13 May 2019
In the last couple of months three reports or consultations have been published by the Business Energy and Industrial Strategy Committee on the future of auditing. These presage the biggest change in the field of auditing for thirty years, but does it have any relevance for businesses and the wider public?
The expectation gap
Who would have thought that a subject as dry and esoteric as auditing would ever rouse public opinion to the extent that government would feel it necessary to commission not just one, but three reports concerning its future? As an auditor I have a vested interest in the reliability of the audit function and the credibility of its practitioners, and in my two earlier blogs (13 March and 31 January) I have discussed threats to the profession caused by recent corporate failures and hinted at the changes that might be on their way. We now have a much clearer view of what lies in store following the publication of:-
- Independent Review of the Financial Reporting Council by Sir John Kingman (December 2018) and the Initial Consultation on its recommendations (April 2019)
- Independent Review Into The Quality And Effectiveness Of Audit by Sir Donald Brydon, Call for views (released April 2019)
- The Competition and Markets Authority (CMA) market study into the supply of statutory audit services in the United Kingdom (December 2018).
These were brought together in The Future of Audit, a report by BEISC in April 2019.
The last report contains a list of prominent recent cases where auditors have allegedly failed in their supposed obligations. I use the word ‘supposed’ because the responsibilities, and indeed liability, of auditors is one of the key questions. In a nutshell, the auditing profession sees its duties as being largely confined to ensuring that the annual financial statements present a true and fair view, and that its responsibilities are primarily to the shareholders. The public, on the other hand, expects the auditors to detect and report fraud, mismanagement and impending business failure. The Brydon investigation plays down this expectation gap, and basically states that if auditors delivered properly under the terms of the existing regime it would considerably reduce the expectation gap. In other words we auditors are doing the right thing but doing it badly.
The political dimension
The Government feels strongly that auditing is a valuable function that generates business confidence, encourages investment and underpins a successful economy. So audit reform is a key contribution to its Industrial Strategy. The changes will, therefore, be far-reaching, starting with the replacement of the Financial Reporting Council, which has been the audit regulator for a number of years. This will be succeeded by the Audit, Reporting and Governance Authority [ARGA], which will have a much closer relationship with Government. Each Parliament will brief ARGA on its economic objectives and ARGA will report regularly to a parliamentary committee. In other words auditing will come under political control.
At the practical level there are some ground-breaking recommendations, some of which have already been accepted. These include the publication of the audit quality review for each assignment, so that the public will see the audit firm’s scorecard on its performance. ARGA may have the power to review a company’s accounts before publication, and the right to amend them.
The audit report, currently a pass or fail affair, where the auditors state that the accounts present a true and fair view, could become much more nuanced. At the moment qualified audit reports are very rare, mainly because such a report could easily precipitate a disaster so the company is strongly motivated to make amendments to its accounts, as recommended by the auditor, prior to publication. It is proposed that the audit report in future presents ‘graduated findings’, perhaps more of a ‘marks out of ten’ verdict.
For company directors who are not qualified accountants it is suggested that they be required by law to follow Audit Enforcement Procedures and be subject to sanctions for failure to do so. Auditors might have a clearer duty to report wrongdoers or other serious concerns such as lack of viability.
The PIE effect
Auditing is already a tightly regulated practice but is about to become even more so. The auditing market will be shaken to its foundations, especially if the big four accountancy firms are forced to make their audit services completely independent from their consulting activities. However, these changes apply to those firms that audit Public Interest Entities [PIEs]. What does this mean for smaller businesses and individuals? It is hoped that employees of large companies will feel safer in their jobs and have more confidence that their pension funds are properly funded. Investors should have more confidence in company annual reports; this applies equally to those who indirectly hold shares via their pension funds and ISAs.
Let us not overlook the top down effect. Higher standards for PIEs will in time force up standards for private companies. Directors of SMEs will eventually have to abide by some version of the new regime applicable to PIEs. Auditors of private entities will no doubt have to observe a scaled-down version of the new regulatory regime applicable to public entities. This will certainly place more of an onus on management, so dealing with the auditors will take more time and effort.
Government interference is often resented, but in this case it is likely to be welcomed as a positive step towards restoring confidence in auditing. If you are interested in this theme why not follow us on Twitter. Or you may wish to contribute to the consultation process. If so use the links above.