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The Future of Audit: Trust

Auditing is a powerful tool in providing investor confidence in financial statements and supporting economic growth. But an expectation gap exists between what audit does and what stakeholders would like to see it do. The Audit and Assurance Faculty argues that with auditing under public scrutiny changes are necessary to enhance trust and confidence in auditing.

A call for action

Enhancing trust in audit has always been a priority, but more than ever before the profession needs to drive forward this agenda to ensure that it remains relevant to stakeholders.

Disruptive technologies, such as big data, and increased challenges around relevance and transparency provide an opportunity to open up the dialogue. The Audit and Assurance Faculty believe now is the time to act and it is calling on all stakeholders to take action to ensure trust in audits:

The audit profession Professional bodies should review the need for a broader skill set within the profession, the mix and diversity of the people it might need and the breadth of professional education that is likely to be required in the near future to ensure auditors and assurance providers have the capabilities that will be expected of them.
The Audit Quality Forum might convene a discussion of the issues raised with all market participants with a view to developing an action plan that aims to strengthen trust in auditors.
Auditors The need for the highest standards in audit work is paramount. Audit failure is toxic to reputation and must be avoided. In considering the risks their audits address they need to consider threats to assets that aren’t on the balance sheet, as well as those that are, to ensure value is subject to scrutiny more broadly.
Auditors need to inform the market about the good work they undoubtedly do, but that doesn’t get referenced in an audit report. Much is preventive of company failures, but happens behind closed doors. It could helpfully come into the open.
Standard setters Standard setters involved in corporate reporting should consider whether the current, largely financial and printed, annual report remains the appropriate bedrock for corporate reporting, and how technology and investor notions of value might be better reflected in it.
Audit standard setters should consider how wider reporting should be assured and how technology may well be utilised in delivering it in future. Standards may well want to deal with principles rather than static modes of delivery in a changing environment.
Stakeholders Stakeholders and investors in particular have shown some reluctance in saying what assurance they really need from audit. There needs to be a dialogue with market participants to determine what they may wish for and what can be feasibly delivered.
Regulators Regulators should encourage experimentation in reporting as part of a drive to best practice, and should promote wider assurance reporting, within the audit context, where there is demand.
Companies Corporates should examine their own bandwidth and resource to deliver reporting that may well be wider in scope and might be reported upon more fulsomely.

The need for action

Corporate reporting informs markets of the position and progress of companies. Markets depend on it as a source of information for decision making. If it lacks integrity investment decisions can be made on the basis of flawed information and, ultimately, markets can become dysfunctional.

While not all corporate reporting is audited, the annual issue of an audit report accompanying financial statements acts as a cornerstone for other stakeholder communications which can be referenced back, or forward, to the company’s (largely “audited”) annual report. The audit process is therefore one which delivers trust to corporate reporting, perhaps more widely than just at a point in time each year.

The expectation gap

Despite the important role of auditing in assuring corporate reports, we continue to see scandals, both financial and behavioural. These are generally accompanied by cries of: “Where were the auditors?”.

This issue is not entirely new; no system is fool proof and an “expectation gap” has long existed between what auditors actually do and what some stakeholders and commentators assume their obligations might be. Yet the incidence of such scandals and their impact seem to be greater than ever before.

One can speculate whether this is a consequence of greater transparency, more effective regulation, changing expectations of corporate behaviour or some combination of the above.

Auditors are not blameless in this regard and the scrutiny they are rightly under requires their work to be of the highest standard and to be alert to the changing needs of stakeholders. Those changing needs are not reflected in an audit infrastructure built for 19th century commerce, one that is outdated and largely immobile.

We now live in an increasingly uncertain world (one which can even countenance “alternative facts”) and it is right to look again at whether audit should, or can, provide the trust in reporting which stakeholders might demand. The auditor’s licence to operate, protected by law, will be under threat if changing needs are not addressed.

The required qualities

This is not to suggest that those who set standards for auditors and those who regulate them have been idle. For example, the insights in longer form audit reports have been well received by investors. However, much reporting is not itself subject to audit.

What then are the qualities that would give rise to trust in audit and by extension to corporate reporting and the underpinning technology which supports the finance and accounting process?

  • Capability: Auditors must have a depth and range of skills that equip them to meet the challenges they face.
  • Effectiveness: Auditors must carry out their duties diligently, using the best tools and techniques to achieve their audit objectives.
  • Professionalism: Auditors need to display objectivity, independence and an appropriate degree of experience.
  • Relevance: The subject of audit must be relevant to the intended audience.

Still relevant?

Relevance is increasingly a challenge. Many of the governance and financial scandals of recent years have been less about immediate past financial loss (the historical subject of audit) and more about behavioural issues. This suggests that management either is not in sufficient control, that it condones inappropriate behaviour for the sake of short-term results (and therefore perhaps for short-term personal pecuniary gain) or, indeed, that it just doesn’t care very much about certain groups of stakeholders.

These issues all go straight to value, irrespective of immediate financial loss through error or fraud. With 80% or more of companies’ stock-market values being assets that aren’t on a balance sheet auditors are only examining, in strict terms, those that are.

These non-financial assets may well be expressed in financial terms, such as the future expected value of cash returns to investors, but the reality is that to a large extent they represent the value of a company’s people and their collective skills and the reputational and brand advantages they create or maintain.

These assets (or their stock-market measurement) are the ones that scandals quickly erode. They are unlikely to directly affect the values of receivables or payables, which will have been subject of much audit effort.

Can the audit really be wholly relevant when it deals with a small part of company value, or do audit committees have to augment their stewardship function by seeking assurance over the culture of the company and its practical application of good governance through its critical operations?

Such assurance could be provided by individuals or organisations without audit qualifications and might be a disrupter of the current audit profession.

The technology dimension

Technological advancement introduces a new dimension to the concept of relevance. The volume and complexity of data companies are now able to access and analyse, opens up significant opportunity for audit and assurance to be even more valuable, relevant and responsive to stakeholders’ changing needs.

However, the advance of new technologies also introduces new risks to companies both in terms of potential disruption to markets and the need to have comfort over the robustness of the underlying platform and code behind the technology.

Used effectively, this increase in data allows stakeholders to identify anomalies and concerns in narrative and verbal communications from companies. We explore the impact of technology in more detail in our examination at the impact of technology on audit.

The educational needs of auditors must keep pace with technological changes and with any moves to align relevance of reporting and auditing and assurance with corporate value, both in initial training and in ensuring continuing professional competence.

A narrow professionalism

The challenges to professionalism are less straightforward. ICAEW’s AuditFutures initiative highlights the increasing sense of a “social purpose” for the audit profession. It regrets that the profession labours within “technical and defensive debates”, rather than “removing opacity in the public interest” and using empathy, reasoning and a broader multidisciplinary technical skill set.

Those matters relating to capability and effectiveness are clearer and are not negotiable down by auditors. For many auditors this implies an extension of the historical notions of professionalism and may require a more diverse workforce and professional leadership than we currently have.

This extension may not sit happily in broadly based professional service firms, which still offer other services to audit clients, albeit more restricted than they were formerly. The YouGov survey published by the Financial Reporting Council in 2016 highlighted a perceived lack of auditor independence as the key reason for investors having lower confidence in audit than other parties, such as audit committee chairs, for example.

New ethical standards have extended independence requirements, but it is now up to the audit profession to demonstrate that these are sufficient to enhance investor confidence sufficiently.

This article originally published on icaew.com.