9675_Changes to the Auditor’s Report and the effects for the bank lenders in the Austrian financial market

Changes to the Auditor’s Report and the effects for
the bank lenders in the Austrian financial market

Barbara Ranninger
1718060

MSc in International Accounting and Finance

Dublin Business School / Liverpool John Moores University

August 2013

Table of Contents
page 2
Table of Contents
Table of Contents
……………………………………………………………………………………………………….. 2
List of figures
…………………………………………………………………………………………………………….. 3
Acknowledgments………………………………………………………………………………………………………. 4
Abstract
…………………………………………………………………………………………………………………….. 5
1
Introduction
………………………………………………………………………………………………………… 6
1.1
Research background ……………………………………………………………………………………. 6
1.2
Aims and objectives
……………………………………………………………………………………… 7
1.3
Approach to the research ………………………………………………………………………………. 7
1.4
Dissertation organisation ………………………………………………………………………………. 7
1.5
Scope and Limitations
…………………………………………………………………………………… 8
1.6
Major Contributions
……………………………………………………………………………………… 8
1.7
Researcher suitability
……………………………………………………………………………………. 8
1.8
Recipients of the research ……………………………………………………………………………… 8
2
Literature Review
………………………………………………………………………………………………… 9
2.1
Auditor’s report
……………………………………………………………………………………………. 9
2.1.1
Current Standard Auditor’s Report ………………………………………………………….. 9
2.1.2
Content of the current auditor’s report
……………………………………………………. 10
2.1.3
Problems with the current auditor’s report………………………………………………. 11
2.1.4
Proposed changes by the IAASB …………………………………………………………… 12
2.1.5
Sought for Changes
……………………………………………………………………………… 15
2.2
Bank lending ……………………………………………………………………………………………… 16
2.2.1
Bank lending process …………………………………………………………………………… 16
2.2.2
Auditor’s report and bank lending …………………………………………………………. 17
2.2.3
Austrian financial market
……………………………………………………………………… 18
2.3
Conclusion on Literature Review …………………………………………………………………. 19
3
Research Questions
……………………………………………………………………………………………. 21
4
Methodology …………………………………………………………………………………………………….. 22
4.1
Introduction
……………………………………………………………………………………………….. 22
4.2
Research Philosophy
…………………………………………………………………………………… 22
4.3
Research Approach …………………………………………………………………………………….. 24
4.4
Research Strategy
……………………………………………………………………………………….. 24
4.5
Research Choice…………………………………………………………………………………………. 25
4.6
Research Time Horizon ………………………………………………………………………………. 26
4.7
Data collection …………………………………………………………………………………………… 26
4.7.1
Primary Data Collection……………………………………………………………………….. 26
Table of Contents
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4.7.2
Secondary Data Collection……………………………………………………………………. 27
4.8
Data Analysis …………………………………………………………………………………………….. 28
4.9
Sampling …………………………………………………………………………………………………… 29
4.10
Practical Efforts …………………………………………………………………………………………. 29
4.11
Researcher Bias
………………………………………………………………………………………….. 30
4.12
Limitations ………………………………………………………………………………………………… 30
4.13
Research Ethics
………………………………………………………………………………………….. 31
5
Analysis and Findings
………………………………………………………………………………………… 33
5.1
Research Question 1 …………………………………………………………………………………… 34
5.2
Research Question 2 …………………………………………………………………………………… 37
5.3
Research Question 3 …………………………………………………………………………………… 42
5.4
Conclusion on Analysis and Findings
……………………………………………………………. 45
6
Conclusion ……………………………………………………………………………………………………….. 46
7
Recommendations for future research ………………………………………………………………….. 50
8
Self-Reflection ………………………………………………………………………………………………….. 51
8.1
Reflection on process and sources ………………………………………………………………… 51
8.2
Reflection on dissertation formulation
…………………………………………………………… 52
8.3
Reflection on own learning ………………………………………………………………………….. 53
9
Bibliography …………………………………………………………………………………………………….. 56
10
Appendix
………………………………………………………………………………………………………. 63
10.1
Interview Guide …………………………………………………………………………………………. 63
10.2
Auditor’s Report ………………………………………………………………………………………… 66
10.3
Proposed Auditor’s Report ………………………………………………………………………….. 68

List of figures
Figure 1: Forms of qualification matrix
……………………………………………………………………….. 10
Figure 2: Financing of companies (in billion €) ……………………………………………………………. 19
Figure 3: Research Onion ………………………………………………………………………………………….. 23
Acknowledgments
page 4
Acknowledgments
First of all particular thanks go to my supervisor, Mr. Cormac Kavanagh, for his guidance and
advice throughout the process of this dissertation.

I would like to say thanks to all the bank lenders participating in my research for their time
and expertise.

Special thanks go to my family and friends that encouraged and supported me through the
whole master programme and in particular during the process of finishing this dissertation.

I also want to say thanks to my fellow MSc International Accounting and Finance students
who have always provided advice.

Abstract
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Abstract
The existing literature suggests that the audit has value for the users of financial statements
but the usefulness of the auditor’s report itself should be increased. Because of criticism from
different groups the current auditor’s report is subject to change. The IAASB issued an
Invitation to Comment: Improving the Auditor’s Report. Those changes should provide the
readers of the auditor’s report with more information, give clarifications to the audit and
provide assurance to other information outside of the audited financial statements.

This study will analyse the bank lenders’ perception of the current auditor’s report and the
proposed changes to the auditor’s report and what changes bank lenders would like to see in
the auditor’s report. To gather primary data a case study methodology was adapted. Four
Austrian bank lenders were included in this research to answer those research objectives.

