The Department for Business, Innovation, Science and Trade is consulting on what it should look like. What could it mean for auditors?
Host
Alex Russell
Guests
- David Smith, Director of Quality and Professional Standards at Kreston Global
- Matt Stroh, Audit Partner, Compliance and Ethics, for Azets
- Katharine Bagshaw, Senior Manager, Audit Standards at ICAEW
Transcript:
Alex Russell: Hello and welcome to the first ever episode of the Audit Report, the podcast that looks at the factors shaping modern audit. I'm Alex Russell, and we're going to kick off this new series with a discussion about the long-awaited consultation on modernising corporate reporting. Now, the modernising corporate reporting agenda was first planned for earlier this year, but was paused over the summer. But now it's here, and the Department for Business, Innovation, Science and Trade is now consulting on what it should look like. Much focus, of course, will be on preparers of accounts, but what could it mean for auditors? Joining me to talk about this today are David Smith, Director of Quality and Professional Standards at Kreston Global, Matt Stroh, audit partner in compliance and ethics for Assets, and our very own Katharine Bagshaw, senior manager in auditing standards at ICAEW. Welcome all.
All: Hello.
AR: This is a wide-ranging consultation and a politically important one that's been signed off by Number 10. It's been expected all year, and then suddenly it's upon us. And the intention is to move on it at some pace now. So why is the government looking at this now? Perhaps I can come to David and then Matt on why now and what are they seeking to achieve?
David Smith: As you suggest, it's a it's a very broad consultation, 70 pages of consultation document, a good number of questions that seek to address the underlying purpose and objective of financial reporting, but as a secondary strand, also make a number of rather significant proposals around the assurance framework that we we wrap around financial reporting. And so, this is more than just increasing thresholds potentially because of a an inflationary need or because of the the lag of of inflation over a period of time, this is designed as, and this is being framed as, a significant set of changes that will that will potentially change the face of financial reporting and the assurance framework around it.
AR: And Matt, growth is very much on top of the government's agenda, and it's it permeates this consultation. So, do we have to think about the proposals with that with that in mind, when we're thinking about clarifying the purpose of corporate reporting, looking at these thresholds and exemptions, removing duplication, etc.
Matt Stroh: Absolutely, clearly there is a significant growth agenda in government, and this is an attempt to kickstart that. I think there are going to be some challenges there because I think it creates some barriers to growth, as I'm sure we talk about during the podcast, because it can create a step change at certain points, but it certainly fits the ambition of government to encourage business, be seen to be streamlining, and as David says, you know, stripping back corporate reporting to make it more proportionate and relevant for the businesses to which it applies.
AR: Now, as we said, we're going to focus mainly on the audit and assurance side of the consultation today, because the wider impacts will be discussed in ICAEW's sister podcast Beyond Finance, which you'll find a link to at the end of the notes. So, firstly, in terms of the audit proposals, the somewhat of a bombshell in the audit exemption hike, the proposed extension of audit exemption through all SMEs, smaller medium-sized entities, and this could cause some consternation amongst our members. Katharine, what's the justification for that particular proposal?
Katharine Bagshaw: The justification for this is the same as it always is, which is that audit is a burden which can't be justified. Now they do acknowledge that the audit does have some value, though, and what they actually say is important. So what they say is the government's considering extending the small company exemption to all SMEs, and while statutory audit provides important safeguards and can support access to finance, we are not convinced it is always necessary for medium-sized companies. And then they go on to say the government recognises that the burden of requiring an audit for all medium-sized companies may not be justified, and they're keen to understand whether extending exemption to all SMEs would reduce medium-sized companies' access to lending or other finance, or add a significant premium on the cost of lending. Now, there's a lot of emphasis on costs here, and and and rightly so. This is what it's all about. But while they talk about important safeguards, they don't actually say what they are. So what we're going to need to do as an institute is to balance the cost and benefits. It's interesting that there's no impact assessment. Now they don't actually have to do an impact assessment for this type of consultation, but at some point they will have to, and things like the tax take, the quality of information companies are using to run their businesses, and what happens when companies grow and suddenly do need an audit really will have to form part of that equation.
AR: We talked there, David, about boosting growth as well as reducing costs potentially. So, what could go wrong with these proposals, or the exemption proposal in particular, if we're trying to remove friction and promote growth in that side of the industry?
