Spotlight on audit

Feb 11, 2019
In the UK and internationally, audit was the subject of much debate in recent times and the attention will continue over the coming year.

2018 was quite a year in the world of audit. A sector often, and unfairly, characterised as ‘grey’ and perhaps unexciting, such stereotypes certainly do not apply to the year we have just had – and it is set to continue in 2019 and beyond. Much media attention has been given to high-profile corporate scandals and failures in the UK and internationally in recent years – BHS, Carillion, Patisserie Valerie in the UK, international cases such as those involving the Gupta family businesses in South Africa and the Commonwealth Bank of Australia to name but a few. Audit regulatory investigations and findings have followed with serious implications in many cases for those involved.

Studies, reviews and consultations involving the audit sector were commonplace throughout 2018. Those of particular relevance, and demanding the attention of this and other Institutes and their members, include: the UK Competition and Markets Authority (CMA) October 2018 invitation to comment on the UK statutory audit market and its December update paper; the Independent Review of the Financial Reporting Council (FRC) in the UK by Sir John Kingman (the Kingman Review) published in August and report issued in December; and the ongoing Monitoring Group (MG) consultation on reforms to the global audit standard-setting bodies. Add to that the upcoming Brydon Review of the scope and purpose of the audit, announced by the UK Department for Business, Energy and Industrial Strategy in late December and the FRC’s post-implementation review of the 2016 ethical and auditing standards.

Overarching questions being addressed by these various studies, reviews and consultations include: What is the value of audit? What is the scope and purpose of a statutory audit? How do we align it better to societal needs and expectations? How do we best expand choice in the audit market? Who should police auditors and corporate reporting more generally? And what powers should the enforcers have? To which standards should auditors be subject, and who should set those standards? Are the current standards fit for purpose, both now and into the future?

These overarching questions give rise to more detailed questions, such as: which, if any, non-audit services should audit firms be permitted to provide, and to whom? Is there a role for other bodies, such as the regulator, in the appointment of auditors or in the governance of the process? Should standard-setting for auditors of public interest entities be separated from standard-setting for the audits of other entities? Should all accountants, irrespective of the sectors in which they work, be subject to the same general ethical principles? One only has to consider the two CMA consultations to appreciate the level of detail and complexity involved – the October consultation contained 27 different questions on 19 potential measures while the December consultation also contained 27 questions, this time focused on a small number of specific proposals.

In Ireland, you can add into the mix the uncertainty that has arisen about the recognition of UK-based auditors in Ireland in the event of a no-deal Brexit and the IAASA consultation on its publication and grading policies relating to quality assurance reviews of public interest entity audits and audit firms. Reporting by IAASA is currently envisaged to commence in early 2020 with respect to 2019 audits.

So, at the time of writing, where are we with all this activity?

Competition and Markets Authority study of the UK statutory audit market
The original October 2018 CMA invitation to comment contained a wide range of potential measures aimed at increasing competition, enhancing incentives to better align audit services to shareholder interests, improving market choice and opportunities for switching auditors and bolstering the resilience of the UK audit market, particularly against the failure of one of the Big Four audit firms.

Following that consultation, the CMA published an update paper on 18 December containing a proposed package of measures, including a number of core proposals:

  • Regulatory scrutiny of auditor appointment and management with a view to securing audit committees’ accountability and independence;
  • Mandatory joint audit with a view to breaking down barriers to non-Big Four firms;
  • An operational split between the audit and advisory businesses of audit firms, aiming to address conflicts between the provision of audit and non-audit services while mitigating against some of the key negative consequences of alternatively introducing full ‘audit-only’ firms; and
  • Peer review of audits prior to the opinion being signed.
Presented as preferred alternatives to other measures originally proposed in October, the update paper suggests that the CMA may still take future steps in relation to those other measures, should sufficient progress not be made through the current package of measures. The CMA is currently consulting on these revised proposals with final recommendations scheduled for April 2019. Potential measures in the October consultation not carried forward by the CMA at this point include the break-up of the Big Four firms and the creation of a national audit office-style auditor for private sector audits. 