The bank lenders included in the research had varied perceptions on whether the current
auditor’s report influences the lending process or not. The research shows that the higher
informative value of the proposed auditor’s report will increase the relevance of the auditor’s
report for the lending process. The interviewees proposed a few minor changes but the
proposed changes by the IAASB are already a step in the right direction.

Introduction

page 6
1 Introduction
1.1 Research background
After the financial crisis banks, rating agencies, hedge funds and central banks have been
criticised for the roles they played. Auditors, who also played an important part, only received
limited attention. For example, several banks reported huge losses in the years before and
during the crisis but still received a clean or a so called unqualified audit opinion. In some
cases auditors approved financial statements shortly before companies failed. This raises the
question if the current auditing legislation is still adequate and appropriate. (European
Commission, 2010)

The primary goal of an audit is to provide an external independent opinion whether the
financial statements give a true and fair view and if they are prepared and presented in
accordance with the appropriate accounting legislation. In the auditor’s report the auditor
expresses his opinion about the company’s financial statements to the stakeholders of the
company. The current report is a standard format and only shows the result of the audit but
does not include any specific information about the findings for each company. (House of
Commons, 2009)

The question of the appropriateness and efficiency of the audit regulation and audit reporting
is because of high criticism from government agencies, regulators, professional groups, users
and auditing overseers under scrutiny. It is a highly discussed topic between regulators and
has led to calls for changes. For example research that shows that the auditor’s report is not
providing sufficient information for users was conducted by the Chartered Financial Analyst
(CFA) Institute. It released a report in 2010 which states that 94% of the respondents would
like additional information in the auditor’s report. The Public Company Accounting Oversight
Board’s (PCAOB) Investor Advisory Group also conducted a survey. Their findings show
that only 23% agree that the level of information provided in the auditor’s report is sufficient.
(Carcello, 2012)

Due to the concerns raised, standard setters worldwide are working on the preparation of a
new standard to improve the auditor’s reporting model. In the US the PCAOB issued a
concept release on possible revisions to the audit reporting standards (PCAOB, 2011), in the
UK the Financial Reporting Council (FRC) issued a consultation paper which revised the
auditing standards and should expand the communication and reporting responsibilities for the
auditors (FRC, 2012) and the International Auditing and Assurance Standard Board (IAASB)
issued an Invitation to Comment: Improving the Auditor’s Report which should increase the
information content of the auditor’s report (IAASB, 2012).
Introduction

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The proposal which was consulted in this research was the Invitation to Comment from the
IAASB. This Invitation to Comment should supply more information for users, should
provide clarifications about the audit and give assurance on other information besides the
audited financial statements. The standard setter is in an early stage of creating revised audit
reporting standards. The anticipated date of publication for the final revised auditing standard
is June 2014. It is important to understand the effects and relevance of the changes for
different stakeholder groups. (Mock et al., 2013)

There are different user groups of the audited financial statements. The researched user group
in this dissertation is bank lenders. Financial information is an important basis for bankers on
deciding whether or not to grant a loan to an organisation. Furthermore they also require
updated financial statements during the loan period to manage their outstanding loans.
Because bank lenders are highly reliant on those statements they need an independent
validation that the financial statements are providing a true and fair view of the company’s
current financial position. (Kim, 2009)
1.2 Aims and objectives
This research is intended to answer the question of in what way do bank lenders use the
auditor’s report in the lending process and lending decision. Moreover it explores if the
identified improvements to the auditor’s report will meet the Austrian bank lenders’ demand
for a greater transparency of the audit of financial statements and also if the value of the
auditor’s report for the lending process can be increased through the changes. Furthermore it
should not only explore what the bank lenders think of the current changes but also what
changes the bank lenders would prefer to see in the auditor’s report.
1.3 Approach to the research
The existing regulations and the changes to the regulations were analysed in terms of how
they influence the lending process. To get deep and insightful information of the bank lenders’
perception to the auditor’s report four Austrian bank lenders were interviewed. This
information was then used to build a framework to answer the previously outlined research
objectives.
1.4 Dissertation organisation
The first chapter following the introduction is the literature review. It describes the currently
existing literature and studies in the area of the auditor’s report and bank lending. In the next
chapter a detailed outline of the research methodology is included to present the approach that
was followed to answer the research questions. The analysis and findings section is the next
chapter. It includes the findings which were gathered during the case studies. The following
Introduction

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chapter is the conclusion. Based on the data in the analysis and findings section a conclusion
for the research questions was drawn. The next chapter provides recommendations for future
research topics related to this area. The last chapter is the self-reflection. This chapter
outlines in detail the process of completing this dissertation from start to finish as well as
the impact this process had on the researcher.
1.5 Scope and Limitations
The dissertation was finished under a time constraint. This limitation has forced the researcher
to make some compromises. This research focuses only on the bank lenders’ perception even
though many other stakeholders are affected by the auditor’s report and its changes.
Moreover, this study focuses only on Austrian bank lenders.
1.6 Major Contributions
According to the ACCA there is little publicly available global research into the value of
audit. (ACCA, 2010) Therefore this research focuses on investigating the value of the
auditor’s report for bank lenders and the effects the changes to the auditor’s report will have
on bank lenders. The findings of this research should improve the understanding of regulators
about the value of the auditor’s report for bank lenders in the Austrian financial market.
1.7 Researcher suitability
The researcher of this study is suited for this topic because of her educational background in
accounting and finance. Furthermore the researcher has successfully finished all courses of the
MSc programme at Dublin Business School and was able to apply the gained knowledge from
these courses to this dissertation.
1.8 Recipients of the research
The recipients of this dissertation will be Dublin Business School and Liverpool John Moores
University because it was finished as part of the MSc International Accounting and Finance
degree. The primary recipient will be Mr Cormac Kavanagh as the supervisor of this
dissertation. As this research is intended to investigate the bank lenders’ perception semi-
structured face-to-face interviews were conducted with bank lenders. Most of the interviewees
have shown interest in the findings of this research. A copy of this dissertation will be sent to
them.
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2 Literature Review
2.1 Auditor’s report
Directors are required by company law to prepare annual financial statements. Shareholders,
who are the owners of a company, as well as investors and creditors, cannot check the
accounts and the annual financial statements on an individual basis. Therefore they hire an
independent, external auditor to examine the financial statements, the underlying accounting
records and the key assumptions and estimates made during the process of preparing the
financial statements. With the auditor’s report the stakeholders receive an independent
opinion whether the financial statements give a true and fair view about the company’s
financial situation and whether it complies with legal and other regulatory requirements.
(Atrill and McLaney, 2011)

