Michael Izza 2 Jun 2017 10:00am

Why we should widen the scope of audit

There is no shortage of questions about the conduct of the audit process, but less substance over how to move forward and ensure best practice

Do you ever get that Groundhog Day feeling that you’ve been here before once, if not twice, too often? I have been getting that sense of déjà vu a lot recently, brought on by another push in the media to look at whether or not the audit profession is meeting the expectations of its stakeholders.

Not that I am complaining. There has always been a gap between the profession’s understanding of the scope and remit of audit and that of the wider public, and even some users of audit reports. Interest in this expectation gap I regard as a sign that people still see the audit as relevant. But I did think we might get a longer breather following the implementation of the latest audit reforms.

It is, after all, only three years since the Competition and Markets Authority carried out its investigation into the statutory audit services market. This in turn fed into the EU’s Audit Regulation and Directive, which celebrates the first anniversary of its implementation this month. A year is hardly enough time for the changes to be embedded and nowhere near enough time for their effectiveness in bolstering audit independence to be assessed. However, there is agreement that mandatory audit tendering and rotation are turning out to be good for the profession.

In the Financial Times in April, Sir Ewan Brown, a non-executive director of Stagecoach and former Lloyds TSB audit committee chairman, kicked things off again with a call to scrap mandatory independent audits in favour of what he called “the best defence against malfeasance” – rigorous internal controls.

A strong internal audit, he wrote, can provide assurances to the audit committee and senior management on the effectiveness of governance and risk processes. He also suggested that questions need to be answered about auditors’ competence in the light of some banks’ criminal behaviour since the financial crisis. Much of this illegal activity was uncovered not through audit, but through whistleblowing or investigative journalism. What, he asked, were the auditors doing while all this was going on? He concludes that audit should go and the com–pany’s directors be made responsible for the accuracy of disclosures.

Not surprisingly, his article attracted some spirited defence of audit as well as a few letters of support. Taken at face value, his call to scrap the audit is unlikely to gain much ground: whenever this question has cropped up in the past, investors and other audit users, as well as legislators and regulators, have resoundingly rejected the idea. Personally, I interpret Sir Ewan’s letter as a slightly tongue-in-cheek challenge not just to auditors but to all the other parts of the wider audit process – audit committees, internal auditors, directors – to up their game, something we are always keen to do.

Of course, I am bound to point out that audit failures are few and far between, and while it’s easy to point out audit shortcomings, it can be more difficult to talk about successes. Many of them are not publicly visible, despite moves over the past few years towards greater transparency in the audit process and a more open relationship between the auditor and audit committee. But I do feel that we are potentially on the cusp of being able to redefine and therefore repurpose the audit if everyone involved is willing to take this step together.

This step will be based on the increasing use of technology and in particular data analytics to help auditors express their opinion on the financial statements.

Moving from sampling to whole population extraction and then exception review could be a game changer in terms of uncovering fraud, but it also could allow auditors to move beyond the financial statements and give assurance to other non-financial measures that, certainly in the public interest entity (PIE) market, are important and in some cases more important than historic financial statements.

This widening of the scope of the audit would, assuming auditors, audit committees and management agree, allow auditors to look at areas currently off limits. This would give the audit profession the opportunity to tackle the expectation gap that stubbornly refuses to go away. But this has to be done in a way that leaves auditors with suitable liability protection and makes the profession, particularly in the PIE market, of interest to a wider group of firms.

We’ve been talking about these issues for decades. Are we going to have the impetus today and the resolve to do something about it?