Caroline Biebuyck 4 Apr 2018 03:43pm

Are audit standards up to scratch?

Is it time for a change in the audit standard setting process? Caroline Biebuyck investigates

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Caption: Illustrations: Adam Avery

The post-Enron era saw a number of changes to audit, with one of the most important being a governance framework around the development of standards for international audit, ethics and education. Presiding over the structure is the Monitoring Group, a body responsible for overall governance and for reviewing how effective and responsive the standard-setting process is to the public interest.

Somewhat more than a decade on, the Monitoring Group thinks it’s time for another change. Its view is that the current structure creates the perception that audit standard-setting is in the pockets of the audit profession, and might not be in the public interest.

In the January issue of economia, Michael Izza asked members with views on this issue to feed into ICAEW’s response. In the March issue, the technical updates feature summarised ICAEW’s response, REP 17/18, which says the Monitoring Group needs to define what it means by public interest, which it fails to do despite frequent references to it. ICAEW believes a consultation needs to address the fundamental question of what best serves the public interest in terms of audit, whether audit is fit for purpose and how it might evolve to serve society better.

Allaying anxieties

Investors have had concerns for some time over the way auditing standards are developed. “The issue of independence is more around perception – and this perception does matter,” says Liz Murrall, director of stewardship and reporting at the Investment Association. “The risk is that unless something is done to change the current framework, future decisions may benefit the profession as opposed to being in the public interest.”

Currently international audit, ethical and educational standards are developed by three standard-setting boards which are supported by IFAC, an organisation funded and run by the large accounting firms.

IFAC manages the nominations process to the standards boards and it directly funds, accommodates and provides support and staffing for these boards and for many of their technical advisers.

Mark Babington, deputy director for audit policy at the Financial Reporting Council, has been supporting the Monitoring Group’s work in developing its consultation. He has heard investors and corporate governance stakeholders worry that the current structure means standards are being set by the audit profession rather than through an independent route. “That’s why the Monitoring Group has set out some options aimed at providing an independent standard-setting entity rather than one which relies on the support of the global profession or the support of a global firm,” he explains.

Different voices

The Monitoring Group proposes bringing together the work on audit standards and ethical standards for audits under one new board. The new board would have no fewer than 12 members and would allow for both full-time and part-time membership. Those members would be drawn equally from three main groups: users, regulators and auditors.

Murrall welcomes the proposals to introduce a multi-stakeholder model. “We think that a third of the 12 board members should come from each of the three groups so there is a cross-balance of representation,” she says. “To ensure board members are aware of the practicalities encountered by the user and preparer community, we support three-quarters of the board being part-time members so that they can bring a practical perspective to the table. If people are full-time, how can they usefully contribute as users or preparers?”

The current proposals share some features of the governance reforms over international accounting standard-setting that took place at the turn of the millennium, says Bill Platt, managing partner of professional practice at Deloitte. “A movement towards independent standard setting for audit standards is the right thing to do, and this is the right time to consider it,” he says.

He points out that changes to the accounting standard-setting process were preceded by greater multi-stakeholder participation in development of the model – something he would like to see replicated with auditing standards.

“The Monitoring Group is including diverse stakeholder representation through its consultation and public roundtables. But as they move towards an actual proposed reformed model, increasing stakeholder involvement and increasing transparency of the direction they are heading in before the model is circulated for public comment would help get stakeholders comfortable that what is being proposed would protect their interests.”

Key among the Monitoring Group’s concerns is to ensure that audit standard setting properly represents the public interest. “The driving concern is that standard setting should follow a process in which issues which are of the most significant public interest are identified and they are brought within the standard-setting process,” says Babington.

He thinks that few people really understand the current process behind the standard setting. For example, a key part of the current governance arrangements is the Public Interest Oversight Board, which sits just below the Monitoring Group in the governance structure, and whose remit is to ensure the public interest is protected.

“The fact the PIOB’s work is ongoing should provide some comfort to stakeholders. But if they don’t know about it and it’s not transparently reported, then you lose the opportunity to demonstrate to stakeholders what’s being done in their interests.”

While Tony Bromell, head of integrity & markets at ICAEW, sees the Monitoring Group’s aim as trying to restore or enhance public confidence in audit, he thinks the group has missed the true public concern with the audit – the expectation gap.

“This is the real public perception problem. Also, they are presupposing that audit problems arise because the standards are wrong rather than because someone didn’t apply them properly. This confusion of non-application of standards with incorrect standard setting simply moves deck chairs around in the standard-setting arena. Standard setters can only set standards based on the framework of what audit is at the moment. None of these proposals will move things forward on the expectation gap problem.”

Show me the money

Where will the funding for a new standard-setting process come from? The Monitoring Group’s consultation talks about needing to create a pathway to a sustainable funding model, one to which Babington feels the audit profession will need to contribute. One of the lessons from the IASB experience is that this cannot be voluntary, he says. “For instance, the IFRS trustees have just moved to a new agreement with audit firms in which instead of making voluntary contributions towards the IASB’s costs, they are going to pay a commercial rate to use the accounting standards – effectively leveraging the IP.”

There might be other funding sources. Should the Monitoring Group, a collection of regulatory authorities, contribute towards the costs of audit standard setting? “One of the things the FRC does is to collect a levy from UK stakeholders and pays that to the IFRS trustees as a way of supporting the costs of accounting standard setting. Options like this could be a way to reduce reliance on the audit profession for funding.”

Platt is concerned that funding should not be left as an afterthought. “There needs to be a clear pathway to move to a funding model that’s not fully dependent on the profession. It could be difficult to do this from day one, but there has to be a clear blueprint and achievable timeframe as to how to get there. If we don’t have a clear vision of how we might move to a more appropriate funding model, we will be left in a position where people could still criticise the profession’s involvement.”.

Licking wounds

International standards on auditing were drawn up when the audit profession was still licking its wounds over Enron. The resulting ISAs provide a good theoretical basis for the conduct of audits, says Nigel Hughes, chair of ICAEW’s Practice Committee. “But the body of ISAs is an over-engineered product: the standards are big and cumbersome and quite prescriptive.”

The one-size-fits-all approach of current audits causes most problems for smaller practitioners, Hughes explains. “Even though you may think there’s no risk of, for instance, turnover being manipulated, ISA 240 says this risk always exists and you need to document why you think it doesn’t apply. This is just one of more than 700 procedures mandated by the ISAs, all of which add to the auditor’s burden.”

He believes there might be a case for leaving some areas to the auditor’s judgment in non-public interest cases. “This way the auditor might be able to gain sufficient assurance about a low-risk, non-public interest entity audit.”

Previous discussions have suggested that the international standard-setting board should restrict its scope to standards for public interest entities. While that has a certain attraction, as it concentrates on the areas that investors and regulators are most concerned with, the counter argument is that standards for PIEs and other entities will diverge, says ICAEW’s Bromell.

“We would end up with two completely different sets of standards; medium-sized firms who have a couple of PIE audits may end up thinking it’s simply too much trouble to stay in these audits,” he says. Adds Hughes: “I worry about audit being unavailable for SMEs because it has become overpriced for that market due to the over-engineering of the standards.”

The Monitoring Group’ consultation closed on 9 February. The group will issue a feedback statement and a public interest framework for consultation before developing its final proposals, which will also be issued for public comment.