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quarterly issue 3

Five views on the future of audit

Author: ICAEW Insights

Published: 19 Sep 2020

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Pressure is growing on the profession to address the challenges of audit reform. We offer some perspectives on the future of audit, along with an argument for change from ICAEW

ICAEW Perspective, a Manifesto for Audit: Martin Martinoff

Programme Manager, AuditFutures, ICAEW

The Brydon Review has opened a new frontier for audit. While there are a number of interpretations to its recommendations, ICAEW would like to offer something different.

Over the past few years, ICAEW has hosted the AuditFutures initiative as an open, collaborative and iterative dialogue about the future of the profession. To articulate the vision, we have distilled the insights from this work into a number of principles. These principles should inform and advance debate and action on modernising the audit profession. If we want to redesign the audit profession so that it brings out the best in its people, we need to be self-critical. Auditors need to think about the type of society they want to create and consider the wider role and purpose of audit in serving the public interest.

The first principle is that auditors should be able to articulate, uphold and communicate the profession’s social and economic purpose. A vibrant and socially relevant profession can inspire and attract responsive and talented people who want to do work that has meaning and broader societal value. A more motivated profession could identify ways to enhance its economic value to the corporate reporting system.

Our second principle is focused on developing and promoting the identity of the audit professional. The essence of ‘professional identity’ is something that is not a measurable behaviour, as it pertains to virtues and world views. The characteristics of this identity need to be developed through multiple stages of education, reinforced through lifelong learning and practice. A modern profession needs to explore the interdependent elements of lifelong learning that interact to develop this professional identity, as well as professional culture and practice. 

Our third principle is about institutions. Renewed attention on improving audit quality and fostering market competition offers fresh opportunities for firms to show leadership and learn from each other, by sharing knowledge and experience. A modern profession should facilitate learning between firms and create precompetitive environments that advance its social and economic roles. We emphasise the need to foster a collaborative, educational community of professional practice of audit.

The value of a pre-competitive space for audit lies in its ability to unite the profession around a common purpose. We must create physical and mental spaces for auditors to learn and deliberate in order to develop agency and mechanisms for solving problems. 

Our fourth principle is to support holistic professional formation and education. Powerful educational experiences foster a sense of liberation, curiosity and commitment. This requires us to pay attention to the seriousness and practice of theory and learning, facilitating the development of critical knowledge in aspiring auditors. This will broaden their perspectives. 

Our fifth principle is about embracing a ‘designer mindset’ to think differently (and better) about audit. Adopting a solution-focussed, action-oriented design approach will put people at the centre of audit and offers opportunities to think differently about the profession. 

Our manifesto is a bold vision for the audit profession. We are inviting other stakeholders to join us in the spirit of open collaboration and exploration. A modern audit profession needs to reach out beyond its traditional stakeholders. A design mindset could take audit past what is perceived as box ticking to create opportunities to be more innovative, judgement-based and reflective.

Find out more about AuditFutures at auditfutures.net.

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An ESG investor perspective: Leon Kamhi

Head of Responsibility at the international business of Federated Hermes

The audit industry is under pressure to change the way it works. Most recently fraud has been a hot topic. But focusing on this distracts the industry from the chance it has to materially enhance the quality of audit across all enterprises.

The headline recommendation for restructuring the industry centres on the separation of audit from non-audit services, and the reduction in market share of each of the Big Four in audit. We support both initiatives, seeing the clear behavioural benefits of audit having a distinct partner profit pool, while a move to reduce concentration should improve resilience, mitigating the risk of firms failing. Both measures should enhance audit quality, albeit indirectly.

The purpose of audit is to ensure that accounts reflect the company’s underlying performance. To do this, greater consideration must be given to the quality of profits, the treatment of goodwill, revenue recognition and accounting for climate change. Errors, misjudgement and lack of oversight of any of these can skew and mislead presentation of performance and the viability of the whole company longer term. For example, a firm that owned land for commercial development in an area of high flood risk 10 years from now should value that accordingly. If that firm were to go bankrupt, taxpayers will foot the bill.

Auditors should also review performance indicators that go beyond financial outcomes. Take employee data. What are a company’s employee turnover rates (both voluntary and non-voluntary)? How many days are lost to sickness each year? Inclusion is also incredibly important. The reason there is wide availability of gender pay gap data in the UK is because of legislation. How can we get that data elsewhere? These measures are often as objective as financial data are and therefore can be followed and audited.

The governance should reflect the fact that the audit is of a public interest. The board should have an independent chair, and the majority should be diverse and independent, including accounting people and public service expertise. There should be public transparency on activities, particularly evidencing how partner remuneration is in line with the quality of audit delivery.

To maximise profit per partner an audit firm can seek ‘leverage’ by using relatively junior, inexperienced staff to do much of the work – staff who often rely on technology and do not interact with people from the business. 

While innovative technology can certainly make audits more rigorous and cost effective, it’s no substitute for diverse perspectives, business acumen, acute human judgement and robust experience of an industry. This will come from using more diversely experienced employees. 

Audit firms should be careful not to box-tick in carrying out an audit. For example, a Big Four firm seeking to assure our Stewardship Code Statement wanted to rewrite it into what I would describe as an anodyne statement stripped of much of its useful content. All to make it easier to audit – a classic example of putting cart before horse. No change comes without risk but the absence of radical change presents huge risk to the sustainability of the audit industry.