The audit report is the only observable outcome that the auditor produces for outside
stakeholders. It is a source of information about the audit process and the auditor’s conclusion
about the company’s financial statements. (Asare and Wright, 2012)

§268 UGB (Austrian Commercial Code) determines the general framework for the companies
that need to be audited in Austria. It states that all limited companies need to be audited. This
does not apply to small private limited companies unless they fulfil the legal requirements to
install a supervisory board. Whether a company is classified as a small, medium or large
company depends on the turnover, balance sheet total and number of employees.
2.1.1 Current Standard Auditor’s Report
If the company’s financial statements comply with the applicable legislation and give a true
and fair view about the company’s financial situation the auditor will provide an unqualified
or clean opinion. (Gray and Manson, 2008) On the other hand if the auditor is not satisfied
with the contents of the financial statement a qualified opinion can be issued if appropriate.
An auditor can have two reasons to be dissatisfied with the presentation of the financial
information. First, the scope of the auditor’s examination can be limited. Second, the auditor
disagrees with the company’s treatment or disclosure of an item in the financial statements. If
the item is material and therefore prevents the financial statements from giving a true and fair
view then the auditor will issue a qualified auditor’s opinion. However, qualified opinions are
rarely issued. This is because before issuing a qualification the auditor will discuss the
problem with the directors of the company and will provide them with the possibility to
correct the contentious item. (O’Regan, 2006)

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Circumstances
Limitation of scope
Disagreement
Form of qualification
Except for
Except for
Disclaimer
Adverse
Figure 1: Forms of qualification matrix
Source: Gray and Manson, 2008, p. 616
Figure 1 shows the three options an auditor can choose from to express a qualification. A
limitation of scope exists if it is not possible for the auditor to access all information needed to
finish the audit, for example documents have been destroyed in a fire or the company is not
willing to provide all necessary documents. If the limitation of scope relates to only one item
or a small number of items which do not affect the whole financial statement an except for
opinion will be issued. If the scope is materially limited and the auditor is not able to form an
opinion a disclaimer of opinion will be issued. A disagreement arises if the auditor has all the
necessary documents to form an opinion but the auditor’s opinion differs from the company’s
opinion. An except for opinion will be issued if the effect of the disagreement is material but
the financial statement does not give a misleading picture. (Gray and Manson, 2008) If the
disagreements are so material that the financial statements are misleading or incomplete the
auditor will issue an adverse opinion. An adverse opinion is the opposite of an unqualified
opinion. An adverse opinion means that the financial statements do not give a true and fair
view. (Porter, Simon and Hatherly, 2008)
2.1.2 Content of the current auditor’s report
The currently existing auditor’s report is a standard format. In Austria the auditor’s report is
based on the regulations of §274 UGB (Austrian Commercial Code) and is supplemented by
regulations of the International Standards on Auditing (ISA) 700 The auditor’s reports on
financial statements in order to increase the information content of the auditor’s report and to
increase the understanding of the duties and responsibilities of the auditor. Those two
standards define the context and form of the auditor’s report. Appendix 10.2 shows a sample
of a current unqualified auditor’s report. The layout and content are the same for every
company. It consists of the title and addressee, a scope paragraph and identification of subject
matter of report, responsibilities paragraphs, an opinion paragraph and a paragraph about the
management report. (KWT, 2010)

The scope paragraph and identification of subject matter of report define what parts of the
annual report are included in the audit. (Gray and Manson, 2008)

The responsibilities paragraphs of the auditor’s report state that it is the auditor’s
responsibility to form an opinion on the financial statements and report that opinion to the
receivers of the report. It is outlined clearly that the preparation of the financial statements,
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which are the basis for the audit, is the responsibility of the directors. It also gives a
description on how the auditing work has been done and how an opinion has been formed. It
states that the auditor’s work has been conducted in accordance with auditing standards. It
should give the reader an indication that the auditor has followed a well established
framework while carrying out the audit. (Porter, Simon and Hatherly, 2008)

As the title already states, in the opinion paragraph the auditor expresses an opinion about the
financial statements of the company. It is only an opinion and not a guarantee because during
the audit the auditor has to rely on judgements and has to evaluate the appropriateness of
alternative accounting treatments. (Gray and Manson, 2008)