DS: Part three of the consultation is written in a, I would say, relatively balanced way, in the context that it it does, as Katharine's highlighted there, kind of set out some of the access to finance considerations, and how that can be leveraged in terms of then generating growth for business. In addition to that, it talks about how, for example, should you not be required under a regulatory regime to have to have an audit, and then all of a sudden you're required to have three years' worth of audited financial statements, either for a listing or for raising capital elsewhere to help to grow. Then again, we've got those factors acknowledged within this consultation document.
It doesn't quantify that to any great degree, but in fairness, the government are asking for evidence to support some of these assertions that we will commonly make. I think there's a well-articulated – and we talk about it every time – there are potential increases to audit thresholds. There are clear links between the ability of people to trust a set of financial statements and that linking to the capacity for growth within business.
Again, I think what the government are after here is something more along the lines of some evidence to support those assertions, and we're not the only place that is consulting on factors such as this, or seeking to make some of those changes.
You know, if we go back to Australia in 2019 and doubling the audit threshold there from whatever it was to AU$25m in terms of the revenue figure that's used as part of their rules, or upping the employee threshold from 50 to 100 across there. We've got very similar proposals being made here, and then again in Australia earlier on this year within their budget, an announcement that they were again seeking to double the large threshold that can be the trigger for audit exemption across there to AU$100m, which is visibly kind of the similar type of proposal that we're getting across here.
And again, I think that some of those views that are being expressed are more or less going to be the types of views that we'll be expressing here in terms of the potential risk around such a broad consultation, some of which is focused on financial reporting, which has certain objectives in terms of clarifying the use of financial statements and setting out information that's relevant for those stakeholders, versus how you get comfort over those underlying financial statements, which is more around your your financial governance side of things. And there's potential risk here in terms of conflating those two objectives.
AR: Matt, some are calling this a once-in-a-generation opportunity to look at modernising corporate reporting, and it is modernising. We've heard some views so far that maybe we should rethink the use of financial quantitative thresholds themselves. Are there potentially other ways of looking at how to classify a medium-sized company or a company with certain risk, looking at local regional business, for example?
MS: Speaking as someone who works and lives up in Yorkshire, there are some pretty sizeable Yorkshire businesses and some nearer Manchester, which may be relevant to those making these decisions.
I appreciate that, at those kind of medium-sized levels, it would be very sizeable in the regional economy and beyond. I know JLR would be a much bigger company, but if you look at the trickle down from something like the shutdown of that business over the past couple of years, when it had its cyber attack, and the impact that had on loads of other businesses in the area, you could see some fairly sizeable medium-sized companies if they were to go awry, creating a massive trickle down in a regional or local economy.
So it is surprising that if this is this once-in-a-lifetime opportunity for change, there is still a focus on seemingly quantitative thresholds, and there might be a more subtle way of doing that. And perhaps also just building on this question around the role of audit and assurance, and what we bring. And as Katharine says it's not yet kind of quantified in there.
There's a significant focus on trusting the directors to know what their investors and creditors will want in a set of financial statements. They could be quite different stakeholder groups and can have quite different sets of interests. And there are probably broader stakeholders, employees, potentially pensioners, for example, who rely on the business doing well. I guess they would be captured by the definition of creditor, but they're two or three steps removed. Without that objectivity and independence that the audit brings, how would a director know exactly which disclosures are relevant to both of those stakeholder groups and be able to take an objective decision if they themselves fell into one, as an owner-manager, for example.
AR: You touched on two really interesting areas there that were in the sort of early questions on the consultation. I think David, that sort of refocusing the purpose of the annual report and financial statements to investors and creditors, but also potentially revisiting true and fair accounts and whether the directors and therefore whether the auditors have to have to sign off on that for a certain size of entity.
DS: Now again, this is an area where there is an element of inconsistency around the truth and fairness aspects, insofar as there are parts of the consultation document that talk about retaining and overriding truth and fairness requirement within the Companies Act, there are then elements of the consultation that essentially say no, we'll leave this down to the financial reporting standards and infer almost a compliance-type framework of reporting.
And again, I think there's elements of that that will require clarification to the government in terms of some of the questions that they're asking, not necessarily fitting in with the global assurance standards and the frameworks that we necessarily operate within for consistency. I think that there is a fair amount of fragmentation already globally in terms of what different countries do and different reporting requirements, different assurance requirements that exist. But we do have global standards that can be fit to a particular set of circumstances, and some of the lack of clarity around the consultation at the minute doesn't necessarily help us frame what that overall assurance picture might look like.
AR: And consistency can bring costs down for reporters and auditors as well, can't it? Matt: We've talked about the impact on the SME, the proposed SME exemption for companies, but in terms of the SMP end of the market and auditors, what impacts could that have on that side of it? And do we need that critical mass of auditors at the smaller side to feed into the larger audit market and then potentially the pi audit market?
