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Audit reform: getting five out of three

Author: Michael Izza, CEO

Published: 21 Feb 2020

The trinity is complete: Sir Donald Brydon’s independent review into the quality and effectiveness of audit now nestles alongside Sir John Kingman’s review of the FRC (which came out in December 2018) and the CMA’s market study of statutory audit services (published in April last year).

Between them, they have put forward something like 157 remedies and recommendations: I trust that near the top of the in-tray of the new Secretary of State at BEIS is a plan for how all these can be refined and reconciled. And then, turned into new regulations and laws which both make sense, and make a difference. Clearly, Alok Sharma’s professional background gives him a flying start, but that is still a pretty tall order.

However, I believe the tenor and the tempo of the debate can now change. Necessarily perhaps, but the profession’s approach over the last two years has been iterative, as it responded to a string of inquiries, reports and controversies, as and when they emerged. Due process will now unfold – maybe four more consultations this year and then another twelve months or so of legislative procedure - but we do not have to wait passively while that happens. Now that the parameters of the challenge have been defined, there is an opportunity for us to show initiative – and every indication that such a move would be welcomed by Government and the FRC. In that spirit, ICAEW has been looking forward to what the net effect of the forthcoming reforms should be, and we can see five clear goals. These constitute not just a set of desirable endstates against which we can assess any individual proposed measure or combination of measures, but an agenda for action. There is much we can do to make them happen.

1. Establish ARGA

The first must be to establish ARGA. We are not alone in seeing an effective regulator as the prerequisite for serious reform, but the current BEIS timetable for doing this, by April 2022, runs the risk of making the perfect the enemy of the good. I am second-to-none in my admiration for the energy and skill with which the new leadership at the FRC have played the hand they inherited, but they (and we, and UK business, for that matter) deserve better. Of course it would be neat and tidy to have ARGA spring fully formed into existence, once its remit has been ratified by Parliament, but that overlooks the cost of letting the FRC limp on until then. The changeover needs to happen as quickly as possible: Sir Jon Thompson and Simon Dingemans have good instincts and good ideas, but without a fresh organisational start they will struggle to maintain momentum. Formal new powers can be added later, but we should be careful not to weigh ARGA down with multiple priorities or unrealistic expectations.

2. An inclusive audit profession

Next comes an inclusive audit profession. There is much in Sir Donald Brydon’s future vision for auditors which we support, not least ensuring that the role has the status to attract and keep the best talent, and to operate effectively in competitive and hierarchical organisational environments. As well as core skills in finance and business analysis, auditors should also possess specialist technical, forensic and cultural expertise. Although chartered accountancy would continue to be one possible (and, I expect, well-travelled) route into the audit profession, entrants from a wide range of non-accountancy academic and vocational backgrounds, of comparable standing and relevance, should be eligible to train and qualify.

3. A more reliable core audit

The third goal might sound slightly retrospective: we need a more reliable core audit. In his speech at Chartered Accountants’ Hall last week Sir Donald Brydon put it well: ‘…what all stakeholders want to know is: is this company being honestly run and is it likely to have a future?’ Auditors need a renewed focus on internal controls, going concern and viability and fraudulent financial reporting. When audit quality is a contributory factor in business failure, the problem generally involves one or some of these three fundamental areas. We can and should improve.

4. On-demand audit extras

Fourth is something new – on-demand audit extras. Assurance of virtually any area of corporate activity is possible, from sustainability delivery to cyber security to human rights compliance, and we would welcome a mechanism which allowed additional checks to be commissioned by a range of stakeholders, to supplement the statutory audit. Not only does this reflect how 21st century business is evolving, with many mission-critical aspects of corporate performance not being visible through traditional financial reporting, it may also increase competition and choice in the market by encouraging the development of niche providers with particular assurance specialisms. That said, all providers, in all areas of assurance, will need to operate to agreed and adequate standards.

5. Pre-tested requirements

Lastly, we have a category which I will call pre-tested requirements. The three reviews contain many ideas for extending the auditors’ mandate and intervening in the audit market – such as new public interest statements, new internal controls attestations, new resilience statements, enhanced communication of judgements, and the introduction of shared or joint audits. Not all of these will work very well, some of them will not work together - and a few of them might have consequences which are neither intended or positive. We therefore conclude with advice that Government looks – and listens - very carefully before it leaps: that it considers, carefully in advance, the impact of new measures on the financial reporting system and the wider attractiveness of the UK as a place to do business. That might sound like common sense, but there is more legacy bad news in the pipeline (not least further reports on the Carillion collapse in January 2018) and it will take considerable ministerial nerve to proceed in a pragmatic manner as public and political pressure grows – understandably - for urgent and radical action.

ICAEW will push these five goals as a way of judging the potential effects of the reform programme, using them as an agenda against which individual suggestions for technical, regulatory and legislative change might be measured – and supported or criticised. We will continue to be ready to discuss specific proposals in detail and in depth, but we will do that - as far as possible - with achievement of these goals in mind. It is also worth saying that although the scrutiny on audit to date has almost exclusively been on the FTSE 350 and the PIE market, we believe there is scope for successful measures of reform to apply, proportionately, to audits right across the economy. All told, there is still some way to go: we are perhaps only half way through the process of review and reform which started in early 2018, but a firm sense of what the final destination should look like will make the second half of that journey a lot easier.