The paragraph about the management report shows that the auditor agrees that the statements
in the management report are in accordance with the financial statements and do not give an
unrealistic picture of the company. (KWT, 2010)
2.1.3 Problems with the current auditor’s report
Research indicates that users of financial statements considered the audit to have value but
they also expressed concerns about the usefulness and the content of the current auditor’s
report. For example a survey was conducted by the Maastricht Accounting, Auditing and
Information Management Research Centre which shows that the users of the financial
statements are more confident with the numbers in the financial statements if they are audited
by an independent party. (Deumes et al., 2010) Gray et al. (2011) conducted a focus group to
discuss the current auditor’s report. The results also show that stakeholders value the audit of
companies but users only check if the audit opinion for the company is unqualified. The rest
of the report is boilerplate and most of the time stakeholders do not read it. Coram et al.
(2011) also published a study which shows that the auditor’s report is relevant for users of
financial statements because financial statements that are audited are more reliable than
unaudited statements. But again the research shows that users have little interest in the
specifics contained within the auditor’s report. It is only used to determine whether the
opinion is unqualified or not. Another survey was conducted by the CFA Institute showing
similar results. It states that 72% of the respondents agree that the auditor’s report is important
for their analysis and the use of the financial statements but 94% agree that more additional
information is needed in the auditor’s report. (CFA Institute, 2010)

The current auditor’s report is criticized for not providing sufficient information needed in the
current global business environment and the more and more complex reporting obligations.
Some users believe that a more informative auditor‘s report could help to provide richer
information about the entity and about the auditing process itself. But there are also opponents
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to this argument. They see the publication of entity-specific information as a problem for the
separation between the entity’s responsibilities and the responsibilities of the auditor. (Hodge
and Murray, 2012)

There are also users of financial statements that see enough value from the current auditor’s
report as a survey from the PCAOB’s Investor Advisory Group (IAG) shows. 23% of the
respondents stated that the auditor’s report provides sufficient information in its current form,
32% were neutral and 45% said that the current auditor’s report does not provide valuable
information. The opinion paragraph attracts the most attention in the auditor’s report. 40% of
the respondents to the IAG questionnaire were not interested in changing the currently
existing pass/fail model. The current pass/fail model has value for the investors because the
standardised language makes the opinion easier to read and easily comparable. (Hodge and
Murray, 2012; Carcello, 2012) In the current model the reader gets an objective opinion from
the auditor about whether the accounts give a true and fair view or they do not. If this
objective opinion were to be replaced with one that includes a degree of subjectivity the
reader could get confused or be overly optimistic or pessimistic about a company. (Sawers,
2013)

As can be seen from this review, most of the existing literature about the relevance of the
auditor’s report for users of financial statements is empirical. The predominantly used method
to gather empirical data in this area are surveys, and therefore mostly quantitative information
is available. (Coram et al., 2011) Antonio Duréndez (2003) writes that the reason for the high
portion of surveys in the existing research is the possibility to extrapolate the results to the
population of the research subject. This review shows that there is a gap for qualitative
research therefore qualitative methods will be used in this research to gather empirical data.
2.1.4 Proposed changes by the IAASB
Due to all the critique and demand for a better auditor’s report the IAASB published the
‘Invitation to Comment: Improving the auditor’s report’ in June 2012. The IAASB has
published an example of the proposed auditor’s report which can be found in section 10.3.
The main goal of the proposal is the improvement of the information output of the auditor’s
report without interfering with the audit quality. The ideas for the proposed changes in that
document are arising from the feedback received from the consultation paper ‘Enhancing the
Value for Auditor Reporting: Exploring Options for Change’. (Mastracchio and Lively, 2013,
p. 31) The next course of action is the publication of the exposure draft in June 2013 and the
final stage will be the agreement on the revised audit standard in June 2014. (Hodge and
Murray, 2012)

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The IAASB has proposed a few adjustments to the current auditor’s report. The changes to the
auditor’s report should give investors more confidence in the presented financial statements.
In the current form they are just indicating a direction for the future auditor’s report. Right
now the proposed changes need to be discussed with the users of the financial statements and
the arising effects, positive or negative, need to be explored and understood. (Sawers, 2013)

The first and probably most significant change is the preparation of a so called Auditor
Commentary. With this narrative, users of the auditor’s report should be provided with
additional information about the most important issues detected during the audit to create a
better understanding of the financial statements and the audit. (Jones, 2012) Under the current
ISA the auditor has the opportunity to express additional information which is extremely
important to the users of the annual report without modifying the auditor’s opinion. This
information can be presented in an emphasis of matter paragraph if it concerns information
which is disclosed within the financial statements. If the information relates to matters outside
the financial statements it can be expressed in an other matters paragraph. (Porter, Simon and
Hatherly, 2008) However, the usage of emphasis of matters paragraphs is rare. The
International Standards on Auditing note that a regular use of those paragraphs would reduce
the effectiveness of the auditor’s communication of those matters. Therefore auditors
currently only use that form of communication in their report if they are required to. However,
users of the annual reports stated that these paragraphs give a good indication about the most
important components in the financial statement and the carried out audit for those areas. The
new Auditor Commentary should follow the same outline as the existing emphasis of matter
and other matter paragraph. In the current form the IAASB proposed to include information
from the following areas to the Auditor Commentary: information about material management
judgements and estimates, the occurrence of material or unusual transactions during the fiscal
year, contentious matters that were found during the audit and other issues that were discussed
with the management and which required a significant audit.

