthe revised report—to clarify but not changethe auditor's role• THE OLD AUDIT REPORT made loanofficers more confident there wore r\o mate-rial misrepresentations in tlip financialstatements. Users gave relatively low satis-faction ratings to both the old and new stan-dard report wordings. More work may needto be done to increase the reports' effective-ness for users.

6 0 JOURNAl OF ACCOUNTANCY, NOVEMBER 1994

AUDITOR'S REPORT

• Hov\' confident they were the financialstatements conformeci with generally ac-cepted accounting principles.

• How confident they were the financialstatements were free of unintentional ma-terial eiTors.

• How confident they were the financialstatements were fi-ee ofintentional misrep-resentations.

• How satisfied they were with the in-

formation provided in the auditor's report.Loan officers indicated their confiilenct'

or satisfaction on an ll-])oint scale with 0representing no confidence oi- satisfactionand 10 representing extreme confidence orsatisfaction.

THiJURVEYSAYS .„The exhibit on ])agc' 64 summarizes respon-dents' average ratings of the five questions

EVOLUTION OF THE AUDITOR'S REPORT

Statement on Auditing Standards no.58, Report!^ on Audited Financial State-ntents, is the American Institute ofCPAs auditing standards boards' mostrecent attempt to cummunicate the na-ture of the auditor's work, manage-ment's responsibility and the auditor'sresponsibility for the financial state-ments. Before SAS no. 58*s issuance, thelast substantial revision to the auditor'sreport was in 1948.

The former report's longevity wasthought to have made it more of an un-read symbol than a meaningful commu-nication between the auditoi- and finan-cial statement users. To remedy thispei'ceived weakness without alteringthe auditor's responsibility, the AICPAauditing standards board modified notonly the standard report wording butalso the audit I'oport categories to whichthe U.S. financial community had grownaccustomed. In a distinctive break fromthe old format, the new standard reportcontains three standard paragraphs in-.steaci of two.

Perhaps the most controversialchange from the former standard opin-ion was the elimination of the refer-ence to consistent application of gener-ally accepted accounting principles.The AK'PA auditing standards boarddeemed the old reference redundantduo to the ado])tion in 1971 of Account-ing Pi'inciples Board Opinion no. 20,Accounting Changes, which requiresall material accounting changes to bedisclosed properly in the financialstatements. Hence, the new unquali-fied report does not contain any refer-ence to consistency when there is nomaterial change in accounting princi-

ple, no change in reporting entity, etc.As a result of a request by the Secu-

rities and Exchange Commission, how-ever, SAS no. 58 requires an additionalfourth paragraph to be added to thestandard report that mentions anychange (in accounting priiu-iple, report-ing entity, etc.) and directs the reader'sattention to the appropriate fooinot.e(s)in the financial statements. In this way,the former exce])t-for qualification forconsistency was eliminated and replacedwith a reference to the inconsistency inthe new modified unqualified consisten-cy report only when there was a materi-al change.

SAS no. 58's reporting requirementson consistency reflect a compromise he-tween the ASB and the SFX'. The ASBposition—as set out in the original exi)o-sure draft and maintained througlioutthe deliberation process—was that anyreference to consistency in the auditor'sreport was redundant and unnecessaiy.The SEC said consistency was an imjxir-tant financial reporting practice and theauditor's report should refer to bothconsistent and inconsistent api)licationsof piinciple, reporting entity, etc. Thecomjn-omise in SAS no. 581'esulted ineliminating the

• Consistency I'efei'enco in the st;m-dard unqualified report.

• Except-for consistency cjualified re-poil category and instituted a foui--paragraph modified unqualified consis-tency report to signal consistency de-partures.

• Controversial I'eqnired opinionqualification yet maintained a mecha-nism to identify companies with consis-tency departures.

JOURNAL OF ACCOUNTANCY, NOVEMBER 1994 61

AUDITOR'S REPORT

for all five groups. Comparisons were madebetween

• The two vo-change gi'oups.• The group receiving the new modified

unqualified consistency report and thegToup receiving the old except-foi- qualifiedreport.

• The gi'oup receiving the new modifiedunqualified consistency report and thegroup receiving the new standard uncjuali-fied report not mentioning the change inprinciple.

No-change groups. The results show nosignificant differences between the twono-change groups for all responses. Ac-cordingly, the new wording did not affectsignificantly bankers' perceptions of audi-tors or the integrity of the financial state-ments or their overall satisfaction withthe report. This was the ASB's intendedresult in issuing the report. Since onlythe report's wording changed and not the

One hundred seventy-eight bankersparticipated in a survey to assessthe impact of the nev/ standardunqualified audit report andthe new modified unqualifiedconsistency report*

auditor's responsibility, knowledgeableusers such as bank loan officers w ere notexpected to vary significantly in theirperceptions because new language wasintroduced.

