Should Companies Use the Same Provider for Financial Statement Audit and Assurance of Extended External Reports? Free

In recent years, companies have been increasingly held accountable for a much broader range of resources and relationships than those traditionally contained in financial statements. This has resulted in companies providing additional, usually nonfinancial information (NFI), to the market, either in the annual report or in the form of a separate extended external report (EER).¹ The importance of this information is evidenced by the recent establishment of the International Sustainability Standards Board (ISSB), which sits alongside the International Accounting Standards Board (IASB) under the International Financial Reporting Standards (IFRS) Foundation.²

To improve its credibility, there is a growing demand for this broader information to be assured (International Auditing and Assurance Standards Board (IAASB) 2022; Bakarich, Baranek, and O’Brien 2023). According to KPMG (2020), 96 percent of the largest global companies produce EERs annually and 71 percent purchase third-party assurance on these reports. Internationally, such EER assurance purchases are relatively evenly split between accounting firms and other professional services firms, such as consulting firms, engineering firms, and certification bodies (e.g., Huggins, Green, and Simnett 2011; Zhou, Simnett, and Green 2016; KPMG 2020).³

Both EER assurance engagements and financial statement audits require an understanding of the entity and its business strategies and processes, and related personnel (IAASB 2022). Thus, having the same firm provide both services may enhance audit quality and save costs, especially given the move toward integration of more NFI into the annual report (International Integrated Reporting Council (IIRC) 2013; Task Force on Climate-Related Financial Disclosures (TCFD) 2017; IAASB 2022).⁴

In their study, Lu et al. (2023) in “Using the Same Provider for Financial Statement Audit and Assurance of Extended External Reports: Choices and Consequences,” identify and examine factors that companies should consider when deciding whether to engage their financial statement auditor’s firm or a different provider to assure an EER. The three factors they identify are independence concerns related to the assurance provider, the expertise of the assurance provider, and the extent to which NFI is integrated into the annual report.

Lu et al. (2023) then examine the implications for audit firms and their clients of using the same provider for both the financial statement audit and the EER assurance engagement. In this article, we summarize results found by Lu et al. (2023) and discuss the implications for companies, assurance providers, and standard-setters/regulators.

When a company decides to purchase EER assurance, management must decide whether to engage its financial statement auditor or a different assurance provider. Engaging the same provider to perform the financial statement audit and EER assurance engagement results in economies of scale in terms of the search for an assurance provider, has potential advantages associated with a better coordination of activities across assurance engagements, and has advantages from the provider using similar methodologies and procedures. They could result in a lower overall cost and/or better overall quality. There are also potential synergies in one provider handling both engagements, as each engagement requires an understanding of the entity, its business strategies and processes, and related personnel (IAASB 2022; International Sustainability Standards Boards (ISSB) 2022b). This may result in more in-depth knowledge of such strategies and processes, which may further enhance audit quality.

However, recent corporate failures and findings from audit inspections (Financial Reporting Council U.K. (FRC) 2019; Australian Parliamentary Joint Committee (APJC) 2020) have intensified the scrutiny and regulation of the provision of nonaudit services (NAS) by financial statement auditors to their clients.⁵ In addition, the International Ethics Standards Board for Accountants (International Ethics Standards Board for Accountants (IESBA) 2021a) has recently tightened its independence requirements for auditors providing nonassurance (not nonaudit) services. Although EER assurance being provided by the financial statement auditor’s firm is not currently prohibited by any regulator and is less likely than other categories of NAS to cause independence concerns,⁶ a company may want to limit the amount and types of services provided by their financial statement auditor to avoid such concerns. Hence, Lu et al. (2023) hypothesize that greater concerns about perceived independence will reduce the likelihood of the incumbent financial statement auditor also providing EER assurance to the same client.

Relevant auditor expertise is also a significant factor in the choice of auditor provider (e.g., Minutti-Meza 2013). Lu et al. (2023) hypothesize that the chances of management choosing the financial statement audit firm to also provide EER assurance is higher if the audit firm has developed expertise and a positive reputation in the EER assurance market.

Finally, Lu et al. (2023) hypothesize that as companies increasingly integrate NFI into their annual reports, the incentives for hiring the financial statement audit firm to provide EER assurance increase.