In the current form the IAASB is still discussing for which companies an Auditor
Commentary should be published. The current plan is to give the auditor the possibility to
include an Auditor Commentary for all companies when he deems it necessary. Primarily the
issuance of an Auditor Commentary was discussed to be compulsory for only listed
companies but the IAASB is reflecting about widening the application area because the
provided information in an Auditor Commentary is relevant for all users of financial
information and not only just certain companies. (IAASB, 2012)

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Users of financial reports have different opinions about the proposed Auditor Commentary.
Opponents of the idea are afraid that the publication of possibly sensitive information about
the company could interfere with the trust and openness between the auditor and management
of the company. Information could be withheld by the company because they fear that it could
eventually become public. (Sonnelitter, 2012) The current standard auditor’s report uses a
standardised language which makes it easy for the readers to compare it with other companies
and it provides the readers with clarity. But it could also be seen as being boilerplate and not
giving any information about the audit process and the quality of the audit. In the opinion of
Hodge and Murray the entity-specific information in the Auditor Commentary would make
the report more relevant for every user group. (Hodge and Murray, 2012)

Another proposed change by the IAASB is a conclusion from the auditor on how adequate the
management’s going concern assumption is and whether any material uncertainties exist
which could threaten the going concern assumption. (Hodge and Murray, 2012) For readers of
the auditor’s report information about the future viability of a company has significance.
Therefore further disclosures in this area could be an improvement for users. To determine
whether there exists any material uncertainties or not involves a lot of judgement from the
management as well as the auditor and furthermore the term material uncertainties, which
derives from the IFRS, is not yet clearly defined. In the proposed auditor’s report the IAASB
plans to point out that future events cannot be predicted with certainty and that the auditor’s
statement about the non existence of material uncertainties does not give a guarantee of the
future viability of the company in order not to raise an unrealistic expectation in the reader’s
mind. (IAASB, 2012)

A further improvement of the auditor’s report should be a statement about the existence of any
inconsistencies between the audited financial statements and other information provided in the
annual report. (Jones, 2012) Other information can be any financial or non-financial
information which is included in the annual report other than the audited financial statements
and the auditor’s report. That information can either address historical events or future
prospects for the company. So far a statement would be expected to be helpful for investors
because it would increase the transparency of the auditor’s work in this area. In some
countries it is already included in the auditor’s scope. (IAASB, 2012) According to the
Austrian Commercial Code the auditor only checks for inconsistencies between the
management report and the audited financial statements. This audit activity does not expand
to all other information included in the annual report. (KWT, 2010)

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Also the auditor’s opinion and other company specific information should be presented at a
more eye-catching position in the auditor’s report. The IAASB suggested placing the opinion
at the first position of the proposed auditor’s report. The IAASB gives further minor
suggestions on how to improve transparency about the performed audit. (IAASB, 2012)

Hodge and Murray (2012) raised the fear that the proposed changes could have more content
but it will not be more informative because there is a chance that the auditors will start using
the same language for every client and therefore the report will be boilerplate again. They also
assumed that the costs will be increased especially through the Auditor Commentary which
could substantially increase the workload for the auditor. Also through the more complex
process of preparing the report it takes longer to finish the auditor’s report and therefore the
publication of the annual report will be pushed back. Furthermore it is feared that the Auditor
Commentary and the associated higher reporting effort will be a hurdle for small companies.
They have fewer resources available than large companies to provide all the information
required by the auditor. (Glover and Reidenbach, 2012)
2.1.5 Sought for Changes
The ACCA held a series of worldwide roundtables on the topic of the value of audit. Those
discussions showed that audit provides value for the users but it also showed that frustration
exists because the auditors could do more. The respondents want to receive more information
than the currently existing pass or fail in an auditor’s report. The bottom line is that
shareholders are paying for an audit so it would not be unreasonable for them to ask to receive
more information. The participants were asking to receive information which is currently only
presented to the board and the audit committee. Furthermore participants of the round table
stated that the currently audited numbers are only focusing on the past. More focus on forward
looking information would be helpful for users of the audited financial statements. Another
downside of the current auditor’s report is that no information about the company’s risk
situation is included. Finally, the narrative reporting is always getting more important in the
annual report and the respondents wanted some kind of verification so they can have more
trust in those narrative reports. (ACCA, 2010)

Houghton, Jubb and Kend (2011) conducted a research about the reporting on materiality
levels. His findings show that users would react positively to more information about the
materiality level used during the audit.

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2.2 Bank lending
The main tasks of commercial banks are to provide retail banking services like acceptance of
deposits, granting of loans and financial guarantees; trade financing facilities like letters of
credit, shipping guarantees and Banker’s Acceptance; treasury services; cross-border payment
services and custody services. (bin Ghuslan, Muhammad and Abidin, 2010) This research will
only focus on the banks’ function of granting loans to non-financial companies. The lending
function in general is assumed to be the most important way to generate funds for the banking
industry. The highest gross profit is earned from loans, therefore the management of the loan
portfolio has a high influence on the bank’s profitability. The prime reason for bank failures is
the high number of non-performing loans. (Wei-Shong and Kuo-Chung, 2006)
2.2.1 Bank lending process
The whole bank lending process can be divided into eight stages. Those are ‘application,
credit analysis, decision, document preparation, closing, recording, servicing, and
administration and collection.’ (bin Ghuslan, Muhammad and Abidin, 2010, p. 42) First the
borrowers introduce themselves to the bank lender. This should help to establish an honest
and trustworthy relationship between the lender and borrower and a loan application will be
submitted. In the next step, the credit analysis, this application is reviewed by the bank lender.
All the information that is available and required should be checked. The purpose of the
review is to predict the client’s default risk on the loan and the willingness to repay the loan.
In this stage hard facts should be tested and estimations should be left out. The information
required from the loan applicant depends on the circumstances, but usually to apply for a loan
a detailed business presentation is necessary. This presentation includes the audited financial
statements and updates about major events that happened between the reporting date and the
application date for the loan, cash flow forecasts, management accounts, budgets and general
details about the company. After the hard facts are adequately examined and the bank lender
approves then soft facts will also be included in the credit analysis step, such as personal
characteristics of the management, product range, competitors etc. (Rouse, Bell and Graham,
2011)

