2020 should at last see a change in the UK audit market that puts the interests of users of accounts and the public at the heart of it.
This follows three hard-hitting reviews by Sir John Kingman, the Competition and Markets Authority and Sir Donald Brydon. Key recommendations will (or should) see the Financial Reporting Council gain more powers as the Audit, Reporting and Governance Authority; audit being separated from consultancy; and the creation of a corporate auditing profession.
The last is a centrepiece of the Brydon review of the quality and effectiveness of audit, published in December. Investors and others who rely on financial information in company accounts have long felt that auditors do not exercise sufficient professional scepticism in dealing with management’s estimates and forecasts. So, they should welcome Brydon’s advocacy of a “forensic mindset”, including the concept of “professional suspicion”. Similarly, he spells out that an auditor is obliged to try to detect material fraud.
The profession’s code would be called The Principles of Corporate Auditing. This represents a welcome revival of The Auditor’s Code, dropped by the FRC in 2015 (as a member of the audit and assurance council, I questioned this). The principles include some important additions. One is that auditors should “act in the public interest”, as opposed to just “having regard” to it; another that “auditors provide appropriate challenge to management”.
Another welcome recommendation is that there should be updates in subsequent auditor’s reports on key audit matters and what has been done about the deficiencies identified. Where measurement uncertainty is an issue, the auditor should provide information on the ranges and sensitivities behind point estimates, building on what the best reports already do.
But here lies the first of the potential disappointments: Brydon does not recommend graduated findings that judge whether management estimates are conservative, balanced or aggressive. He simply says that this evolution should be “left to the marketplace”, where the response to date has been underwhelming to say the least.
He also sticks by the binary auditor’s opinion, despite discussing in the consultation document whether more use should be made of existing forms of qualification or indications of material uncertainty. Some believe that the near-ubiquitous “clean” audit opinions are both too reassuring and too crude.
On a company’s resilience beyond the technical going concern basis, Brydon places responsibility firmly on company directors and their narrative on risk. Beyond the one-year view, the proposed Resilience Statement would provide a stress-tested medium-term assessment, with an option of obtaining independent assurance; and a statement of potential longer-term threats and how the company would react. This should provide more meaningful information than the current viability statements. Coupled with Kingman’s recommendation that the ARGA should be able to sanction directors, this should focus boardroom minds on financial sustainability.
But on the related subject of dividend payments, Brydon does not back routine, audited disclosure of distributable reserves, which may disappoint some investors. This ball is thrown back into the government’s court since it entails interpretation of the Companies Act.
Even more contentious may be the suggestion that the term “true and fair”, beloved by many UK users of accounts, be replaced with “present fairly, in all material respects”. Brydon has a nice line on this: “It does not need a philosopher to question how an opinion about judgments relating to the future can be ‘true’.” But he may unnecessarily stir up opposition to the report by treading into this quagmire.
This would be a pity because there is much to give hope that audit quality will improve. But in parallel with his belief that the focus for business resilience needs to shift back to directors, he also gives homework to users of accounts. A key recommendation is that there should be an Audit Users Review Board, ideally run by the Investment Association.
Investors and analysts would have an opportunity to suggest points of concern about a company’s accounting in the run-up to the audit. Their concerns would form part of a list of external signals that a company is getting into trouble, which the auditor should consider and report on.
Overall, the message is that auditors should be tougher on management, more forensic in their approach and provide more meaningful information. But they are by no means the only players. Responsibility for making good use of the information remains with those who manage or recommend equity investments and assess creditworthiness. Brydon stops well short of saying that auditors should make judgments for them.
Jane Fuller is a fellow of the CFA Society UK and Co-director of the Centre for the Study of Financial Innovation, she has recently featured in:
You can read the Brydon report here.