Would last year’s reviews have improved audit?

Following the collapse of Carillion and Patisserie Valerie last year, it was assumed that their auditors should have warned stakeholders about the probability of the collapse.

Sir John Kingman, the Competition & Markets Authority and Sir Donald Brydon were asked to recommend ways of improving audit and its regulatory body, the Financial Reporting Council.

The recommendations have not yet been implemented. If they are, will they improve the audit?

When faced with a systemic problem, people often address the symptoms rather than the causes and look for someone to blame. Audits are not a cause of company failures and cannot prevent them. Only the directors of a company can determine a company’s success or failure and even they may be defeated by the economic environment.

Nevertheless, it is true that audits fail to meet expectations.

The causes of audits failing to meet expectations are:

  • auditors are employed and paid by the companies they audit, which leads to conflicts of interest and insufficient independent challenge;
  • the information provided by companies is retrospective, unpredictive, biased, partial, fragmented, and hard to access;
  • going-concern statements rely on opinion rather than logic, and wishful thinking rather than cash.

The three reviews fail to address these issues. Until they are addressed, the quality and effectiveness of audits cannot improve.

The Kingman Review recommends several organisational changes including a change of name.

The CMA Review recommends a split between audit and advisory businesses; regulatory scrutiny of auditor appointment and management; and encouraging more choice. No evidence is given to prove that these recommendations would increase the quality of audits. On the contrary, it is likely that they would increase the complexity of audit, and thereby reduce the quality of audits and increasing their cost.

The Brydon Review recommends removing the truth: “I, therefore, recommend that: ‘true and fair’ be replaced in UK company law with the term ‘present fairly, in all material respects’.”

The three Reviews recommend several principles and statements. We’ve had plenty of principles and statements since Cadbury in 1992, and we still have problems because doing the same thing produces the same result. Principles are easily ignored, and statements say whatever the author wants them to say.

To enable audits to meet expectations, every organisation should be required to make publicly available on a digital platform a single picture of everything the organisation is aiming and likely to achieve, do and employ so that anyone can audit the company at any time and challenge management about issues they notice.

The integration, transparency and predictability provided by the platform would automatically improve the quality of audit, enhance assurance, and increase the productivity and profitability of companies. Fewer companies would fail, and the public expectation that audits should prevent problems would be mollified.

The role of audit would expand from inspecting the past to include using the platform to provide informed going-concern opinions. The role could also involve ensuring that the platform is being used correctly, and assuring the quality of the information on it.

There would be no need to break up the Big Four, appoint joint auditors or meddle in the market.

To remove conflicts of interest, audit should be made a regulatory function with auditors appointed, supervised and paid by the proposed Audit, Reporting and Governance Authority from a levy on companies.

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