Kingman Review of the UK Financial Reporting Council

The Kingman Review, also published on 18 December, calls for the replacement of the FRC with a new independent regulator, with the suggested title of ‘Audit, Reporting and Governance Authority’. It recommends that this regulator should have clear statutory powers and objectives, and should be accountable to the UK parliament. In total, there are 83 different recommendations addressing the structure and purpose of the regulator, the effectiveness of its core functions, the role and powers of the regulator with respect to corporate failures, oversight and accountability, staffing and resources, and other matters. Notable recommendations include:

  • The new regulator taking responsibility for the approval and registration of audit firms which audit UK public interest entities from the recognised supervisory bodies (including Chartered Accountants Ireland);
  • Enforcement action against accountants in relation to apparent wrongdoing in public interest entities should be undertaken on a statutory rather than voluntary basis;
  • That the regulator is given the powers necessary to investigate the actions of all directors, not just those who are members of accountancy bodies;
  • The introduction of a duty of alert for auditors to report viability or other serious concerns to the regulator;
  • That the UK Department for Business, Energy and Industrial Strategy (BEIS) give serious consideration to a strengthened framework around internal controls; and
    That BEIS should put in place a statutory levy and that the current voluntary funding approach should cease.
In welcoming the publication of the Kingman Review, Business Secretary Greg Clarke noted that Sir John Kingman has delivered the “root and branch review of the FRC” as requested and said “the government will take forward the recommendations set out in the Review to replace the FRC with a new independent statutory regulator with stronger powers”. The Chairman of the FRC, Sir Win Bischoff, also welcomed the recommendations, saying that they have “addressed the gaps in our powers... [and] have the potential to bring about significant improvements in the work we do in protecting the interests of investors and the wider public”.

Independent review of the quality of UK audit standards (Brydon Review)/FRC post-implementation review

On the same day as the publication of the Kingman Review and CMA update paper, BEIS announced the appointment of Donald Brydon to chair another review in the UK. The Brydon Review, which is intended to build on the work of the Kingman and CMA reviews, will consider how the audit and auditing standards may be evolved to better address the expectations gap between what the audit can and should deliver compared to the public expectations from audit. The terms of reference are expected shortly.

Separately, the FRC issued a consultation in November as part of its post-implementation review of the current UK auditing framework. These standards were revised primarily to support the implementation of the EU Audit Regulation and Directive and to reflect changes made by the IAASB to the suite of international standards on auditor reporting. The FRC notes that having applied to two cycles of audits, it is seeking to learn the lessons from its enforcement work and, at the same time, gather feedback on whether the changes made to the standards have had the desired impact on auditor independence and audit quality.

The Monitoring Group consultation on the future of international auditing standard-setting

The Monitoring Group (MG) is a group of regulatory and international organisations committed to advancing the public interest in areas related to international audit standard-setting and audit quality – members include the International Organisation of Securities Commissions (IOSCO), the World Bank, the European Commission and the Financial Stability Board.

The MG issued its initial consultation entitled Strengthening the Governance and Oversight of the International Audit-Related Standard-Setting Boards in the Public Interest in November 2017. A May 2018 feedback statement highlighted concerns raised by respondents under the primary objectives of serving the public interest; independence from the profession; and timeliness of standard-setting. We await the MG white paper setting out its more detailed proposals, which are expected to include the core principles of a ‘public interest framework’ and proposals relating to a sustainable funding model that is consistent with, and indeed enhances, the desired levels of independence of the standard-setting processes. International audit-related standard-setting is currently undertaken by independent boards (the IAASB and the IESBA) within the International Federation of Accountants (IFAC) in New York. IFAC’s standard-setting activities are funded primarily by IFAC member bodies, including our Institute, and international audit networks (which also provide significant people resources to the standard-setting boards). The underlying position of the MG and the regulatory community in general is that in order to ensure that standard-setting is undertaken in the public interest, and to enhance public confidence in audit, the governance processes involved need to become more independent of the audit profession and multi-stakeholder in nature. To achieve this, the MG envisages a separation of the standard-setting processes away from IFAC. The MG aims to implement the new standard-setting arrangements by the second half of 2020 or the beginning of 2021.

