“Audit is not broken but it has lost its way,” says the author of a new report into the U.K. audit industry, which has faced fierce criticism for not being effective in rooting out apparent governance failures ahead of a spate of large-scale corporate collapses.
The high-profile collapses of the construction company Carillion, the retailer BHS, and, more recently, the travel company Thomas Cook have led to calls from British lawmakers for a shake-up of the audit market to spot problems earlier and avoid thousands of job losses.
The latest (and third) report commissioned by the government to examine the shortcomings of the external audit profession (in particular, the Big Four firms—Deloitte, KPMG, PwC, and EY) makes dozens of recommendations to improve audit quality through better shareholder engagement and by expanding the auditor’s remit to look outside of just the financial statements to “external signs of concern.” That includes fraud—an area the profession has historically been reluctant to be held responsible for.
- A redefinition of audit and its purpose;
- The creation of a corporate auditing profession governed by principles;
- The introduction of suspicion into the qualities of auditing;
- The extension of the concept of auditing to areas beyond financial statements;
- Mechanisms to encourage greater engagement of shareholders with audit and auditors;
- A change to the language of the opinion given by auditors;
- The introduction for company directors to publish a resilience statement and a public interest statement to set out the role of the auditor and the assurance the board wants from it;
- Suggestions to inform the work of The Department for Business, Energy and Industrial Strategy (BEIS) on internal controls and improve clarity on capital maintenance;
- Greater clarity around the role of the audit committee;
- A package of measures around fraud detection and prevention;
- Improved auditor communication and transparency;
- Obligations for auditors to acknowledge external signals of concern;
- Extension of audit to new areas, including alternative performance measures; and
- The increased use of technology to provide better assurance and audit reporting.
Source: Brydon review final report
Report author Sir Donald Brydon, a former chairman of the London Stock Exchange, recommends separating audit from the accountancy profession and giving it its own governing principles, standards, and professional qualifications. He also suggests that, under a new professional body, auditors should receive appropriate forensic training to detect and report fraud.
Fundamentally, Brydon believes “audit lacks a clearly understood and fully encompassing purpose,” which leads boards, investors, and other stakeholders to overly reply on reports that may not be as probing or skeptical as they should be. Instead, he suggests a new definition should be adopted and enshrined in company law that is “written in plain English” that explains clearly what the different elements of an audit report mean—as well as what they do not mean.
“The purpose of an audit is to help establish and maintain deserved confidence in a company, in its directors and in the information for which they have responsibility to report, including the financial statements,” Brydon writes.
In the wake of accounting scandals like Carillion—where supply chains suffered as a direct result of the company’s attempts to make it appear the business was still viable by paying out bonuses and £54 million (U.S. $71 million) in shareholder dividends—the report recommends auditors should provide information that is useful to present to potential investors, lenders, creditors, and other users making rational decisions and assessments about the company.
Brydon also recommends auditors “should be free to include original information, materially useful to a wide range of users, in their audit report and at the [annual general meeting], and not be confined to commenting on that which has already been stated by directors.”
While Brydon’s report is critical of the way external audit work has been carried out, it adds that “all the actors in the audit process bear some measure of responsibility,” including boards and audit committees. Directors should also report on the actions they have taken to prevent and detect fraud.
Meanwhile, Brydon recommends audit committees should publish a three-year rolling audit and assurance policy which would be put to an annual advisory vote by shareholders for approval at the AGM, as well as publish a formal invitation to shareholders to express any requests they have regarding the areas of emphasis they wish the auditor to incorporate in the audit plan.
He also calls for the government to “give serious consideration” to mandating a U.K. internal controls statement. This would involve the CEO and CFO providing the board with a signed statement that an evaluation of the effectiveness of the company’s internal controls over financial reporting has been completed and whether or not they were effective, as is the case in the United States with the Sarbanes-Oxley Act.
Brydon was commissioned by former Prime Minister Theresa May to review the quality and effectiveness of audit earlier this year. His recommendations come after former Treasury mandarin Sir John Kingman produced a damning review of regulation in the sector last year (which included scrapping the current regulator, the Financial Reporting Council, and replacing it with a new body called the Audit, Reporting and Governance Authority), while in April, as part of a separate probe, the Competition and Markets Authority—the U.K.’s antitrust regulator—called for new legislation to end the dominance of the Big Four accounting firms, including making joint audits mandatory for FTSE firms.
The government has said Brydon’s review “will help inform our reform of audit early next year.”