Proposed changes to auditor reporting will be embraced by the profession
The auditing profession has had just over one week to digest and reflect upon the BEIS Committee recommendations for the future of audit.
Whilst some of the BEIS report is heavily critical of the profession, most auditors would probably agree that the audit, as we know it, needs to evolve. The business environment continues to change at a breath-taking pace, with the arrival of new technology and business models, and audit must also keep up.
None of this is new to auditors. The profession has continuously had to reinvent itself in response to external factors. Albeit the current rate of change, and the amount of scrutiny and criticism of auditors’ work, is at a level not seen before, not even in the aftermath of the global financial crisis.
If we turn the clock back seven years to 2012, the UK was in the midst of the debate on the EU audit reforms which would introduce mandatory audit firm rotation and further restrictions on the provision of non-audit services. Much of these were tabled in response to some of the high-profile failures in the banking sector and what were described in certain quarters as audit failures.
At the same time, having listened to demand from investors for greater insight into the ‘black box’ of audit, the UK led the way by requiring the inclusion of more informative material in the auditor’s report for the largest UK companies. By introducing this requirement, the FRC was a few years ahead of the international standard-setting body, the International Auditing and Assurance Standards Board (IAASB).
The new UK auditing standard went much further than the proposed international standard and continues to do so. The FRC made it a requirement in 2012 for the auditor to state their materiality level in the auditor’s report accompanied by an explanation of how the concept of materiality had been applied. This development alone has been widely welcomed by investors as a means of providing greater insight and transparency into the audit process and of encouraging greater investor engagement with companies.
Around the same time, the new enhanced reporting requirements led to one of the Big 4 firms, KPMG, introducing a new basis of reporting, one that moved away from the binary style audit report (i.e. pass/fail) to one which presented more graduated findings. Once again this was widely welcomed by investors who were provided with details of the auditor’s assessment of management judgements and estimates.
These findings were described by the auditor on a range between those considered to be optimistic and those considered to be cautious, highlighting how the concept of professional judgement had been applied to the areas concerned. This information gave investors greater insight as to how aggressive, or conservative, an approach the entity in question had adopted in the way they had accounted for certain matters. It was disappointing, however, that use of this new approach was only agreed by a small number of the firm’s clients and, as a result, it was not adopted to the extent that either the firm, or investors, had hoped. Equally disappointing was that this approach was not mandated based on investor feedback.
How encouraging then that both the BEIS Committee and Sir John Kingman proposed that the FRC should make the reporting of graduated findings mandatory in the UK. This proposal will be welcomed by many auditors and investors, after all it was the auditors who initiated it. But what we need is for companies and boards to also embrace the graduated findings approach to auditor reporting in order for it to be truly successful in enhancing the value of the audit and potentially helping to close the audit expectation gap.
Since the BEIS report was issued, Sir Donald Brydon has issued his Call for Views on the quality and effectiveness of statutory audit in the UK which will also no doubt explore the merits of the graduated findings approach.
Meanwhile, I have no doubt that the UK auditing profession will continue to innovate and experiment and willingly work alongside the relevant stakeholders to ensure that the statutory audit, which underpins our capital markets, remains relevant both now and in the future. However, that will only happen if the corporate and regulatory environments support and endorse these endeavours to create an audit of the future that is truly fit for purpose.