MS: I mean, absolutely yes. We've got a business model, I guess, as auditors now that you know trains auditors up, and you you earn your spares on different types of complexity audit, and there are different skills involved in auditing a pie audit to a smaller company that perhaps is having a voluntary audit because their creditors or shareholders insist on it, which of course is the case now, or you're part of one of those convoluted ineligible groups which cause all sorts of bother, but we'll deal with that later, I appreciate.
But absolutely yes. I think it would fundamentally change the training model, which obviously we'll respond to because we are business people in our own right, and we'll be able to deal with that ultimately. But it feels like a very significant step for business to go through.
I would emphasise, in terms of those kind of step changes between different tiers of size, and that to me creates a massive barrier to growth for those entities, as well as, of course, not necessarily having auditors or accountants trained to work in and with those businesses, which is a key ground now for finance directors, CFOs of all sizes of business, which I think will be lost. If audit becomes only auditing public interest entities or those close to it, it would look like a very different space to now. And the quality of financial information, the comparability of financial information that lenders, investors, and stakeholders use would change massively.
AR: And you touched on something there. I mean, you were Chair of ICAEW's Council. You'll be aware more than most of what a task we've got in our hands to reconcile the views of our membership from those, as you say, who are CFOs, who are on boards, audit committees, those who are auditors. We might have friendly disagreements on some of these proposals, but ICAEW will have to come up with a firm position.
MS: Yeah, I mean the ICAEW is made up of a broad base of members, as you say. I had the honour of chairing Council for the past three years, I've just stepped down, but I'm still a council member for Yorkshire, so please do channel comments to me, as I know my members do. But it is a broad membership, and we do have to reflect those different views. And whilst obviously audit is a key tenet of what the ICAEW is about, we represent you know... a massive chunk of our membership is in business and we need to respect those views. But as Katharine intimated before, we haven't actually got the assessment in here of how much does a business save by not having an audit and what are the consequences of not having an audit in that medium-size space.
AR: Katharine, one of the other proposals, and this is designed, I think, to enable more medium-sized companies to take advantage of that potential exemption, is a proposed new voluntary assurance standard. So, it hasn't been described what that would look like or who would write that, but we've been here before, haven't we?
KB: Well, yes, Alex. We really have been here before, and this is going to be one of the more challenging areas for us to come up with something constructive in the response. What they've said is that if lenders can gain confidence through other means, or if medium-sized companies have a limited need for external finance, the cost of mandatory audit may not be justified, and they are therefore interested in views on whether a voluntary assurance standard could provide the level of assurance lenders need at a lower cost than that of a full statutory audit.
AR: What are the options then, Katharine?
KB: Firstly, what stakeholders actually want is a less burdensome and maybe less costly audit, something specifically designed for SMEs, not a lower level review, which is something different altogether. And secondly, there's a widely held belief that and some evidence, I think, that unless you actually mandate this type of engagement, and if there's no overwhelming commercial reason to do it, it's very unlikely that companies will voluntarily take it up.
Now, all of that said, things are different now to the way they were in the 1990s or even a decade ago, but the discussions we've had so far on this suggest that there are a lot of very different views about who should be developing this standard and what authority it would have. It might be the FRC, but they might well not want to do it. It might be ICAEW. It could be reasonable assurance. It could be limited assurance, and the starting point could be any number of standards, including, of course, the ISA for LCE, which has already been through due process, but which we know the FRC is strongly opposed to.
AR: We've got a challenge on our hands there, haven't we? Because we could argue that limited and reasonable assurance are poorly understood as they stand now, and certain aspects of audit and what the audit entails. So, David, have we got a PR job, a communications job, to really articulate if there was a voluntary assurance standard, exactly what that's covering, for fear of further expectations gaps?
DS: Yes, I think that one of the barriers to implementation of things like the assurance review engagements that were promoted by the ICAEW 10 or so years ago, has been practitioners' ability to communicate the benefits of it, or to sell the benefits of it, in the absence of a regulatory obligation to have an assurance engagement and audit conducted.
In the event that you removed 10s of 1000s of potential audit customers, maybe there is a greater incentive for an audit profession or an assurance profession to be able to articulate some of the benefits of separate types or different types of targeted assurance, or limited assurance in the whole. But again, there are frameworks that we can apply that kind of derive from global standards that try to seek to meet similar objectives, and so the proposal to maybe knock something up from scratch isn't necessarily the right approach in terms of again fragmentation and enabling firms to take a consistent approach, regardless of the jurisdiction that they're operating in.