The literature has documented the benefits of knowledge spillovers from auditors providing NAS in the form of tax-related services or internal audit (DeFond and Zhang 2014). EER reports typically contain information on an entity’s objectives and strategies, business models, and significant business risks (IAASB 2022; International Sustainability Standards Boards (ISSB) 2022b), and recent revisions to auditing standards have acknowledged the importance of financial statement auditors understanding these matters (ISA 315, International Auditing and Assurance Standards Board (IAASB) 2019). Financial statement auditors are also expected to explicitly consider the impact of a range of prominent nonfinancial risks on financial statements, including climate change, cyber security, and supply chains (Australian Accounting Standards Board (AASB) & Auditing and Assurance Standards Board (AUASB) 2018; Securities and Exchange Commission (SEC) 2018; International Auditing and Assurance Standards Board (IAASB) 2020).

Given the increasing significance of NFI to financial statement auditors, Lu et al. (2023) posit that knowledge transfer is facilitated when the same provider undertakes both the financial statement audit and EER assurance, which could translate into higher audit quality. With the financial statement audit and EER assurance teams being more likely to use each other’s work when they come from the same provider, this could potentially reduce duplication and provide synergies, leading to lower audit costs. Therefore, Lu et al. (2023) further hypothesize that the use of the same provider leads to lower audit fees.

Lu et al. (2023) identify 1,524 company observations (642 unique companies) from 35 international jurisdictions between 2012 and 2016 that have their EER statements assured and for which required data for regression analyses was available.⁷ The most represented jurisdictions are Taiwan with 149 observations (9.8 percent), United States with 132 observations (8.7 percent), and South Korea with 108 observations (7.9 percent).⁸ Descriptive information reveals that 33.9 percent of these companies use the same provider for financial statement audit and EER assurance, with approximately 40 percent of EER assurance engagements performed by providers from outside the accounting profession. The likelihood of engaging the same provider becomes much higher (64.6 percent) when companies use Big 4 firms for both services.

Lu et al. (2023) use regression analysis to determine the relationship between a company using a single provider and (1) independence concerns, proxied by a company’s prior year NAS-to-audit fee ratio; (2) provider expertise, proxied by whether the auditor is the market leader for assurance services in the company’s jurisdiction; and (3) the production of a report that integrates the financial statements and EER (yes or no). Lu et al.’s (2023) results indicated that greater independence concerns reduce the likelihood that a company will use the same provider.⁹Lu et al. (2023) also found that a company is more likely to use a single provider when the company’s auditor has high assurance services expertise and when the company produces an integrated report.

Lu et al. (2023) also use regression analysis to analyze the impact of a company using its financial statement audit firm as its assurance provider on (1) audit quality using both discretionary accruals and propensity to issue a going concern opinion as the proxies and (2) audit fees. Lu et al. (2023) find that when companies use the same provider for the financial statement and EER, the financial statement audit quality is higher¹⁰ but audit fees are not higher.

Lu et al. (2023) provide evidence that companies likely consider independence concerns, provider expertise, and the possibility of provider synergies when deciding whether to engage their financial statement audit firm to perform EER assurance. Lu et al.’s (2023) findings can be used by auditors when deciding whether to invest in resources and training to expand into EER assurance. They can also be used by auditors to educate their clients about the benefits of using the same provider for the financial statement audit and EER. Specifically, Lu et al. (2023) find that companies reap benefits in the form of higher audit quality without incurring higher audit fees when using a single provider. This is important as companies are increasingly being held accountable for a broader range of resources and relationships and are expected to combine financial information and NFI in presenting the results of their operations and telling their value creation story.

Lu et al.’s (2023) results further demonstrate the value of auditing standards that require a consideration of NFI in auditors’ assessments of inherent and control risk. Their results suggest that whether or not financial statement audit firms are engaged to assure NFI, an expanded consideration of NFI can benefit audit quality. Although recent revisions to auditing standards require auditors to explicitly consider NFI during their audit, there is little detail about the form or extent of consideration. Lu et al.’s (2023) results also support extant literature concerning the possibility of beneficial spillover effects in financial statement audits. Standard-setters/regulators should consider the benefits of spillover effects of companies using a single provider for their financial statement audit and EER assurance when crafting new or amending old regulations. Finally, as the IAASB is considering further guidance for EER assurance engagements, a more explicit recognition of synergies between financial statement audits and EER assurance should be considered.