In recent years, there have been numerous and varied developments in auditing practices and procedures. The Auditing Standards Board (ASB) recently issued several SASs intended to improve and enhance the communication process between the independent auditor and external users of financial statements. SAS 58, "Reports on Audited Financial Statements," significantly altered the basic auditor's report. This article discusses the results of a study undertaken to find out whether the wording of the new auditor's report effectively improves communications between auditors and the users of the independent accountant's report.

Deficiencies of the Old

Standard Report

Except for minor editorial changes, the standard auditor's report remained virtually unchanged from 1948 to 1988. During this period concerns that users might not be correctly interpreting the auditor's intended messages were widely expressed, and major revisions were considered by both the ASB and its predecessor. However, these attempts to revise the standard audit report failed to attract widespread support and were unsuccessful.

In 1978 the commission on Auditors' Responsibilities, also known as the Cohen Commission, identified several possible deficiencies in the auditor's report. The Commission believed these deficiencies hindered communications between the auditor and the users of financial statements, alleging that users were sometimes confused as to the respective responsibilities of management and the auditor. In addition, it suggested that the use of standardized language may have made the report a symbol which was not being carefully read, considered, and fully understood by users. The Commission asserted that the report should clearly describe the work of the auditor. In short, the Cohen Commission recommended that the auditor's report should be revised to describe more explicitly both the role and the responsibilities of the auditor. Surveys indicated that confusion existed among bankers, analysts, and shareholders concerning the relative responsibilities of management and the auditor for the financial statements.

In short, a number of misconceptions seemed to exist that many believed would be corrected by altering the standard audit report.

Potential Improvements in

the New Standard Report

Many of the changes suggested by the Cohen Commission and by subsequent research were ultimately incorporated in the provisions of SAS 58. In making these changes, the ASB considered the comments, criticisms, and suggestions of numerous interested parties. For example, the Cohen Commission, practitioners, and accounting researchers all agreed that there was possible confusion concerning the relative responsibilities of management and the auditor. The new audit report includes an introductory paragraph which specifically addresses this issue. In addition, it was suggested that users have a general misunderstanding of the basic objectives of an audit and may be aware of its limitations. Accordingly, the scope paragraph has been expanded to include a brief description of an audit. Terms such as "reasonable assurance" and "materiality" are introduced and the reference to consistency is eliminated.

Current Research Study

The study adds to the body of evidence addressing the issue as to whether the new report is, in fact, more understandable. The study tested the wording of the unqualified audit report described in SAS 58, involved a national sample of bankers who were actual users of financial information, and contrasted the views of large and small lenders.

The study was designed to test user perceptions concerning a variety of issues pertaining to the auditor's standard unqualified report. The objective was to determine whether the new standard audit report was more useful than the old report to bank loan officers, primary users of audit reports.

A sample of bankers was obtained from The Rand McNally Bankers Directory. Each banker was sent either the old or new standard unqualified audit report and was asked to answer a series of questions concerning the audit report enclosed. Responses to each question were made on a 100-point scale. The 23 questions posed and the endpoints used for each question are presented in Table 1.

Responses to the questions were examined to determine whether the new report elicited different reactions from bankers than did the old report. The opinions of bankers employed by smaller banks were also contrasted with the perceptions of bankers working at larger institutions.

Research Results

The mean responses for the survey are presented in Table 2. To facilitate discussion, the 23 questions are categorized into six groups: 1) the responsibilities of management and the auditor; 2) the auditor's responsibility for the detection of fraud; 3) the reliability of the financial statements; 4) auditor communications; 5) the extent of testing and the scope of the audit; and 6) going-concern issues.

Responsibilities of Management and Auditor. In issuing SAS 58, the ASB intended to provide the readers of the auditor's report with a clearer understanding of the responsibilities assumed by both management and the auditor. The responses to our survey indicate that the new audit report favorably addresses this concern. Bankers who examined the new audit report expressed a greater awareness of both management's responsibilities and the auditor's obligations than did those bankers who received the old report. This reaction appears to be consistent with the objectives of the ASB. The Cohen Commission noted the existence of confusion concerning the relative responsibilities of management and auditors. Subsequent research has indicated that users may place too much responsibility for the financial statements on the auditor and too little on management. The direction of the average response indicates that the ASB may be accomplishing its goal.

