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ICAEW submission to Sir Donald Brydon's Independent Review

Announced in December 2018, following the important work of Sir John Kingman and the CMA, Sir Donald Brydon’s review is looking at the scope of the audit, how far it can and should evolve to meet the needs of users of accounts, what other forms of assurance might need to be developed, and to define and manage any residual expectations gap. Below you can find the main points in ICAEW’s written submission, as well as the full submission to Sir Donald Brydon’s Call for Views to inform his Independent Review into the quality and effectiveness of audit.

A New Vision For Assurance

ICAEW Submission

Read ICAEW’s full written submission to the Independent Review.

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The so-called ‘expectation gap’ in audit is not new – it has developed over many years. Previous attempts to address it have been gradual rather than fundamental, and in the process failed to have a meaningful effect. The Brydon Review needs to think differently and embrace generational reform rather than incremental change – this is an opportunity to tackle the key challenges in a coherent, comprehensive and conclusive fashion, helping to restore trust in audit.

In response to Sir Donald’s comment that, in the debate about audit, ‘the voice of the ultimate user has been curiously muted’, ICAEW is recommending consideration of a radical new three pillar model of User-Driven Assurance directed by the needs of shareholders, and comprising a range of assurance outputs and involving multiple providers. This would require significant effort to develop and implement, but could be an effective way of meeting the needs of all users – and finally and fully closing the expectation gap.

The first pillar in User-Driven Assurance should be an improved version of the statutory audit product with a renewed focus on avoiding disorderly failure, fresh thinking on fraud, better audit reporting and championing proportionality to address the delivery gap. The second pillar would be provided by a range of other assurance engagements – as now. Building on this proven approach, the third pillar should be a significant empowerment of shareholders through new voting rights, enabling them to require the commissioning of assurance on a flexible and discretionary basis.

A Better Core Product

ICAEW believes that the core audit product for shareholders – the statutory audit – remains essential, but it must be improved to address the delivery gap. This can be done through a renewed focus on avoiding disorderly failure, fresh thinking on fraud, better audit reporting and championing proportionality.

Avoiding Disorderly Failure

The internal control responsibilities of directors and auditors can, and should, be strengthened – ICAEW recommends the consideration of the development of a robust UK framework based on the current duty under the Companies Act for companies to maintain adequate accounting records, and the current framework used by companies floating on markets such as the London Stock Exchange to fulfil their regulatory obligation to establish procedures that ‘provide a reasonable basis for them to make proper judgements on an ongoing basis about the company’s financial position and prospects’.

Viability reporting should be improved alongside the introduction of a new assurance requirement – investors want a ‘better indication that companies are looking at the longer term’. At the heart of this is more robust and more focused risk reporting on the business model, so we need to examine how such reporting can be improved to provide a clear indication of the principal factors that could reasonably be considered to affect viability.

The capital maintenance regime must be revisited and ICAEW has been calling for investigation of the merits of a solvency system for some time. However there should also be a frank debate about the level of capital which shareholders want to support a business.

Fresh Thinking On Fraud

The public expects auditors to detect material fraud, and ICAEW, alongside other professional and regulatory bodies, need to support them robustly in their duties. Looking further, there needs to be fresh thinking to recognise how and when fraudulent reporting occurs and make sure that management, boards and auditors are equipped to address this.

Whistleblowing has an important role to play – more could be done to ensure that channels that enable or require whistleblowers to share their concerns with the new regulator are effective in encouraging these individuals to come forward. This requires careful definition of who may have a duty to blow the whistle and how such duty is framed, while ensuring that a duty to report does not discourage voluntary disclosure.

Better Audit Reporting

Extended audit reports have increased the value of the audit, however we can go further. ICAEW believes there should be an exploration of improving audit reporting, along with other communication between auditors and users. One way this could be done, for example, is the use of graduated auditor findings, which would include commentary on positions adopted by companies.

Championing Proportionality

A proportional regulatory system recognises and reflects the different risks and incentives of Public Interest Entities and small owner-managed businesses. Robust regulation is crucial for Public Interest Entities where ownership and management are separate, however the access to appropriate professional support is a key factor in the success and survival of small owner-managed businesses.

Better Regulation Principles

The problems witnessed with audit are in many cases simple failures of conduct or quality – they demand simple, but robust responses which focus on the core objectives of audit. The application of the Better Regulation principles is incredibly important – a rigorous impact assessment of the recommendations proposed not just by Sir Donald’s review, but also those from the CMA and Sir John Kingman, as a complete package is essential. This has yet to be carried out and Government’s Better Regulation Framework suggests it should.

The Role Of The Professional Body In Reform

In making suggestions for the future of audit and assurance, ICAEW recognises the importance of our own role and responsibilities as a major professional body, and the potential for us to do more. This starts with explaining better to those with an interest in audit and the audit profession what we and our members do.

Equipping Members To Meet Both Current And New Public Expectations

ICAEW recognises that changes arising the reform of audit will place new demands on our members – with any extension of audit’s scope, we need to ensure those doing it can deliver what the public expects to a high professional and ethical standard. We also need to demonstrate that our qualification and CPD requirements can adapt to meet these new demands, and provide members with appropriate advice and guidance on technical and ethical issues and developments.

Encouraging And Contributing To The Policy Debate

ICAEW will continue to consult extensively with our members, working groups and committees in determining the way ahead. The debate about the future of audit will carry on following the conclusion of this Call for Views, so we will be active in encouraging discussion in coming months. One area of focus will be the attractiveness of the profession – the degree to which firms can recruit and retain the best people – and assuring the quality of future professionals.

Developing New Thinking

The Audit and Assurance Faculty at ICAEW is currently producing a series of succinct thought leadership essays considering a range of issues directly or indirectly relevant to the policy debate. These essays, and events related to them, are intended to help directors, politicians and policy makers understand the key issues and will, inter alia, help to inform the various reviews currently in progress.

UK Global Leadership

While ICAEW fully acknowledges the significance and impact of recent corporate failures, and the need for fundamental change, we believe it is important to recognise that the UK audit sector operates to rigorous professional and technical standards, and is recognised internationally as high calibre.

Sir Donald Brydon’s review provides the opportunity for the UK to show global leadership in developing solutions to challenges being faced globally – we should not hesitate to seize this opportunity. It is also important for the UK to maintain a fair, open, welcoming economy for inward investment – robust audit and corporate reporting are a key part of this, but it must not be at disproportionate cost.