Berger and Udell (2006) defined four methods to predict the risk of a loan default. Those are
financial statement lending, asset-based lending, credit scoring and relationship lending. The
first three categories are using quantitative methods to assess the risk of default. Therefore
bank lenders base their decisions on hard financial data which is relatively easy to obtain from
the credit application. In the financial statement lending technique the statement of financial
position, statement of comprehensive income and cash flow statement are the core elements of
the lending decision process. It is important for that information to be verified by an
independent auditor to be reliable. The asset-based lending technique bases the granted credit
Literature Review

page 17
amount on the existing company’s assets which are used as collaterals for the credit. In the
case of a default on the credit the bank uses the collaterals as a financing source to repay the
loan. (Berger and Udell, 2006) To assess the credit risk in the credit scoring technology the
bank lender uses a manual scorecard or risk-measuring software. The relevant information is
primarily hard information about the company and the client. It is analysed through those
systems and gives the bank lender an indication whether to approve the loan or not.
(Trönnberg and Hemlin, 2012) The loan decision process in relationship lending is based on
soft facts. Soft facts include the personal characteristics of the borrower and further
information which cannot be found in the company’s financial statements. In order to use this
method to assess the risk of a loan a long relationship between the borrower and the bank
officer must exist. This form of lending is mostly used for small companies. (Peltoniemi and
Vieru, 2013)

The described initial lending decision is an important part of the lending cycle but even if a
well informed decision was made things can go wrong during the credit period. Therefore a
bank will arrange in the loan agreement to receive regular updated financial information.
These can include performance figures, audited financial statements, budgets, monthly reports
and even regular site visits and meetings with the client. This accompanying information will
be compared to the initial information received at the time the loan was granted. (Richard et
al., 2008) An important monitoring tool for commercial clients are covenants. In the facility
letter the bank lender can determine conditions that must be fulfilled during the credit period.
Those conditions are usually a range of accounting ratios. If the borrower fails to achieve
those conditions the bank can require an immediate repayment or a renegotiation of the loan.
Through that instrument the bank can protect itself against a negative change. (Christensen
and Nikolaev, 2012)

As can be seen from the different methods to determine the credit risk, commercial bankers
are major users of financial information. For their lending decisions they rely on hard
financial data. (Kim, 2009) A bank lenders’ main task is to assess the likelihood of the
repayment of a possible bank loan. Therefore a bank lender needs to forecast future cash
flows which are available for the loan repayment. The Basel Committee on Banking
Supervision even requires banks to look in the future for 12 months and also 5 years to predict
the so called Probability of Default. (Rouse, Bell and Graham, 2011)
2.2.2 Auditor’s report and bank lending
Bank lenders were chosen for this research because the changes to the auditor’s report were
initiated by users of the auditor’s report and this research should investigate if the changes
have really increased the user’s satisfaction with the report and the relevance of the report.
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page 18
(IAASB, 2012) Furthermore bank lenders are in constant contact with the various types of
auditor’s reports and they represent an important element for their work. Also, finance
providers are reliant on the financial information presented by the company and therefore
require an audit to ensure the accuracy of the obtained information. (Antonio Duréndez, 2003)

There are different studies that acknowledge the importance of the auditor’s report for the
bank lenders. For example Asare and Wright conducted a survey which indicates that the
auditor’s report is important when making a lending and investment decision. The study
further shows that bank lenders see the report as less important than other investors because
financial providers do not only rely on publicly available information. Bank lenders have
options to request information from the borrower personally. (Asare and Wright, 2012)
Antonio Duréndez published a research that shows similar results. The conclusion of the
research was that the auditor’s report has value for bank lenders. The type of the audit opinion
has an influence on the lending process. The respondents further confirmed that the type of
opinion has an effect on the lending decision but to a lesser extent than on the lending process.
(Antonio Duréndez, 2003) The ACCA published a report about the value of the auditor’s
report. Their findings were that banks see audits as being valuable because the financial
information is an important part in the decision making process and if the information is
verified by an independent party it has more value. (ACCA, 2010) These studies only look at
the value of the current standard auditor’s report for bank lenders. This dissertation will
further explore how the IAASB’s changes to the auditor’s report will affect the bank lenders’
decision making process and the assessment of the auditor’s report for lending decisions.

The currently conducted research about the value and usage of the current standard auditor’s
report for lending decisions was researched in different contexts (in Spain by Antonio
Duréndez, 2003, in Australia by Coram et al, 2011, in the USA by Carcello, 2012 and by
Asare and Wright, 2012 and in the Netherlands, Germany and the UK by Deumes et al., 2010)
but even though bank lending is an important financing form for Austrian companies there is,
to the best of the author’s knowledge, no existing research for this topic for Austrian bank
lenders.
2.2.3 Austrian financial market
The Austrian corporate landscape consists of 99.7% of small- and medium-sized corporations
(SMEs). (European Commission, 2012) The access to external finance for SMEs is almost
completely restricted to debt financing because the hurdles for financing over the stock market
and thus the access to equity are too high. (Austrian National Bank, 2007) Therefore bank
lending in Austria is an important financing opportunity.

