Three ways to start fixing audit now

We are living through a pivotal time in the history of audit.

Last December saw the release of Sir John Kingman’s report into the operation of the Financial Reporting Council and the preliminary findings of the market study by the Competition and Markets Authority (CMA).

This year we are seeing the Business, Energy and Industrial Strategy Select Committee inquiry into audit and the Brydon Review into UK audit standards.

But right now onlookers could be forgiven for asking what, exactly, is changing?

The problem with audit is here, right now: a series of big-name corporate collapses have rightly caused the public to question its value. But all the currently proposed solutions will take time.

Many of the Kingman proposals will require legislation, and could take 18 months to come into effect. We wait to see what the CMA will eventually recommend, but two years would be a best-case scenario for implementation, and it could take more like five.

A week is famously a long time in politics. Five years, in politics or business, is an eternity.

We need action now. We need remedies to restore confidence in audit, and to start rebuilding the profession’s reputation.

It is my opinion that some current perceptions are unfair. Every year hundreds of thousands of audits do exactly what they are supposed to. Chartered accountants remain one of the most trusted professions. But high-profile failures are eroding this trust. And I believe that there are answers to hand.

It is sometimes said that the first rule of business is know your customer. But I believe we have lost sight of who the customer really is.

To outside eyes, perhaps even to some inside, it looks as though the auditor’s customer is the company they examine.

This is simply not the case. It is the shareholders who are the clients, and a good case can be made that wider stakeholders – including customers, employees and pension-holders, for example – are too. So how can we address this?

It may seem semantic, but one important change would be to stop describing companies as “audit clients”. We have all been guilty of this, but the business is not the client and this must be unambiguous. If auditors were to talk instead about “the companies they audit”, this would have a significant cultural impact.

But more concrete changes are also needed. One would be for auditors to be required to present formally at all annual general meetings (AGMs) – including discussion of the extended audit report.

Currently, auditors are not even required to attend. Although in practice many do, it is not unusual for an audit partner to spend their entire professional career without ever being asked a question at an AGM.

Changing this would provide a greater level of information and transparency to shareholders, and demonstrate that they – not management – are the client.

This could be supplemented by the company’s internal audit function also presenting at the AGM on the work they have done in the course of the year. This would raise the profile of the internal assurance activities – around governance, risk-management and compliance, for example – which are often under-appreciated.

It is not just auditors who need a culture change, though. The corporate world, and its regulators, must follow suit. The danger of seeing everything through the prism of auditor and client is that we forget that management has a role to play in being examined.

Under section 501 of the Companies Act, it is a criminal offence to knowingly provide misleading information to auditors – and yet this power is rarely, if ever, used.

Increased emphasis would reinforce the obligations of providing all information to the auditors that they need to fulfil their duties.

These measures would not address all the problems of audit – clearly we also need to deal with issues such as concentration in the market, oversight, quality, and scope.

But they would both demonstrate that the profession is taking this seriously and – more importantly – serve as evidence that we recognise that there is a trust problem, and are doing something about it right now.