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A regulator’s perspective: Martijn Duffels

Senior Supervision Officer, Dutch Authority for the Financial Markets

Auditing in the Netherlands continues to change significantly. This follows partly from implementation of the European Audit Directive in 2006 and the establishment of the Dutch Authority for the Financial Markets (AFM) as the independent audit regulator. A number of incidents, such as Ahold, DSB Bank, Vestia, have also contributed to significant political scrutiny of the audit profession. 

Recently, the Dutch government commissioned a report from the Committee on the Future of the Accountancy Sector, which proposed changes for the government to implement. These changes target many elements within the financial reporting and auditing chain, aimed at sustainably improving audit quality. (The Dutch Parliament is expected to discuss this in late September.) 

The biggest proposed reform is an overhaul of the supervisory system, and enhanced sanctioning powers. Audit oversight in the Netherlands is split between the AFM, bearing ultimate responsibility and exercising direct oversight of public interest entity (PIE) audit firms, and two professional organisations that inspect non-PIE audit firms. Reforms propose centralising audit oversight with the AFM, and to reconsider and strengthen the AFM’s enforcement powers in regard to significant shortcomings in individual statutory audits.

In response to the AFM’s findings in its report, “Vulnerabilities in the structure of the audit sector”, which outlined market imperfections likely to have a negative bearing on audit quality, other market structures will be r explored further. This will include experiments with the ‘intermediary model’, whereby the appointment of the auditor will be dealt with by an independent body. This is expected to result in the auditor focusing more on satisfying the stakeholders’ needs for quality, and focusing less on the commercial aspects of the auditor’s relationship with the firm. Also, the reviews are also considering ‘audit only’ and ‘joint audit’ models, which includes gathering more insights of developments and experiences in other jurisdictions.

Audit Quality Indicators (AQIs), which are already public, will receive greater prominence. A mandatory annual publication is expected, and the scope of the indicators will be broader. Further work, taking stock of domestic and international experiences with AQIs, is under way to develop the AQI and measurement framework. AQIs are expected to give meaningful information on audit quality, on top of the AFM’s regular reporting on inspection outcomes, safeguards for quality within the firms, and culture and behaviour.

Other measures to be introduced may include a requirement for major non-PIE audit firms to set up a supervisory board to oversee its policymaking. Part of that will be an extra focus on culture and behaviour, which should also contribute to the profession’s attractiveness for students, and focus on the ethics from the public interest perspective. 

The future development of auditing in the Netherlands is aimed at a sustainable delivery of high-quality audits, and maintaining a strong focus on public interest needs. A series of interrelated measures is expected to be approved and implemented to contribute to that focus. This is a lengthy process. While legislation is expected to be proposed this year, implementation isn’t likely to happen until the end of 2023.

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A young auditor’s perspective: Joseph Morgan

Manager, Audit, Grant Thornton

I joined Grant Thornton as a school leaver eight years ago and have seen many changes in audit. Investors, employees and other stakeholders are increasingly interested in information beyond historical financial data. They care about diversity in businesses, their environmental and social impacts, as well as forward-looking information. These are not new concepts; non-financial information is already included within clients’ annual reports. 

The demand instead appears to be for more useful information for the market and more assurance over other aspects. If the scope of audit is enhanced, there will be a need for training to develop future auditors and, potentially, a greater need to bring in experienced specialists. 

All this may also require changes to the auditing standards. Many recognise the need for change. 

Brydon recommended a standing AGM point for audit and the chance for shareholders to submit areas of focus to the audit to audit committee chairs who would respond, accepting or rejecting the risk into the scope of the audit, with explanations. This could be implemented in cases where shareholders have a desire without legislative reform.

If audit becomes more about where a business is going, its impact on people and on the planet then this would continue to help attract and retain talent in the sector.

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An historic perspective: Paolo Quattrone

Professor of Accounting, Governance and Society, Alliance Manchester Business School

Financial value is an intrinsically volatile and subjective measure. The values on financial reports are the result of the mediation of different interests, and value is both fluid and context-dependent. For example, a bottle of water’s real worth is much greater in the middle of the Sahara Desert than it is in central London. For this reason, the idea of ‘transparent value’ is an illusion. Everyone in the financial world understands this at a fundamental level. So why is it that no one is willing to embrace uncertainty as the cornerstone of the accounting framework publicly? Why don’t the press and regulators praise doubt, scepticism and debate? 

Wouldn’t it be better to see a general assembly of stakeholders where auditors worked in the public interest to facilitate the interrogation of financial statements and investigate value?

This approach would be more in line with the reason why double-entry bookkeeping was invented in the first place: to reflect ourselves into our own accounts as if ‘we were looking into a mirror’, to quote the 17th-century Jesuit accountant who was the first to systematise the accruals process. The idea of accruals was invented to prevent a focus on a continuous flow of entries, and instead force us to speculate on our morals. How interesting that the word ‘speculation’ (from the Latin speculum) was once a signal of wisdom but has now become the symbol of the worst of capitalism.

‘Accounts’ were literally narratives; indeed, this is why auditors are called auditors, as they were supposed ‘to listen’ to the story recounted by the accountants and assess whether it made sense – a story that would describe the past but also speculate about the future. Accounts were driven therefore by an understanding that certainty and transparency were impossible, and that wisdom and judgement should inspire their preparation and how useful and valid they were as a result of that.

It is only the acceptance of a lack of certainty that will foster constructive, critical conversations about value, rather than rubber stamping. Ending the problematic commercial relationship between companies and the firms they employ to audit them would be the first trick. Let’s be ambitious. Imagine a new national agency, directed by regulators to collect fees from companies to be audited and then to use this funding to appoint the most appropriate auditors that serve the public interest. Now that really would be magic.