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The Austrian Financial Market Authority (FMA) is the supervisory authority of the Austrian
financial market. It is responsible for the observation of credit institutions, insurance
companies, pension funds, staff provision funds, investment funds, securities-related services
enterprises, entities listed on the stock exchange and the stock exchange itself. Currently 824
credit institutions are under the control of the Austrian FMA. (Financial Market Authority,
2012)

2000 2001 2002 2003 2004 2005 2006
Funding in billion €
18.5 16.6 14.7 16.3 12.9 18.6 19.8
bank loan
9.8
5
−1.9 3
3.8
4.5
5.7
loan from the state and abroad
7.3
6.3
8.1
2.8
1.1
2.1
0.3
securities issues
2.1
0.6
−0.4 4.3
2.9
4.3
2.6
equity financing
1.6
4.9
7.8
3.6
4.6
7.2
10.4
trade credits and other liabilities −2.3 −0.2 1.1
2.7
0.6
0.6
0.7
Figure 2: Financing of companies (in billion €)
Source: Austrian National Bank, 2007

The table above shows the source of financing for Austrian companies from 2000 to 2006. It
can be seen that the importance of equity financing was growing up to the financial crisis, but
the director of the Austrian National Bank Mr Zöllner stated that the Austrian financial market
will be reliant on debt financing because legal and financial requirements for an IPO limit
equity financing for the predominantly existing small and medium corporate business
structure in Austria. (Austrian National Bank, 2007)

As a result of the financial crisis, bank lending to non-financial companies started to rise
again. In the first half of 2012 29% of external financing for non-financial entities was
provided by domestic and foreign banks. In the same period financing through equity almost
came to a halt. Only 0.3% of the external financing for non-financial entities was raised
through the stock exchange. There were no new listings and only small capital increases on
the Austrian stock exchange in the first six months in 2012. When taking other equity
instruments like unquoted stocks into account only a little over 10% of the external financing
was raised in the form of equity. (Financial Stability Report, 2012)
2.3 Conclusion on Literature Review
The current auditor’s report is a standard format. Currently existing research shows that the
audit function in general provides value for the users but the usefulness of the content of the
standard auditor’s report is questionable. Further studies show that the current standard report
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is important for the bank lenders but to a lesser extent than for other users because bankers
have access to information which is not publicly available. It is important because the
financial information used in the lending process is verified by an independent party. The
report influences both the lending process as well as the lending outcome, but the outcome to
a lesser extent. The audit opinion is seen as the most relevant paragraph in the auditor’s
report. In the standard auditor’s report the audit opinion is a pass/fail model.

The IAASB proposed changes to the standard auditor’s report. The four changes are a
narrative report called Auditor Commentary, a statement of the auditor’s assessment of the
appropriateness of the managements going concern assumption, a statement about any
inconsistencies between the audited financial statement and other information included in the
annual report and a more prominent position of the audit opinion in the auditor’s report. Fears
that arose because of the proposed changes are that auditors will use the same language in any
Auditor Commentary and the report will become boilerplate again, the preparation of the
report takes longer, the hurdle for small companies is higher and the extensive publication
requirements could interfere with the trust between the auditor and the management.

The existing studies primarily research the reactions to the current standard auditor’s report.
Only little research was done about the proposed changes to the auditor’s report and the most
sought for changes to the auditor’s report. This research will explore what Austrian bank
lenders expect from the proposed changes by the IAASB and furthermore what changes they
think should be made.

Research Questions

page 21
3 Research Questions
The goal of the research is to explore the value of the auditor’s report for the lending process
and the effects that will occur due to the changes to the auditor’s report. The following
research questions will be answered:

1. How is the current standard auditor’s report used for the lending process and
the lending decision by bank lenders?
Bank lenders rely on financial information provided by companies for their lending decisions.
Therefore it is important that an independent auditor verifies that it gives a true and fair view.
Several existing studies show that the auditor’s report is important for bank lenders. But this
research is not intended to only show if the auditor’s report is important but also how it is
used, what parts are relevant and are providing value for the bank lenders and why.

2. How will the different proposed changes to the auditor’s report influence its
usage in the lending process?
The purpose of this question is to evaluate the effects of the changes to the auditor’s report for
bank lenders. Changes like the Auditor Commentary, the auditor’s evaluation of the
appropriateness of the management’s going concern assumption, a statement about any
inconsistencies between the audited financial statements and other information in the annual
report and a more prominent position of the auditor’s opinion will be researched. It should
show how effective those proposed changes really are and if they would cause any changes to
the lending process.

3. What is the change to the auditor’s report that bank lenders are seeking the
most?
The changes proposed by the IAASB were made because of criticism raised by users of
financial statements. The objective of this question is to explore changes that would be most
helpful to bank lenders in their loan decision process and which are not considered in the
currently proposed changes.

Methodology
page 22
4 Methodology
4.1 Introduction
The intention of this research is to investigate how satisfied bank lenders are with the
proposed changes to the auditor’s report by the IAASB or what changes they would think are
most important for them. The topic to be researched and the research questions are the main
influencing factors for the methodology. In this chapter the methodology that was used
throughout the research will be described step by step.
4.2 Research Philosophy
The research methodology was influenced by the research philosophy. There are different
positions on the research philosophy which can be described in the following way: ‘It is the
interpretation of explanation […], and how explanation can be gained through the study of the
empirical world, that divides researchers. Opposing positions in this debate are characterized
by alternative philosophical assumptions about the nature of human action (ontological
assumptions) and about how this nature can be revealed through research (epistemological
assumptions)’ (Wass and Wells, 1994, p. 2)

The researcher’s ontological assumptions influence the epistemological assumptions which in
turn influence the chosen methodology. Research ontology can be divided into subjectivism
and objectivism. Researchers who choose objectivism believe that there exists an objective
reality. Therefore things exist independent of a person’s mind. In this research the researcher
studies the bank lenders’ satisfaction with the changes to the auditor’s report. This research
goal is abstract and no single reality exists for this research topic because every bank lender
will have a different opinion. As a result objectivism is rejected as the research ontology.
(Cameron and Price, 2009) Therefore the chosen research ontology is subjectivism. The
researcher accepts that reality differs from person to person. Thus the researcher expects every
bank lender to have a different view about the changes to the auditor’s report and the effects
on the bank lending process. The goal of this research is to explore and understand the reasons
why and how bank lenders got to their point of view. (Holden and Lynch, 2004)

The adopted research epistemology gives important assumptions about how the researcher
sees the world. Those assumptions substantiated the way the research was conducted. The
research epistemology will be described in depth using Saunders, Lewis and Thornhill’s
(2009) research onion.

