The views expressed in this article are the author’s own.
As well as more than 100 pages of ethical standards for auditors, there are 36 International Standards on Auditing with more than 590 ‘shall paragraphs’ and more than 2,000 paragraphs of introductory, application and explanatory guidance. They also include 39 appendices and three annexes. That doesn’t include UK jurisdiction-specific material and some large standards that become effective from later this year, all of which you ignore at your peril.
Under such intense regulatory pressure, firms have adopted the ‘airline risk management approach’ of lengthy checklists that need to be completed during the closedown of the audit.
To add to this mountain of auditing standards, during the past 20 years directors, management and auditors have also had to cope with the advent of financial reporting standards that have resulted in large volumes of financial reporting requirements, interpretations, guidance and checklists. In addition, there have been many other laudable reporting expectations arising from governance codes, statute and regulatory guidance, resulting in yet more checklists. Auditors have also acquired more demanding and time-consuming responsibilities relating to those parts of the annual report beyond the annual accounts.
An analysis of 36 mainly larger FTSE 100 companies’ annual reports filed at Companies House reveals that their average length increased from 83 pages in 2001, to 189 in 2011, to 257 in 2021. These are huge increases, which also include substantial increases in the length of financial statements. However, it seems that reporting timetables have, on average, not become longer. This is despite all the time pressure on audit engagement partners and managers and the level of multitasking that they are expected to perform during the audit closedown.
Time pressure is also exacerbated by the delivery of information from management to the auditors. It can be late, of poor quality, or both. There is also much academic evidence on the impact of this time pressure on the stress levels felt by auditors, which is alarming. These factors combined may be far greater causes of failed audits than the alleged wrong ‘tone at the top’ in audit firms or the influence of other services within audit firms.
Sir John Kingman has wisely proposed in recommendation 23 of his report that the regulator should be required to promote brevity and comprehensibility in accounts and annual reports. Could it be that a major driver behind the current problems may actually be the policymakers themselves, who keep adding to the mountain of standards whenever concerns arise?
Leading audit academic Professor Chris Humphrey has said that “thinking differently is audit”. Building on this, if we are to close the audit performance gap, there is a need to provide auditors with more time and space to think differently, imaginatively, sceptically and beyond the numbers. This is how frauds, even collusive frauds, are found. It would also increase the level of real challenge and professional scepticism. The investors indicated that this is essential to auditing effectively rather than the ‘fill-in-the-box mentality’ that the issuance of more and longer standards is inducing.
So how do we improve things? The FRC Financial Reporting Lab needs two projects that would help. The first is developing good practice in terms of suggested maximum lengths for annual reports, bearing in mind that some sectors have increased complexities. The second would promote a healthy and private discussion between the relevant directors, management and auditors, based on the results of the Corporate Reporting Review and Audit Inspections, as to how the reporting timetable needs to be extended for particular companies.
Policymakers also need to restrain their normal response to issues by way of producing more and longer standards. There should be a priority project by the International Audit and Assurance Standards Board to apply the thinking currently developing on less complex entity audits to the audits of public interest entities, which are also getting choked by standard-setting zeal. The aim should be to reduce the box ticking and increase the quality of thinking, challenge and informing by auditors.
Auditors should ask for a delay in the reporting deadlines where the need arises, but it would be better if the need to do so does not arise at all. To do this, succinct and practical guidance is needed for directors and management so that they help achieve an effective and timely financial reporting and audit closedown.
Auditing standards already make provision for stand-back procedures. But it needs to involve a period when the audit engagement partner and manager, and the engagement quality reviewer, cease all other activities so that they can think in a calm and reasonable way about the financial statements and the evidence learnt about the business. But this should not be turned into a box-ticking exercise.
Accountancy bodies should take a leadership role here and develop a mandatory learning unit on stand back and the wider skills needed of all audit engagement partners and engagement quality reviewers. This should be based on real-world experience of situations supplied by existing and former senior statutory auditors, including those who have gone on to significant roles within public interest entities and corporate finance. A stand back should also not just take place at the very end of the audit, but at other key junctures. The accountancy bodies or the Regulator can also encourage members of audit committees – and indeed, other non-executive directors – to carry out a stand-back procedure.
We should also listen to investors. And we should pay attention to lessons from the past and present, such as BCCI, Parmalat, WorldCom, Enron, Madoff, Carillion, BHS, Thomas Cook, Patisserie Valerie, Wirecard and Facia Group, which factor into my practical suggestions for the stand back. Clearly the time has come for more ‘stand back’ rather than more standards if we are really serious about improving the quality and effectiveness of audit and corporate governance.
Martyn Jones is Chair of the Advisory Board to the Department of Economics and Finance at Brunel University London. He is a former ICAEW President and Chair of its Board. His views do not necessarily reflect those of the ICAEW.
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