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How the audit profession has lost its way (and how to fix it)

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A report into the deficiencies of the audit profession by former London Stock Exchange chair Sir Donald Bryden says the audit profession has lost its way. The audit, says Bryden, has become a “credence good” – meaning its actual quality is unknown at the point of use.

Part of the problem is just four firms audit the FTSE-100 companies and while more competition would certainly help, it is up to the audit firms themselves to demonstrate sufficient independence so as to allow regulators to assess the need for competitive intervention. It’s the same story on the JSE, where the Big Four – EY, PwC, Deloitte and KPMG – account for the vast majority of audits of the 40 largest companies.

One of the solutions proposed is joint audits (similar to what is being proposed in SA) though this has not been warmly received. This would allow smaller audit firms to tag alongside one of the larger Big Four firms and, hopefully, create a more competitive landscape.

Bryden’s key recommendation is to make audits more informative to users, particularly where these are Public Interest Entities (PIEs), defined as companies traded on the stock markets.  

Make the audit voluntary

Piet Delport, retired professor of mercantile law at Pretoria University, proposes a radical overhaul of the audit profession – in essence, make it voluntary, which would shift responsibility from the audit profession to the users. “The function of the audit is to provide comfort to investors and creditors. It’s not a blanket guarantee that there’s nothing wrong in the company,” says Delport. “If an investor chooses to buy shares in a company that does not provide an audit, he does so at his own risk. Also, the intention with the voluntary audit option will ensure the market forces will eventually determine if the audit adds value and will shift the focus to what the public – as opposed to the existing stakeholders – require.” 

The introduction of a 10 year audit rotation is the latest suggested reform to overcome the inevitable Stockholm Syndrome that arises from auditors getting too cozy with clients over a long period of time. Delport says the intent may be good, but the costs of switching auditors every 10 years will be huge. “It takes sometimes two years for auditors to figure out what is happening in the company, so the quality of audit during the first years after the change-over period cannot possibly be that trustworthy.”

Audits need to address specific users

Nicolaas van Wyk, CEO of the SA Institute of Business Accountants (Saiba) adds the audits need to have more specificity: “As things stand, the audit is designed to satisfy all users of the information but it is severely lacking.  In the kind of detail different users require. For example, if the company wants to take out a loan with a bank, it should provide an audit that specifically addresses the kind of information that the bank requires. So I could see a time when you have different audits providing different levels of assurance to different users.”

Audit independence

Another suggestion that has been doing the rounds for many years is the establishment of an independent body to appoint auditors on behalf of companies – this would remove any potential bias in having the company under audit appointing its own auditor. Audit fees could also be funded by companies’ insurance providers, which has the dual benefit of better managing insurance risks and improving auditor independence.

Remove audits from the Companies Act

Van Wyk also believes the section relating to compulsory audits be removed from the Companies Act. The JSE’s smaller cap companies are paying as much as 3% of turnover on compliance, which is prompting a move for the exit door. Other markets around the world have introduced much softer audit requirements for smaller companies seeking access to capital markets, and the JSE has been criticised for drowning smaller companies in red take and stringent audit requirements.

Delport adds that auditors can never do more than sign off on a sample of company transactions, though new technologies – something Bryden says will improve the quality of audits – allow for real time verification of 100% of transactions rather than just a tiny sample. “If you have a CEO who is intent on committing fraud, that can be virtually impossible to detect. Take Steinhoff, for example. It would take possible six years to audit what went on there because of the complexity of the transactions.

“All this leads us back to what is the purpose of the audit. Is it to represent the broader public, or – as was originally intended – to provide comfort to investors and lenders? If it’s in the public interest, the audit cannot possibly fulfill this mandate satisfactorily. I think we need to get back to the original purpose of the audit.”

Here’s a brief summary of Bryden’s recommendations.

Recommendations for the reform of the audit

  • A redefinition of audit and its purpose;
  • The creation of a corporate auditing profession governed by principles;
  • The introduction of suspicion into the qualities of auditing;
  • The extension of the concept of auditing to areas beyond financial statements;
  • Mechanisms to encourage greater engagement of shareholders with audit and auditors;
  • A change to the language of the opinion given by auditors;
  • The introduction of a corporate Audit and Assurance Policy, a Resilience Statement and a Public Interest Statement;
  • Suggestions to inform the work of BEIS on internal controls and improve clarity on capital maintenance;
  • Greater clarity around the role of the audit committee;
  • A package of measures around fraud detection and prevention;
  • Improved auditor communication and transparency;
  • Obligations to acknowledge external signals of concern;
  • Extension of audit to new areas including Alternative Performance Measures; and
  • The increased use of technology.

The purpose of the audit is to “establish and maintain deserved confidence in a company, in its directors and in the information for which they have responsibility to report, including the financial statements,” says Bryden.

Audit should be a profession separate from accounting with its own governing principles, qualifications and standards. “At present it is an extension of the accounting profession, whose ethics and (arguably) mindset it largely adopts,” says the report.

It should embrace auditors of financial statements as well as auditors conducting cybersecurity and environmental audits, for example.

What is “true and fair”?

One of the problems highlighted in the Bryden report is the “true and fair” standard that is applied to audits, particularly when so much use is made of estimates and judgments. This makes it difficult to assert that company accounts are “true” in any meaningful sense of the word. Hence, Bryden recommends replacing this wording with “present fairly, in all material respects”.

An auditing profession separated from the accountancy profession, a redefined audit away from true and fair and moving beyond the financials, and auditors suspicious rather than just sceptical are just some of the radical changes proposed in Sir Donald Brydon’s report on the future of audit

“The current audit framework is made up of a mosaic of legislation, statutory and self-regulation and formal and informal guidelines developed over a century,” he says.

“It is no longer capable of fully supporting the expectations of the users of audit. Audit is in need of urgent reform if we are to increase confidence in business and increase the chances of preventing unnecessary corporate failures. I have been given the opportunity to propose a robust framework for the future for auditors and all those who engage with audit.

“I believe this package of recommendations will significantly improve confidence in a proportionate manner and ensure the UK remains a leader in this field.”