AR: And Matt, I think we touched on it earlier. It's not so straightforward moving between limited assurance and full audits, is it? There's sort of a lot of work to do on the company side to get your processes, your controls in place, and it's not necessarily as easy as switching an audit on and off, if you're going between those, or if you're seeking to list later on.
MS: Absolutely, and certainly, our experience, and my experience of picking up new audit clients where they haven't been audited before, you typically find prior adjustments in that first year, because the business hasn't been fully cognisant of the impact of all their transactions and how they're reflected in accounting standards.
They're for relatively small companies at the moment, and we can usually deal with those with the owner managers much more directly, and they understand the implications, and they can talk to their financiers, investors, stakeholders, and we could deal with that. The size of a medium company coming into, well, a large company coming into audit for the first time, there'd be some big numbers flying around that could be incorrect.
And accounting standards haven't got more complicated for the fun of it. At least I don't see any fun in it at all. And however complicated it is, it's only a debit or a credit sitting behind it all, isn't it? But the accounting standards over the years have evolved to reflect the complexity of finance, whether it's different types of shares, different types of debt, trying to avoid significant off-balance sheet financing. None of us want to go back to the dot-com boom, where – what was it? Share options in those days that were off balance sheet, everyone was caught by surprise.
I'm just about old enough to remember when defined benefit pension scheme accounting hit properly for the first time, and suddenly businesses with assets suddenly had massive liabilities because the whole accounting for payments to pension schemes changed and reflected those liabilities in businesses. If a director who's preparing those accounts, and we're trusting them to prepare those accounts, and of course have been paying dividends using solvency statement based on the accounts they've created, and are suddenly exposed to audit for the first time in the business of that scale. We could unearth some pretty chunky skeletons in the closet.
AR: David, another proposal we haven't touched on yet is potential changes to subsidiary audit exemptions. Now they're looking at that. I think some companies' preparers might welcome some of that, but are DBIST looking at the right areas there, or have they missed something?
DS: Good question. Again, the consultation document itself specifically talks about subsidiary audit exemption in the context of Section 479A parental company guarantees, etcetera. It also talks about ineligible groups, i.e. those groups that include maybe something that is more public interest and therefore it taints the rest of the group.
One of the ironies, I think, in the consultation documents that does a relatively good job of articulating just how complex financial reporting and assurance requirements are here in the UK, is that it then forgets some of the additional complexity around group audit exemption and how it is different to small company audit exemption from a financial reporting perspective.
One of the areas where maybe we do see some challenge around public interest and the benefit of assurance or audit is around smaller subsidiaries of overseas, larger public groups. Now that isn't explicitly called out in this consultation as being an area that they're going to look at potential relaxations around, but it's maybe one of those areas that they should be encouraged to take a look at, you know, there are a pool of audits where potentially the stakeholders don't derive a great deal of value, and sometimes the auditors don't always make the hugest difference.
They don't often find significant material misstatements in that subpopulation of audits that they're performing. And so again, I think it's important that the government looks at that from a completeness perspective, and are thinking about where audit is generating value into these growth arguments.
AR: Within that, is there maybe an assumption by DBIST that, under a normal group audit, under ISA 600, that maybe auditors are doing more on those really tiniest subsidiaries, but perhaps if it's left to auditing the group accounts, maybe there isn't risk in those tiniest entities.
DS: Yeah, I mean we've had changes to ISA 600 over the past couple of years that have spun some of this on its head potentially in terms of the way that group auditors are scoping their their audits and those aspects or those components, they're a rounding error in some sets of accounts, and therefore those people that are running the group or are running the overall sometimes significant group can be quite difficult for an auditor to even engage with the real level of management or governance in those organisations from the UK spec.
AR: We're just going to spend a bit of time on some of the other proposals affecting assurance. Katharine, we were talking about expectation gaps a moment ago. One of the proposals is around how much company information is on the website rather than in the annual report in some format. Do you think that will impact the way the audit is seen? Are there risks around that, around expectations on how much the auditor is doing around that other information that's come out of the accounts?
KB: Well, we know from talking to a wide range of stakeholders that despite the disclosures in the audit report about what has been audited and what hasn't, there is a very high level of misunderstanding out there about what's been audited and what hasn't. There are things, there are opportunities to improve that, but of course, at the same time, one of the issues is where all of this information appears, and there have been calls for including a lot of information that's in a very bulky annual report. This is really where we came in to have it in different places for different stakeholders, and we just need to be very careful if we're going to go down that road, and there is an opportunity here to tailor the information for different stakeholders. But we need to be very clear about what the auditors have done and indeed not done to each element of it, wherever that is.
