Audit redefined

 With the future of the audit and accountancy profession under scrutiny just before the world’s attention turned to the Covid-19 pandemic, the Brydon review of the quality and effectiveness of audit set out a pathway to lasting changes that will make tomorrow’s audit fit for purpose. Sir Donald Brydon, chairman of the Sage Group and veteran of a number of FTSE 100 boardrooms, was asked in February 2019 to chair a review of audit by the UK government. The review’s report was published in December 2019.

In a hard-hitting appraisal of the current state of quality and effectiveness, the report contained some 64 recommendations, which taken together will have a far-reaching impact on the profession – not just in the UK, but worldwide.

The recommendations called for a redefinition of audit and its purpose alongside the creation of a new audit profession and qualification. They said that great suspicion, with added onus on the auditor to detect fraud, should be brought to the fore, together with a stronger framework for internal controls reporting, akin to those introduced under the Sarbanes Oxley Act in the US nearly two decades ago.

There is little doubt that the reforms will be echoed around the world – many jurisdictions outside the UK are having similar debates. However, the report acknowledges that these reforms should not be seen in isolation, as they sit alongside the work of the UK Competition and Markets Authority’s (CMA) report on the audit market, and the recommendations of Sir John Kingman, another City grandee, whose report called for the creation of a new audit regulator, with greater powers and sharper regulatory teeth.

Brydon in brief

Sir Donald Brydon’s review into the quality and effectiveness of audit set out 64 recommendations. Highlights include:

The purpose of an audit 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 should be enshrined in the Companies Act 2006.

Auditing should provide information that is useful to current and potential investors, lenders, creditors and other users in making rational investment, credit and other decisions and assessments about the company.

The Audit, Reporting and Governance Authority should act as the ‘midwife’ to create a new profession of corporate auditing, establishing the necessary professional body to encompass today’s auditors and others with appropriate education and authorisation, with ARGA as its statutory supervisory body.

Principles of corporate auditing should be established to form an overarching framework governing the behaviour of corporate auditors, and standards and rules should sit within this framework.

Directors should set out in a public interest statement (as part of the strategic report) how they view the company’s legal, financial, social and environmental responsibilities to the public interest.

The government should give serious consideration to mandating a UK internal controls statement consisting of a signed attestation by the CEO and CFO to the board that an evaluation of the effectiveness of the company’s internal controls over financial reporting has been completed and whether or not they were effective, as in Sarbanes Oxley Act 302(c) and (d).

ARGA should amend ISA (UK) 240 to make clear that it is the obligation of an auditor to endeavour to detect material fraud in all reasonable ways.

Directors should report on the actions they have taken to fulfil their

obligations to prevent and detect material fraud against the background of their fraud risk assessment.

Taken together, these three pillars are likely to create a wholesale shift in the role and purpose of the audit and of auditors themselves, assuming that the relevant legislation is introduced by the UK government.

‘The profession is positive about contributing to improvement in audit, but Sir Donald’s review cannot be taken in isolation,’ says Maggie McGhee, ACCA’s executive director for governance. ‘There is a huge amount of recommendations, and we are pleased to see that this is still a priority for the government to take forward.’

But she adds that ‘the devil is in the detail’, and as such is looking forward to the government’s own view on the review. That said, she believes that the establishment of the Audit, Reporting and Governance Authority (ARGA), the new regulator to replace the Financial Reporting Council (FRC), ‘is definitely key and needs to be established as quickly as possible, making sure it has the right capabilities within it’.

The creation of an ‘auditing profession’ could be a greater challenge. ‘We need more clarity,’ McGhee argues. ‘We need to understand what this means, as organisations like ACCA deliver against this because we have a separate audit certificate.’ However, she is more supportive of the proposals that will, to a certain extent, emulate the Sarbanes Oxley rules in the US. ‘Placing additional responsibility on directors is critical in making this work,’ she says. But she adds that the design of this particular aspect will be critical. ‘It should not clash with what is happening in the US.’

International impact

Indeed, the international impact of the proposals will be significant. Even if they remain a uniquely British affair, the fact that many UK businesses are global in nature and that many multinational companies have a listing on the UK stock exchanges will mean that the proposals, if implemented, will need to be adopted around the world.

‘The [Brydon] report will have wide-ranging impacts, not only due to it being an important UK government policy piece but the fact that it is also one of the most fundamental and comprehensively informed reviews into the scope of auditing completed in recent times,’ says Amir Ghandar, assurance and reporting lead at CA ANZ. ‘The report covers a very broad ground.Certainly some of the ideas will catch on more than others but in any event, I think this will be a landmark in the audit debate for the coming decade at least.’

