FRC CEO: audit reform still top of the agenda

16 October 2020: In conversation with ICAEW chief executive Michael Izza, the Financial Reporting Council’s Jon Thompson spoke about the drivers for and progress in audit reform, the attractiveness of the profession and the challenges of COVID-19.

The audit market faces a number of factors that could result in significant change. From several reviews into the audit profession, each bringing its own set of recommendations, to the challenges of auditing and reporting during the COVID-19 pandemic. 

Jon Thompson, chief executive of the Financial Reporting Council (FRC) has a unique overview of this. His organisation is going through its own change agenda, and his team are in constant contact with key players across the audit and accounting sector.

ICAEW CEO Michael Izza spoke to Thompson this week for a webinar Q&A about the issues facing audit, the FRC’s response to COVID-19 and how the UK audit sector can stay competitive. He started by asking Thompson about his first year at FRC – what was he expecting?

Not quite what he got, Thompson explained. He joined the FRC in the wake of the Kingman review, intending to reform the organisation in line with some of its recommendations, but halfway through his first year, COVID-19 shut everything down. 

“I think, particularly early in the crisis, we did some fantastic work with the FCA and PRA and the Bank of England: changing the rules of the game, giving more flexibility to companies on reporting, transparency, AGMs and so forth.”

The aim is to maintain some of that agility post-COVID and meet some of the recommendations in Kingman. “You can't turn around an organisation, and the ecosystem that it supervises, quickly. I think we're making some progress. It's been a great year; I've really, really enjoyed it. I’ve met some fantastic people and listened to lots of views. We'll continue to do so.” 

Pandemic priorities: where does audit reform sit?

Izza pressed Thompson further about the audit reform agenda post-pandemic. “Throughout 2018 and 2019, there was a real urgency to keep going with that agenda,” said Izza. “Has that changed today? Clearly, people have got pandemic priorities, but how do you see it from, from where you sit?” 

Thompson does not believe the drivers for change have fundamentally shifted and along with the three primary external reviews (Kingman, the CMA and Brydon) shaping the agenda, there is still substantial public and parliamentary pressure to push on.

Audit quality is not quite where it needs to be, Thompson said, but progress is being made. There is a time lag between the investment that firms are making and the results, as the most up-to-date reports are 2018/19, but the FRC can see the work is being done. 

Izza built on the time lag theme, and asked Thompson about output from investments in audit quality: “Are you starting to hear about any impact positively or negatively from that investment that's being made?”

“We can see massive investment in terms of methodology…” said Thompson. “We can certainly see significant investment in technology, in terms of moving much more towards whole system transactions, exception reporting and much more use of data analytics and so on ... Most importantly, we continue to see significant training in people who are going to do the audit.”

Competition in audit

One big issue is competition in the audit market, said Izza. Some firms feel the risks involved are too great. “What would you say to a firm either thinking about entering or expanding in the PIE market today: what encouragement would you give?”

Thompson explained opportunities are opening up, one being around the definition of a public interest entity. The Kingman review questioned whether the definition was drawn broadly enough, and the government is looking to act on it. Larger private companies may be brought into regulatory scope. 

“That was recommended and has been part of the discussions we've been having to stakeholders this year,” said Thompson. “I think we should expect, in due course, to see the government consult on bringing large private businesses into scope, which could expand the market quite significantly.”

The CMA has recommended joint audits for large firms, which the FRC board is not in favour of. Instead, it proposes a managed shared audit for groups, in which a primary auditor signs off on the accounts but other firms conduct the audit for each subsidiary. This reflects the preference of committee chairs, who choose auditors based on the expertise of the lead partner, says Thompson. 

This also gives smaller firms the chance to build up audit experience with those subsidiaries. “We find that an attractive way to upskill smaller firms’ audit practices and expose them to larger groups, then they can take on larger entities if they want to.” 

Post-Brexit positioning

Izza asked Thompson’s thoughts about the UK’s positioning post-Brexit: “The government is very keen that Britain plays its role in the world. It's looking for sectors in which we can be global leaders, and professional and business services (in which accountancy sits) is one of the sectors that's been identified. There is actually a sector strategy waiting to go at the moment, and the government deems it right.”

Will the UK be a world leader for accountancy? Thompson believes it already is. “The vast majority of accountants are doing great work. It's already a great export for this country.”

Other nations look to the UK for best practice when it comes to setting standards. “The Corporate Governance Code, as you and others will know, is regarded as a world leader. We believe The Stewardship Code is following very closely behind that, in terms of the encouragement for investors to get much more engaged in corporate life.”

The FRC has recently put out a statement encouraging diversity in the profession. Izza asked Thompson for his views on how the UK can retain the best people in the audit sector. Thompson said that the qualification itself was a factor: “It is very portable across our own economy and internationally.”

Challenging reporting period

Finally, Izza touched on reporting: “This is probably one of the most challenging reporting periods that preparers, directors and auditors can ever remember. The issues of being true and fair, balanced and understandable. It's really difficult at the moment ... ISA 540 is coming in, which is all around management estimates. I wouldn't like to hazard a guess as to what the UK GDP is going to be in Q1, and I'm sure you wouldn't either. Have you got any, any thoughts about how people should be approaching this most unique of year-ends?”

The answer, according to Thompson, depends on the company and the market sector. Some sectors are performing quite well, while others are struggling. This does raise a potential going concern issue. “We know it has led to some tensions on occasions between companies and their auditors, particularly because auditors are rightly, in my opinion, thinking very carefully about whether they can sign off the going concern question. What that does is put more emphasis on companies to say: ‘these are our estimates, this is why we did it, this is the underpinning rationale’ …that is clearly going to be a big issue for 31st December audits. It was for 31st of March audits.”

Watch the discussion between ICAEW CEO Michael Izza and FRC CEO Jon Thompson in full here.