AR: One of the proposals around companies being transparent about the assurance they've sought. So I suppose we need to understand the light of potential assurance, the direction of travel in the audit reform agenda, which has now been scrapped, was thinking about an audit assurance policy. Should we be bringing that thinking back onto the table, or what do we need here?
MS: Yes, of course. To those of us around this table, that would make perfect sense because we understand what assurance is and the different levels of assurance. It's quite hard to imagine that translating from the other side, although it'd be lovely if it did, but yes, I think it's got to be really clear to a user of those accounts what level of assurance has been sought and applied, and that will help explain the context of whatever report goes on those accounts, but for all the reasons we said earlier on, that's quite an ask for the scale of, the breadth of, business this consultation covers.
But at the top end, that makes perfect sense, but you'd expect them to be covered by audit anyway, as you go down the chain. And as Katharine said several times, the previous attempts to come up with the assurance standard failed because no one really understood or appreciated it. How's that going to be captured succinctly in a set of streamlined financial statements, which this consultation aims to produce?
AR: Something important we need to get across to DBIST in our response. I'm going to finish on a question for David. It is modernising corporate reporting and some of the proposals include more around digital tagging and XBRL. Do you think that's a step in the right direction? Do you think perhaps AI is superseding that, or do you think that will improve the information investors get, or is that sort of more useful for other stakeholders?
DS: I think when it comes to providing assurance over things like tagging, if we're thinking about genuinely once in a generation, opportunities, or I think in the document it talks about okay something that will sustain for the next 10 years or more.
There's an argument that we maybe need to think bigger around some of the technology and some of the assurance that could be by design within some of the proposals that are in this consultation. If we talk about taxonomies where it specifically calls out assurance over taxonomy, and thinking about well, hold on, how can we design that component of the financial reporting ecosystem to build assurance by design, such that you don't necessarily have to, I suppose, call and tick in that particular regard to a specific taxonomy?
Again, if we're looking at the underlying fundamentals as to the debits and credits that are pulled into a set of financial statements, longer game in terms of the genuine once-in-a-generation opportunity we've got, is that there are far more ways to automate, if not through AI, but to automate certain elements of the assurance system by design.
AR: So we should look to future-proof where possible. We're not sure when we'll get another opportunity like this.
DS: I think what we're doing here, or indeed what the government is proposing in a number of areas here, is rightly around the financial reporting, an acknowledgement that there have been a lot of incremental changes year on year on year. Different government objectives and policies that have squirted their way into a set of annual reports that don't necessarily hold value when you look at them collectively.
I think we have to be very careful when it comes to then mixing up good financial governance with that, in the context that… look, if I pay for a gym membership, then there has to be some control in there to make sure that I'm going to go and attend the gym. If I have a personal trainer and they're going to show up whether I want them to or not, it will drive a level of behaviour into me that will make sure that I remain disciplined. And I think, if we're not very careful around some of the implementation around these proposals, we potentially end up in that 'I've got a gym membership, but I don't go to the gym' category, and that's potentially dangerous when it comes to assurance.
AR: On that note, I think we'll put an end to the discussion on those proposals. Katharine, we'll of course be carrying on working with DBIST on the direction of travel, on the Modernising Corporate Reporting response. Can you say a little about how ICAEW members can get involved?
KB: We are consulting very widely on this with a very wide range of members and committees, and indeed people outside ICAEW. We have kicked off a member survey that's available to all of our members about questions in the consultation. The consultation itself has 60-odd questions in it. This hasn't. It's very short, and the link to that consultation is in the notes to this podcast. So please do have a look at that.
AR: And of course, we've got till the end of November for us to respond to it. So, thank you very much, Katharine. Well, that's it for the first episode of the audit report. Thank you to David, to Matt, and Katharine for joining me. Hopefully, we'll have you back in the future.
KB: Thank you.
DS: Thank you.
MS: Thanks very much.
AR: You'll find links to technical details, guidance, and other useful information in the show notes, including how to get involved with the consultation, as Katharine mentioned, remember this podcast also counts towards your CPD, so be sure to log it on the ICAEW website. And we'll be back in a couple of months with our next episode, which is being shaped at the moment. So be sure to subscribe to the podcast so you never miss an episode, and give us a rating and review if you found this helpful.
Thanks for listening.
