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Under the microscope

Are international auditing and ethical standards fit for purpose?

That was the question raised by the Monitoring Group in 2017 when it issued a consultation on the basis on which standards are made.

The main concerns of the Monitoring Group – the multinational body responsible for governance and oversight of the process for setting international audit, ethics and education standards – went to the heart of its remit. First was the perception that the standard-setting process is in the pockets of the audit profession; second, whether the process really meets the public interest.

The Monitoring Group took the unusual step of asking a third party to analyse responses to the consultation – a step which was all the more surprising given the lack of agreement with the core premises of the consultation. Two-thirds of those who responded disagreed with the Monitoring Group’s contention that there should be significant changes to the standard-setting process – a process which they felt had yielded high-quality standards that have gained widespread acceptance. They also did not think there was any credence in the view that the accounting profession exerted undue influence on the process, and saw no signs that the current standards were not developed in the public interest.

If the Monitoring Group thinks there is a public interest issue, why do most commenters think otherwise? Different people have different ideas about where the public interest lies. Some believe that the public interest sits in the capital markets, for example, and that the International Auditing and Assurance Standards Board (IAASB) has a mandate to serve capital markets.

The Monitoring Group’s membership could explain its equating capital markets with the public interest as it includes international financial institutions and regulatory bodies such as the International Organization of Securities Commissions, the Basel Committee on Banking Supervision, the Financial Stability Board and the World Bank. For others, the public interest lies in financial institutions and huge multinationals as after all, we all use the goods and services that these companies provide.

The power of small

But might public interest extend to smaller entities because of their economic significance? Small companies matter the world over because they provide stability in society, far more employment than people realise, and they make a huge economic contribution.

The perception of auditors dominating the standard-setting process owes much to the way the process is managed and funded. The International Federation of Accountants (IFAC) Council and Board manages the nomination process for the audit, ethics and education standard-setting boards, while directly funding, accommodating and providing support and staffing for them.

What’s more, most of the board members and their technical advisers are from audit firms and professional accountancy bodies. The Monitoring Group proposed creating a single board to set audit standards and ethical standards for auditors. The new board would have no fewer than 12 members, both full time and part time, and they would be drawn equally from three main groups: users, regulators, and auditors.

There was widespread disagreement among those commenting on the consultation on the idea of having a single board, a view that is shared by ICAEW. “There’s a feeling that the Monitoring Group is driven by people who forget that ethics applies to accountants other than auditors,” says Tony Bromell, ICAEW’s head of integrity and markets.

He believes there is some confusion about IFAC’s role in the standardsetting process. “It’s probably very sensible to remove the nominating committee from under IFAC’s remit. But realistically the three boards already run themselves independently. Yes, the staff they use happen to be legally employed and paid by IFAC. But they work for the boards, not for IFAC.”

More of an issue is the fact that the boards, particularly the IAASB, are understaffed so use experts seconded by the largest firms. The Monitoring Group wants to end this by employing more staff at an appropriate level as well as trimming the board sizes to speed up the process.

“At the moment 48 people sit on the IAASB and they speak many different languages. If you cut the board then standards may be approved faster than at present,” says Katharine Bagshaw, audit standards manager at ICAEW. “But you will lose the consensus of members going back to their home nations to say, ‘We really need to implement this’. Consider the quality control standard. This was first discussed in 2016 and will be implemented sometime in 2020 or 2021. If you did it in half the time, would there be too little buy-in or would you end up with something that’s almost as good? That’s the concern of many of those responding to the consultation.”

Back to basics

The Monitoring Group’s idea of increasing representation is to have more regulators and investors on board, says Bromell. “But that isn’t the sum of the public interest. And you do need to have enough people who know how to apply the standards in practice so they can say when something is unlikely to work or to suggest another approach that might be more efficient.”

The question underlying all this is: do the Monitoring Group’s proposals address the real issues with audit? Bagshaw thinks the Group has not really made a case for its proposals. “They have not explained in what manner they feel the standard-setting process is broken and, more importantly, the connection between their proposals and the brokenness. Assume the standards could be improved. If you write better standards, will you get better audits? Perhaps. But it isn’t the whole story.”

There’s a sense of moving deck-chairs rather than looking at the main issue, says Bromell. “The real problem is the expectation gap. The Monitoring Group might not see this as being part of their remit but we think they have a role here. Suppose the Brydon review [into UK auditing standards] comes up with something radical and it’s agreed and introduced into the UK via legislation. “The Monitoring Group, with its membership of international regulators, seems well placed to say: ‘We think the UK has come up with a good plan for the future of audit and you should consider it’.”

SMEs bear the brunt of complex standards

Since ISAs are written using a onesize-fits-all approach, small and medium-sized company auditors often find themselves facing a barrage of mandatory requirements which are long, difficult to follow – and expensive to implement.

Nigel Hughes, managing director of Totteridge Associates, says there are some 700 mandated procedures in the 1,000 pages of ISAs. “Every auditor has to consider all these issues, even if it is blindingly obvious that they’re not relevant.”

Scale is the biggest problem, thinks Hughes. “ISAs represent a sensible framework for carrying out audits. They concentrate on assessing and addressing the risks, documenting the work done in reaching a rational conclusion. But there’s a conflict between flexibility and the sheer scale of the documentation required and the number of procedures an auditor must carry out. So smaller practitioners are more worried about not ticking a box, making it more likely that they do not do the things needed to assess the risks involved.”

Hughes is not a fan of the idea of introducing a separate standard for less-complex entities. “The auditor has to do the work needed to be satisfied that the accounts show a true and fair view in order to fulfil their statutory duty. To say one set of standards applies to ‘big’ audits and another to ‘small’ doesn’t really square with that.”

He would like to see a return to principles-based standards which would apply to all audits with guidance or mandatory requirements for specific issues or situations. “An audit should start with a thorough understanding of the entity’s business model. That way the auditor is likely to assess the risks properly and adopt an intelligent approach that can currently get overwhelmed by the sheer volume of material present in today’s ISAs.”

Originally published in Economia on 6 June 2019.