An overview of the findings can be found at www.apb.org.uk. The objective of the research was to
- better understand the cost implications;
- explore the effectiveness of the IPR in identifying misstatements;
- assess the reactions of practitioners and directors;
- test the illustrative guidance developed by the APB for performing the IPR.
Cost savings averaged around Pounds 1,100 where the firm provided accounting assistance and used the same people to perform the IPR, representing a saving of about 27% of the combined audit and accounting fees for the previous year, although the savings ranged from 4% to 70%. This may be because the extent of accounting work varies considerably from engagement to engagement, but in any case it indicates that care should be taken in extrapolating the results.
There were greater savings where the firm provided no accounting assistance or where another team provided the assistance. In this case the saving averaged around Pounds 2,400, representing 61% of prior year audit fees. The main reason for this greater saving appears to be because the IPR (like the audit) is a ‘top-up’ function where the firm is also involved in accounts preparation.
Some firms were concerned that the trials may overstate the extent of cost savings for a number of reasons. Firstly, the IPR relies heavily on the use of analytical procedures and enquiries of directors, both of which require experience and the exercise of judgement. Secondly, the savings may diminish over time as the accumulated knowledge of the business arising from prior audits diminish, although it is conceded that this may be mitigated by firms becoming more familiar with the IPR process over time.
Effectiveness of the IPR in identifying misstatements
The findings show that whilst an IPR is capable of detecting misstatements, an audit is more effective in doing so. The research also shows that a significant number of misstatements are detected as part of the accounts preparation process. One of the reasons for this is the fact that, in practice, many practitioners perform corroborative procedures whilst preparing accounts.
The reactions of practitioners
The illustrative guidance developed by the APB for performing the IPR consists primarily of:
- analytical procedures; and
- enquiries of directors,
with a view to obtaining ‘plausible’ explanations. Practitioners had strong views on the need for corroborative evidence and the nature of the review report.
The APB’s illustrative guidance is based on the relevant International Standard on Auditing (ISA 910 Engagements to review financial statements). But unlike the ISA and similar guidance, the APB’s illustrative guidance prohibits the practitioner from obtaining corroborative evidence under any circumstances, even where the practitioner suspects that something is ‘wrong’. The main reason for this is that the Company Law Review states that if the introduction of the IPR is to be worthwhile, it needs to be clearly distinguished from the audit, and there should be significant cost savings. If corroborative evidence is obtained, the cost savings are reduced and the distinction from the audit may be lost.
Practitioners found this prohibition difficult to deal with. Analytical procedures are sometimes difficult for firms to apply to smaller businesses because of the lack of regular production of accounting information and therefore comparative data. The application of these procedures was further hampered by the inability of some clients to provide satisfactory explanations. This often resulted in the practitioner having to ‘lead’ the client.
Practitioners were also uncomfortable with the extent of reliance on directors’ explanations, the other main plank of the IPR, again because of the requirement to accept seemingly plausible, but possibly unsatisfactory, explanations without corroboration.
Many practitioners disagreed with the position taken on corroboration. They took the view that there were situations in which corroboration might resolve uncertainties at little additional cost. As noted above, many practitioners in practice perform corroborative procedures whilst preparing accounts and for this reason, some of the firms considered that their compilation procedures provided a higher level of assurance than the IPR!
The review report
Almost all practitioners were uncomfortable with the negativity of the review report and the lack of communication of the work, including accounting work, performed. The review report states that on the basis of the review, the firm is not aware of any material modifications that should be made to the financial statements in order for them to be in conformity with the provisions of the Companies Act 1985 and the requirements of United Kingdom Accounting Standards.
The review report mentions analytical procedures and enquiries of directors (which some practitioners felt to be jargon) and a warning that an audit has not been performed. But there is no mention of the requirements for practitioners to consider whether there is a sound accounting base for the preparation of financial statements and the plausibility of explanations, as required by the illustrative guidance.
The reactions of directors
Many directors considered that, if their company were to become audit exempt, they would still spend the same amount on services from their auditors, but on services that they perceived to be more beneficial than either the audit or the IPR. Some directors of the larger companies involved (only one company with a turnover of over £3m took part in the research out of a total of twenty companies) considered that there should be no requirement either for an audit or for an IPR. Others believed that the audit (but not the IPR, which prohibits corroborative evidence) provided some protection from unscrupulous directors and assurance for themselves and other stakeholders.
The overall finding from interviews is that the benefits of the IPR as it currently stands are far from firmly established in the minds of directors.
The views of bankers
Detailed discussions were held with small company and risk management experts from a number of banks, even though this was not a part of the field testing per se.
Bankers were concerned about the possibility of an excessive number of modified review conclusions on the basis of uncertainties, as well as the effects of audit exemption on small companies that may need an audit track record if they wish to raise finance as they grow. The research also notes that the absence of risk assessment in the IPR might be incompatible with banks’ lending techniques which make extensive use of risk assessments, and the fact that the quality of the assurance provider may be as important as the assurance provided.
It became apparent during the field trials that if the IPR is to be functional from the practitioner’s point of view, further work has to be undertaken in three areas: corroboration, analytical procedures and the review report. The research states that if Standards are developed for the IPR, the APB and the profession need to consider the level of detailed procedures to be specified in Standards, the extent of corroborative work to be permitted (if any), how to make the review report more descriptive and how practitioners can be assisted in the performance of analytical procedures.
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