Out-Law / Your Daily Need-To-Know
The UK audit industry requires "a fundamental shift in definition and approach" to improve the quality and effectiveness of its work, an independent report has concluded.
Sage Group chair Sir Donald Brydon has made a number of recommendations in his final report to the government including a new definition of the purpose of an audit; more involvement from company shareholders; better training and specific qualifications for auditors; and increased transparency around the audit process.
Brydon's review is the third of three commissioned by the government, following Sir John Kingman's independent review of the Financial Reporting Council (FRC) and a study of the statutory audit market by the Competition and Markets Authority (CMA) (219-page / 1.5MB PDF).
Brydon has called on the government to quickly establish the Audit, Reporting and Governance Authority (ARGA), the new regulator which Kingman recommended as a successor to the FRC. The government confirmed in this week's Queen's Speech that it would proceed with setting up this new regulator.
This appears to be a thoughtful review with some important reforms, but nothing too radical.
In his report, Brydon said that auditors "have a unique advantage in having the right to see everything that goes on in a company and to assess whether that trust [in a company's directors] is deserved".
"Audit is not broken but it has lost its way and all the actors in the audit process bear some measure of responsibility," he said.
"There needs to be a fundamental shift in definition and approach to ensure that all appropriate opportunities are taken for the auditor to inform as well as to confirm and verify. This will mean sometimes going beyond the information contained in the statements of the directors. With this change in mindset, and appropriate structures and principles, combined with more focused training and better user engagement, I consider that audit can serve a much more useful purpose," he said.
Corporate governance expert Martin Webster of Pinsent Masons, the law firm behind Out-Law, said that it was not yet clear the extent to which the new government intended further regulation on audit and corporate governance; which was "an area of focus for Theresa May and Greg Clark in the last government".
"This appears to be a thoughtful review with some important reforms, but nothing too radical," he said.
"There will clearly be a lot more process and paperwork, and audit fees are bound to continue on their upward trajectory, but the audit landscape remains familiar. Whether Brydon's reforms will achieve their purpose of restoring confidence in the audit process is a question that will not be answered for a few more years," he said.
"Brydon clearly does not like the proposals from the CMA for joint audits in the FTSE 350. The new chair of the FRC has also spoken out against them, so their days may be numbered," he said.
The review proposes redefining the purpose of an audit to "reflect and reinforce audit … as a public interest function". The definition proposed is "to help establish and maintain deserved confidence in a company, in its directors and in the information for which they have responsibility to report, including the financial statements". This definition should ideally be enshrined in company law, according to Brydon.
Brydon has also recommended replacing the current description of a company's financial reporting by an auditor as 'true and fair' with a statement that accounts have been fairly presented in all material respects. This is designed to reflect the increasing use of estimates and judgements in corporate accounting. Auditors should also have regard to users of their report beyond a company's shareholders.
Directors should publish a 'resilience statement' setting out the directors' assessment of the short, medium and long-term viability of the company, instead of the current system of going concern and viability statements. Any proposals for dividends would have to be consistent with the resilience statement. Directors should also produce a concise 'public interest statement' explaining how their company serves the wider public interest, and report on what they have done to prevent and detect fraud. Auditors should then report on the accuracy of these statements and assurances.
There are also proposals for increased transparency around audits and the work of auditors. Shareholders should be given an advisory vote on the company's audit and assurance policy at last once every three years, and should be given the opportunity to propose matters that they want covered by the audit.
The recommendations apply to so-called public interest entities': listed companies other than those on the alternative investment market (AIM); and credit and insurance firms.