06 February 2019 by Peter Swabey
There are three crucial aspects of the audit process that have not been addressed
Audit remains in the news. On pages 32-35 I have offered an update on the future of the audit market, summarising the output from Sir John Kingman’s review of the role and performance of the Financial Reporting Council (FRC), the initial thoughts of the Competition and Markets Authority (CMA) market study into the statutory audit market and Professor Prem Sikka’s review of the auditing industry for the Shadow Chancellor of the Exchequer, John McDonnell MP.
The papers remain focussed on the trials and tribulations of Carillion and Patisserie Valerie – even as I write, the business pages are talking about KPMG auditors being suspended over one and inquiries into Barclays and HSBC over the other. We have also seen the first of the Parliamentary Business, Energy and Industrial Strategy Committee evidence sessions on the future of audit.
It is important that all these disparate initiatives are brought together and it is to be hoped that this is what Donald – now Sir Donald – Brydon’s review will do. There are three important aspects of the audit problem that have not really been addressed by publications to date, and they are all linked together: the purpose of audit and how this can be synchronised with public perception; the fitness of audit standards to achieve this purpose; and how to oblige auditors to do a better job.
We noted in our response to the Kingman review that ‘There is an important education issue here – the political, press and public expectation of the role of audit is very different from what an auditor would perceive it to be’. This was not in scope of Sir John’s review, but I was pleased to see that he welcomed the need for ‘a piece of independent work … to explore the issues arising from the audit expectation gap’.
The CMA undertook some further analysis of the perception gap, which they published as an appendix to their report. This was very useful but the CMA rightly focussed on the fact that the FRC have found too high a proportion of audits to be below standard and that audit quality is a central problem. It is therefore disappointing that their ‘remedies’ focus in the main on supporting the challenger firms rather than on steps to improve audit quality. A far more effective means of increasing competition in the audit market, which should then drive up standards, would be independent evidence that the challenger firms are able to provide an audit of an adequate standard for large, particularly multi-national, companies.
Finally, there is the question of accounting standards – are they fit for purpose and, if so, what purpose is that? There were some impassioned arguments submitted to the CMA to the effect that they do not, and that a focus on compliance with IFRS standards has led to a move away from the principal of the ‘true and fair view’.
If a rebalance here means that the traditional virtue of prudence will prevent some of the ‘restatements’ of accounts which we have seen in recent years – and which in my experience, never enure to the benefit of shareholders, this cannot be a bad thing. I don’t agree with all their proposed solutions, but the submission from Sarasin and Co is particularly eloquent on the purpose of audit and the issue of standards.
One area where I think we do, as governance professionals, need to make our voices heard is around the issue of the independence of the Audit Committee. The CMA stated in their original invitation to comment that ‘Audit is a service for shareholders, but is commissioned by company management’ and that ‘the evidence does not inspire confidence that Audit Committees consistently prioritise quality’. In the first session of evidence to the BEIS Committee inquiry on the future of audit, an academic claimed that there ‘has been a lot of research evidence showing that, although there are all these rules set up to ensure the independence and competence of audit committees, they remain under management power.
A lot of the time the non-execs who sit on the audit committees have been recommended to the board by management, so there are social ties’. I should be interested to see any such evidence as all the feedback that we had from members who are, after all, those who see the committees in action and take their minutes, was that audit committees take their role incredibly seriously and are far from being a management patsy. The CMA are proposing action based on this misconception – we must not allow those who make claims of this sort to do so without producing hard evidence to back up their assertions.