Implications of a ‘no-deal’ Brexit on the registrations in Ireland of UK-based audit firms
The UK parliament recently voted by an overwhelming majority to reject the withdrawal deal negotiated between the UK Government and the European Union (EU), leading some commentators to state that a no-deal Brexit is more likely than ever. The Institute has been actively engaging with IAASA on the position of UK-based audit firms as regards registration to undertake Irish company audits post-withdrawal in the event of a deal not being agreed and information on that engagement has been published on our website. Space constraints do not allow for a summary here of the many clarifications sought or various scenarios presented, but suffice to say that in the event of a no-deal Brexit, the indications are that our registered audit firms (and those of the other recognised accountancy bodies) based in Northern Ireland and the rest of the UK will not be recognised under Irish law post the withdrawal date to undertake statutory audits of companies in Ireland, unless they are recognised as a ‘third country auditor’ by IAASA. Such recognition can only be granted post-withdrawal and, except with regard to a small number of UK firms auditing non-EU entities with Irish listings, will require a reciprocal arrangement to be put in place by Ireland and the UK, which is likely to take some time. This is not likely to be an issue in the event that a withdrawal deal between the UK and EU is agreed and there is a transition period.

It should be noted that the UK Government issued a technical notice in October, which stated that the UK will unilaterally provide a transitional period as regards audit until the end of December 2020. During this transition period, EU auditor registrations will continue to be recognised in the UK. As such, audit opinions issued by Irish-based audit firms on the financial statements of entities in Northern Ireland and the rest of the UK will continue to be valid under UK law.

It is an evolving situation and the Institute continues to engage with the relevant authorities. Audit firms likely to be affected should make reference to a regulatory bulletin issued in recent days by the Professional Standards department.

The Institute’s ‘Value and Future of Audit’ event

Many of the topics mentioned above were debated during an excellent event on the value and future of audit hosted in October 2018 by the Institute’s Deputy President, Conall O’Halloran, and organised by Aidan Lambe, Director Professional Standards. Conall and Aidan assembled a top quality panel of contributors, drawn from the profession, business and the media. Given the significance and topical nature of the issue, the event naturally drew a very large and engaged audience, resulting in a lively debate. Some interesting perspectives from contributors to the debate included:

  • The much-discussed ‘expectations gap’ between what the audit can deliver and what the public expects from the audit does not necessarily apply across all stakeholder types. Speakers argued that consumers of audit services, practitioners, regulators, audit committees, boards and analysts all understand the limitations of a statutory audit;
  • That being said, there was general agreement that audit may need to better address the needs and expectations of society in order to survive and thrive into the future. To do so, the scope and purpose of the audit may need to change, though debates in this regard need to begin from informed positions;
  • That the application of ever-increasing regulatory requirements intended to enhance the quality of audit may actually have the contrary effect of diminishing the importance of professional judgement in the process;
  • That the audit profession, operating, as it is perceived by many stakeholders, from a privileged position in society given the legal requirements pertaining to the purchase of audit services, is validly challenged by politicians and the media in the event of corporate scandals and failures, and the onus is on the profession to meet those challenges; and
  • The need for the profession to better communicate the value proposition of the audit, and indeed the output, in a manner that doesn’t disenfranchise stakeholders. The irony was noted of the audit opinion relating to listed entities and certain other public interest entities having in recent years moved clearly away from boilerplate language to provide very interesting and useful information, while the focus on the opinion at the annual general meeting has simultaneously diminished.
As the Deputy President acknowledged in closing the event, the debates created some great content which the Institute will consider when formulating its own contributions to consultations going forward and we will return to some of the topics discussed in future issues of this magazine.

Concluding remarks

It is fair to say that the underlying theme of the various studies, reviews and consultations, the level of regulation of the audit sector globally, and the extent of media and political interest and scrutiny the sector continues to receive all clearly highlight the continuing importance of audit today. Audit faces significant challenges to bridge the expectations gap and to evolve to embrace technological developments and artificial intelligence, but the significance of its oversight role has not diminished. The profession needs to present a strong voice to ensure new measures achieve the goals of providing more assurance to stakeholders and higher quality audit. Collectively, we need to commit our talents to develop solutions to ensure the continued relevance and importance of audit to the market into the future.

These studies, reviews and consultations are inextricably linked and responses from this Institute, and the profession in general, have voiced the need for proposed measures to be coordinated and coherent, and to encompass developments and changes in corporate reporting. Other key messages include serious concerns about the implications of UK-only approaches, given the international nature of audit and the need for solutions that work globally. There is a general recognition that public trust in the audit needs to be restored. While we may not agree with all the proposals on the table, we welcome the debates and will continue to actively contribute to the debates both locally and internationally.

Never a dull moment, it seems!

Mark Kenny is Director, Representation & Technical Policy, at Chartered Accountants Ireland.