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From perception to perfection (June 2012)

The audit profession sits between the proverbial rock and a hard place. Since the financial crisis, its role as watchdog has been brought into question and, in the public’s view, some of the sheen of its professionalism has rusted.

The challenges of communication and auditor reporting were high on the agenda at the Audit Quality Forum. Julia Irvine reports

The audit profession sits between the proverbial rock and a hard place. Since the financial crisis, its role as watchdog has been brought into question and, in the public’s view, some of the sheen of its professionalism has rusted.

Changing public perception is no easy task, as auditors down the generations have learnt. The expectation gap is just as wide as it ever was, despite years of standard-setting and regulation. But if the profession is to regain trust, a key issue to resolve is how to communicate more effectively and transparently with its various audiences.

The auditor’s main tool, the audit opinion, is no longer acceptable in its current form, the FRC’s Financial Reporting Review Panel head Richard Fleck told the Audit Quality Forum when it met recently to discuss audit communication as part of its Global Challenges programme.

“Most people regard the current audit opinion as pretty uninformative,” he said. “It’s black and white, it doesn’t say anything other than what’s been done or what hasn’t been done, and there’s no real transparency about the audit process. It’s very difficult for people to know what weight to give the audit opinion.”

What they want, he said, is to see beyond the opinion, to try and see what the key issues have been, what key judgments the auditors and the company have had to address, and to establish if there were any areas of disagreement. In other words, they want to be put into a position where they are able to assess the performance of the company and its prospects.

Agreeing what information stakeholders want is the easy part, but more difficult is the method of delivery. The Financial Reporting Council (FRC) is consulting on changes to the guidance on its corporate governance code as well as UK auditing standards, and these are designed to result in more information on the external audit being provided to stakeholders in the audit committee report that is included in companies’ annual reports.

The issue is also being looked at by several bodies including the International Audit and Assurance Standards Board (IAASB). The IAASB is studying proposals that may mean big changes to the auditor’s report, such as a requirement for auditor commentary on key areas of emphasis. Auditors may also be required to provide additional information on their work on going concern and other information in the annual report.

Jon Grant, FRC’s international auditing standards director and a member of the IAASB, said that if these proposals go ahead auditors will be required to describe in the audit report “the important things that they spent their time worrying about”.

“That will be very judgemental as what is an area of emphasis will differ significantly from one audit to another,” he says, “so any requirement in the ISAs will be principles-based rather than framed by detailed rules.”

Most people would agree that greater transparency between auditors, audit committees and management is a good idea. Yet in practice, it’s not so easy to deliver, as Gillian Lord, PwC partner and chair of the ICAEW working group on enhancing the dialogue between the auditors of banks and their audit committees, pointed out.

Revealing the full extent of the dialogue between auditors and executive management can be challenging. “Culturally, I think we still find it very difficult, even embarrassing, to talk about the fact that it may have been tough to get to a position which is mutually acceptable to auditors and to executive management. But the audit committee must understand the evolution of this debate if they are to properly evaluate the judgments in the financial statements,” she added.

One chairman of a major UK bank’s audit committee, she added, had told her that what he was looking for from his auditor was “a frank discussion of the issues and of the debate”, the sort of exchange that he might have had “over a pint in the pub with his friend”.

“I think it’s only if we get the internal communication between auditor and audit committee working really effectively then we can hope to reach a position where the external communication gets improved as well,” said Lord. There was also a danger that in upping the lot of information included in the formal reporting, the story of the audit may be lost.

Myles Thompson, head of KPMG’s European technical audit group, agreed. He said that what investors want to see is the information that auditors give audit committees. However, these documents are normally very comprehensive and provide significant detail on the key areas that the audit has covered. They are also supplemented by the detailed two-way dialogue with the audit committee, which enables the committee to better understand the context of the audit work and obtain the auditors’ informal views.

All this is difficult to replicate in a stand-alone report. “It is vital the information provided by auditors is in context and does not create uncertainty in the reader’s mind over importance of the issues,” he says. Thompson also thought that the FRC requirement for audit committees to talk more about what the audit is about is something that probably would not “fly” in Europe, as the idea of audit committees is less developed in many countries. This is why there would be a need for longer audit reports, and he agreed with the FRC’s view that the EU proposal that auditors should report on issues like going concern was possible, but that this should be on management’s assertions. It is for the company to report and for the auditor to opine, he said.

Not surprisingly, the negative effects of the financial crisis ushered in a flock of innovative research projects geared to restore trust in audit. ICAEW is revitalising its long-term project on reliability, Robert Hodgkinson, executive director technical, told the forum.

The project would look wider than just auditing, he said. “You can’t just look at auditing in isolation because it is part of a broader, longer financial reporting supply chain. So we are going to put audit firmly in that context and use it to direct attention at some of the real issues arising from the crisis.”

He added that the project would also emphasise two important behavioural aspects of professionalism: the process of slow thinking (in a reflective and analytical way) and the fast intuitive judgment that enables auditors to spot when things aren’t right.

The Audit & Assurance Faculty is currently working with the Finance Innovation Lab (FIL) on a new work stream, “The Audit Pop-up Lab”, which is investigating trust and the future of the profession. FIL is a joint project between ICAEW and World Wildlife Fund and explores new ways of evolving the financial system so that it sustains people and the planet.

According to Henry Irving, faculty head, the lab will be able to leverage FIL’s reputation and existing convening structure. It would host an event designed to develop a sense of purpose and commitment, strong relationships, and learning and collaborative action around the future of the audit profession.

“Providing direction and promoting dialogue about audit market needs, audit performance and audited financial information through the AQF; driving innovation in the public interest through the Finance Innovation Lab; helping practitioners develop their services under the current standards and promoting the value of audit as a vital part of good financial management – this all-encompassing programme of activity should help unite the financial establishment and public in learning the lessons of the financial crisis and stimulating business confidence and economic growth,” he adds.

The ABC of the AQF

The Audit & Assurance Faculty set up the Audit Quality Forum (AQF) in 2004, at the request of the Secretary of State for Trade and Industry. The AQF aims to promote quality and confidence in corporate reporting. Its Global Challenges work programme covers:

  • How national infrastructures affect audit quality.
  • What makes financial statements reliable.
  • The auditor’s potential role in managing systemic risk.
  • The provision of non-audit services by auditors.

This article first appeared in Audit & Beyond, magazine of the ICAEW Audit and Assurance Faculty, in June 2012.