Methodology
page 23

Figure 3: Research Onion
Source: Saunders, Lewis and Thornhill, 2009, p. 108

Research philosophy, the outer layer of the research onion, consists of three areas: positivism,
interpretivism and realism.

A positivist researcher focuses on observable and measureable variables in a certain
controllable environment. From the existing theory the researcher produces hypotheses that
will be tested during the research. When collecting the data the researcher is independent and
the data collected is objective. The hypotheses will either be rejected or accepted and they will
always be revised until it gives a sufficient prediction of the reality. The reason for positivist
research is to predict outcomes of the research and to be able to control those outcomes in the
future. The positivism approach is not suitable for this research because through this
philosophy the understanding of how and why bank lenders arrived at their viewpoints cannot
be increased.

Realism is quite similar to positivism. Both philosophies are a scientific approach of
generating knowledge. The idea behind realism is that what our mind shows us as reality is
the truth. In a realist’s opinion a reality exists independent of the human mind. In this research
it was accepted that every bank lender has their own truth about the effects that will be
generated through the changes to the auditor’s report and therefore realism is also not a
suitable approach.

Methodology
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Interpretivism requires the researcher to understand the behaviour of the researched people
who have experience in the researched field on a daily basis. The researcher in the
interpretivism field has to enter the world of the bank lenders and understand the rationale for
their point of view. Interpretivism is argued to be highly suitable for business and
management research. This is because business situations are complex and unique and many
different individuals are coming together at the same time. Therefore the epistemological
position in this research was interpretivism. This research aimed to understand the behaviour
of bank lenders rather than explain it. The goal of the research was to highlight why the
auditor’s report is important for bank lenders and why they are reacting in a certain way to the
changes of the auditor’s report. (Saunders, Lewis and Thornhill, 2009)
4.3 Research Approach
The second layer in the research onion describes the research approach. The research
approach can be differentiated between the deductive and the inductive approach.

The deductive approach is used when the creation of a hypothesis from the existing literature
is the starting point and the research strategy is designed to test this hypothesis. The inductive
approach consists of first collecting the primary research data and then using the information
to develop a theory which can be used to explain the results.

Due to the nature of the topic the inductive approach was a more suitable method for this
research. This research followed the process of gathering empirical data from bank lenders
through interviews and observations, translating those into findings and in the last step
establishing a theory about how the changes to the auditor’s report will affect the bank lenders
decision making process. Therefore the collection of the primary data was the starting point of
the research. In general the extent of the knowledge about the research topic at the beginning
of the research also is an influencing factor for the research approach. The inductive approach
was the best fit for the research because the proposed changes to the auditor’s report and the
effects on the bank lenders is currently not a highly researched topic. (Ghauri and Grønhaug,
2005)
4.4 Research Strategy
The next layer in the research onion is the research strategy. Saunders and Lewis (2011) give
different options to gather data for the research, for example through an experiment, survey,
case study, action research, grounded theory, ethnography or archival research.

Methodology
page 25
For this research a case study was used. Robson (2002, p.178) defines a case study as: ‘a
strategy for doing research which involves an empirical investigation of a particular
contemporary phenomenon within its real life context using multiple sources of evidence.’ The
reason for choosing a case study strategy is that it gives the researcher the opportunity to take
a broader view at the problem, whereas with surveys or experiments the research addresses a
well defined and narrow problem. Because of the broader approach it gave the researcher the
chance to find new patterns or explanations that were not anticipated or expected at the start
of the research. A case study is suitable to build a theory inductively which was the intended
approach for this research. (Blumberg, Cooper and Schindler, 2011) Furthermore a case study
was the best fit for this research because multiple data collection techniques were used to
answer the research questions, in particular interviews, observations and a researcher diary.
Because of the use of more data collection methods, the collected information was richer and
created a more complete picture. (Eisenhardt and Grabner, 2007) As opposed to a survey
which answers questions of who, what, where, how much, and how many, a case study
focuses on the questions why, what and how. With this research the questions that should be
answered are how is the current auditor’s report used during the lending decision, what do
bank lenders think of the changes to the auditor’s report and how and why they got to their
opinion and what would be the most sought for changes. Therefore the research objective
already clearly showed that a case study was the best fit. (Saunders and Lewis, 2011)

A multiple case study was used in this research. Four Austrian financial institutions were
included in this research. The theory about the effects of the changes to the auditor’s report for
bank lenders was developed through the identification of relationships within the cases and
between the cases through a so called comparative design. A comparison between the cases
showed what was common between those cases and what was unique in each case.
(Eisenhardt and Graebner, 2007)
4.5 Research Choice
A researcher has several research choices: mono method, mixed method and multi method. A
mono-method describes the approach when a researcher only uses a single data collection
technique and a corresponding analysis procedure. Multiple methods, which are mixed
methods and multi methods, use more than one data collection technique and analysis
procedure. A multi method research choice refers to combinations where more than one data
collection technique with the corresponding analysis procedure is used but those are within
either the quantitative or qualitative research. A mixed method approach mixes quantitative
and qualitative data collection techniques and analysis procedures to answer the research
questions.