Bank affiliation accounted for some of the difference noted in user reactions to the auditor's reports. Loan officers from small banks perceived that the auditor assumes more responsibility for the accuracy of the financial statements than did those from larger banks. In addition, some interaction between type of opinion and size of bank appears to be present regarding the lenders' opinions of management's responsibility. In comparing the responses to the old report with those for the new report, the responses from loan officers affiliated with small banks showed more dissimilarity than those from the large banks. These results indicate that the new audit report may have had a more significant impact on loan officers from smaller banks than on those from larger banks. Thus, those statement users commonly believed to be most in need of enhanced communication apparently did obtain an improved understanding of the relative responsibilities of management and the auditor.

Detection of Fraud. The responses to the questions pertaining to fraud and irregularities also provide a number of interesting implications. For the old report, officers from large banks perceived that much more testing was performed by the auditor to determine the existence of fraud or irregularities than did officers from small banks. However, the average responses for the new report were identical when leaders were grouped by size of bank. As anticipated, a significant interaction between the type of opinion and the size of bank is present.

Size of bank was also found to be significant. Loan officers from large banks reported more confidence that the tests performed by the auditor would actually detect material fraud or irregularities than did those from small banks. Again, the gap in the average responses between large and small banks narrowed when the new report was read.

Reliability of the Financial Statements. Few differences were noted in the responses to questions pertaining to the reliability of the financial statements. All respondents, regardless of where they worked or the report examined, believed that audited financial statements were generally credible and that there were no inherent errors. Loan officers who examined the new report were slightly more confident that the financial statements were fairly presented in accordance with GAAP.

Auditor Communications. Responses to the questions dealing with the information communicated by the auditor's report suggest that loan officers believe that the new report is more useful than the old report. Loan officers from both large and small banks expressed a stronger belief that value was added by the new report and suggested that the new report was more understandable than the old report.

Loan officers from small banks, however, were less sensitive to audit report messages pertaining to audit reliability and statement usefulness than were users from larger institutions. Regardless of whether the new or old report was examined, loan officers from larger banks were more likely to believe that value was added by the expression of an unqualified opinion. Further, they reported that through this opinion the auditor was providing a greater level of assurance that the statements were free of material misstatement. This result may be because loan officers from the smaller banks deal with their customers on a more personal level and, thus, place less reliance on the auditor's report.

Scope of the Audit. Although the new audit report was lengthened to describe in detail the nature of an audit, it did not have a significant impact on the loan officer's perceptions of the scope or nature of the audit. Only one significant difference was noted for the questions pertaining to the limitations and nature of an audit. Loan officers from small banks indicated a greater conviction that evidence was being gathered by the auditor when they read the new report. The lack of response differences in this area may have occurred because the loan officers responding had many years of experience; a less experienced officer might have been influenced more by the type of opinion.

Going-Concern Issues. The unqualified report has not changed with respect to the information provided regarding going-concern issues. Neither the old nor the new audit report mentions possible liquidation unless there is clearly a going-concern problem. No significant differences were noted in the responses concerning the likelihood of liquidation. Neither the audit report being considered nor the size of the bank affected the responses. This outcome is consistent with expectations, since no additional information regarding going-concern issues was added by the new report.

The responses which dealt with the testing performed and evidence gathered by the auditor to determine whether the company was a going- concern, however, showed significant interaction. For both questions, the responses of loan officers from small banks increased from the old to the new report, while the responses decreased for loan officers from large banks. Evidently, the more explicit description included in the new audit report caused lending officers from both small and large banks to adjust their perceptions of the auditor's testing in evaluating going-concern issues.

CONCLUSION

The greater uniformity observed in the responses among users from both small and large banks regarding the new audit report indicates that SAS 58 has reduced the expectations gap.

It appears that the ASB has been successful in refining certain aspects of communication between auditors and users of financial statements. Loan officers are better able to identify the degree of responsibility that both management and the auditor assume for the financial statements. Lending officers from small banks appear to be affected more by the new audit report than are loan officers from larger banks. As a result, greater consistency appears to be present for bank loan officers receiving the messages of the new auditor's report than was the case with the old report. The bank loan officers also believed that the new audit report was both more understandable and of greater value than the old report. These results are encouraging. Clearly, the ASB has had some success in addressing concerns raised by the Cohen Commission and others in the financial community.

By Jeffrey R. Miller, Sarah A. Reed, and Robert H. Strawser, all from Texas A&M University, College Station, TX