Last year, CA ANZ developed a 15-point plan on audit and risk, during which it undertook a programme of extensive engagement with the audit profession as well as stakeholders, including investors, directors and business. ‘We can see an overlap in a few key areas with what Brydon has heard from these stakeholders in his consultation, namely when it comes to risk, control, business resilience and the public interest,’ Ghandar says.

In general, he adds, the response to an ‘open horizon view’ on the future of audit has been positive, and the profession is ready to take a fresh look at the role of auditing in a rapidly evolving market and economic context that if nothing else, ‘is crying out for greater integrity of information and risk management’.

‘A consensus around what an audit does and doesn’t do and whose purpose it serves has been long overdue’

And he believes that Brydon will have a greater impact than the other two reviews (Kingman and CMA). ‘It is clear that stakeholders and the profession have been able to see the Brydon review is quite different in terms of the scope and implications beyond the UK than earlier reports such as the CMA and Kingman that are by their nature and subject matter more UK-centric,’ he says.

‘We’ve reached a tipping point in terms of the demand from stakeholders, and the will within the profession for transformative change,’ Ghandar argues. ‘Our view is there are very solid fundamentals in terms of the ethics, methodology and unique level of global convergence in auditing. It’s time to build on this and set up for a continued and increasingly vital role in society in the coming decades.’

CA ANZ has mapped the Brydon recommendations against current practice in Australia. For instance, Australian auditors must be aware of the risk of fraud and design their audit procedures to address that risk. Directors must ensure that financial reports are true and fair, which includes not being misstated through fraud or error.

The Brydon review recommends that auditors should endeavour to detect material fraud in all reasonable ways and that auditors should receive more targeted training on fraud detection. Similarly, directors would have to detail the actions they have taken to fulfil their obligations to prevent and detect material fraud.

Likewise, the Brydon proposals on internal controls are a step up from Australia’s current requirements. Auditors must understand the internal controls relevant to the financial report but they don’t provide an opinion on their effectiveness. Any material weaknesses that are identified are communicated to the board and management.

Existing requirements in New Zealand and other jurisdictions are similar to Australia, so the debate on what Brydon means for audit will happen globally,

according to CA ANZ.

Accounting firms’ reaction

Reaction from the international accounting firms has been positive, partly in the hope that the review will put to bed what the role of audit and auditors is in the wider context of financial reporting. Stephen Griggs, Deloitte’s managing partner for audit and assurance in the UK, says: ‘A consensus around what an audit does, and doesn’t, do and whose purpose it serves has been long overdue. These recommendations would settle that debate and go a long way to repairing trust in business, strengthening the audit profession and improving the overall quality of UK financial and corporate reporting.’

Bill Michael, KPMG’s UK senior partner, agrees. ‘This is an important moment for audit: we recognise that the expectations of audit, and of corporate reporting, have evolved over the years. Sir Donald’s review is an important milestone in setting out how audit might better meet stakeholder needs both now and in the future,’ he says.

And as Jonathan Riley, Grant Thornton’s UK head of quality and reputation, says, the international context cannot be underplayed: ‘The government must now consider these recommendations not just in context of earlier inquiries into the profession, but also against the backdrop of global trade and Britain’s future role as a pillar of global commerce.’

He adds: ‘The report places new obligations not only on auditors, but also on company directors. We need to ensure that these, taken with other regulations such as the revised ethical standard and wider corporate governance requirements, strike the right balance and do not dent our place on the world’s financial stage.’

McGhee shares Riley’s view. ‘Business now is global, so we need to make sure it is easy to do business in the UK. We want to protect the public interest, but we need to make sure the barriers do not make it difficult for businesses to work in the UK. But we also need to make sure reforms reflect the global economy.’_

Australia’s parliament has been holding its own inquiry into audit quality, publishing an interim report in February. Its 10 recommendations included a requirement for the Australian Financial Reporting Council to review the effectiveness of Australian reporting standards related to fraud and company managements’ assessment of going concern, as well as the requirement for companies to assess their financial reporting internal controls, and auditors to report on those assessments. The final report is expected in September this year.

Meanwhile, the UK profession is waiting on the result of further government consultation, the result of which is also expected later this year. This will not only inform the future direction of audit in the UK but will also echo around the world.._@maneesh_m_b.