One interesting result, however, wasthat the bankers had a higher average lev-el of confidence about the auditors andtheii- work (average rating of the first fourquestions: 7.57) than their satisfaction withthe auditor's report (average rating of thelast question: 5.90), with the new auditor'sreport recei\ing the lower satisfaction rat-ing. One possible explanation is the auditrei)ort histoi'ically has not provided lenflerswith the information they want or need, re-sulting in relatively low satisfaction ratingsfor both the new and old reports. Assess-ing future satisfaction levels in a vaiiety ofcontexts ultimately will determine if therevised report proves more useful than itspredecessor.

Change groups. For bankers receivingapplications with a change in accountingprinciple, the first set of comparisons wasbetween the new modified unqualified con-

sistency report and the old except-forqualified report (groups 8 and 4). The ex-hibit shows the two groups differed signif-icantly on the absence of i-ntevtional niift-representations and satisfaction iritli theaudit repoH questions. Contrary to expec-tations, the old except-for report madeloan officers more confident there were nomaterial misrepresentations in the finan-cial statements than did the new modifiedunqualified consistency report. However,resi)ondents were significantly more satis-fied with the new modified un(|ualifiedconsistency report than they were withthe old except-for qualified report. In addi-tion, the satisfaction rating for the newmodified unqualified consistency reportwas the highest for all five groujis. In gen-eral, the loan officers' perceptions werefaii'ly consistent over the two types of au-dit reports for companies changing an ac-counting principle. However, satisfactionincreased substantially for the new consis-tency reporting requirements.

To test the ASB's original position thatall references to consistency be eliminated,the last set of comparisons was betweenthe group receiving the new modified un-qualified consistency report and the gi-oupreceiving the new unqualified report notmentioning the accounting change (groups3 and 5). These comparisons also helped as-sess the impact on users had a compromiseon consistency not been reached with theSecurities and Exchange Commission (seethe sidebar for background).

The exhibit shows the bankers' confi-dence levels that CPAs were independentwere significantly different for these twogroups, with the requii*ed new modified un-qualified consistency report (group 3) elic-iting much higher confidence ratings thanjust the new audit rejiort with no referenceto the consistency departure (grou]) 5). Allother confidence ratings also were higherfor the required new report, although theywere not statistically significant.

Bankers receiving the new modifiedunqualified consistency re])ort also hadthe highest satisfaction, while those re-ceiving the potential new consistency re-port (just the standard unqualified re-port) had the lowest satisfaction of allgroups. This finding suggests the ap-proach to inconsistency the SEC persuad-ed the ASB to adopt seems to have pro-vided loan officers with the informationthey need in a form they prefer. The loanofficers generally interpreted eliminatingthe except-for qualification for consisten-

6 2 JOURNAL OF ACCOUNTANCY, NOVEMBER 1 994

AUDITOR'S REPORT

Summary of average responses

tndepencJence

Conformitywithgenerallyacceptedaccountingprinciples

Absence oferrors

Absence ofintentionalmisrepresen-tation

Satisfactionwith auditreport

N = Number of

No

(1)Otd

standardreport

N=34

7.47

779

7.47

7.88

6.03

change groups

(2)

Standardreport

N=25

7,92

7,04

6.92

8.08

5.76

Probabilitygroups 1and 2 are

equal

.33

24

.36

,73

,69

bank loan officers in ihe group.

(3)New

consis-tencyreport

N=31

7,32

7,38

7.09

7.22

6,84

(4)Old

except-for

report

N=42

7.31

7,40

6.86

7.90

6.00

Depreciation change groups

Probabilitygroups 3 and4 are equal

,98

,95

.60

.08

,08

(5)

Newstandard

report

N=46

6,59

6,94

6,36

6.51

5,64

Probabilitygroups 3 ond5 are equol

.09

.29

.12

.13

,01

cy coupled with the new modified unqual-ified consistency report as satisfactoryreporting changes.

WHAT IT ALL MEANSAs the ASB intended, the new standardaudit reporting' requirements under SASno. 58 did not appear to have a significanteffect on loan officers' perception ratingswhen compared with the old standard re-port. This was the desired result—for thenew report to clarify, but not change, theauditor's role in performing an audit.However, the relatively low satisfactionratings for both old and new standard au-dit report wordings were troubling.These findings suggest there may be aconsiderable amount of work left if thestandard audit report is to be substantial-ly more effective as a means of communi-cating with users.

The new modified unqualified consisten-cy report, however, was perceived by thebankers to provide a significantly higherlevel of satisfaction than the former

except-for consistency qualilieation. Addi-tionally, the new reporting requirementsfor companies that changed principleselicited higher ratings of confidence inCPAs and in the integrity of the financialstatements, as well as higher ratings ofsatisfaction with the report, than did re-ports that didn't mention the accountingchange. These findings -support the consis-tency repoiting ref|uirements adopted inthe current standards and suggest a posi-tive effect of the SEC compromise.

CHANGED PERCEPTIONSThis project represents an early attempt togather evidence on users' changed pei-cep-tions of the new audit reports. Furtherwork should be done for these and othertypes of audit reports adojitcd in SAS no.58 to see how loan officers and other usersperceive the reports after they have beenin circulation longer. Such efforts wouldhelp the ASB identify areas where commu-nications between auditors and reportusers can be enhanced. •

64 JOURNAL OF ACCOUNTANCY, NOVEMBER 1994