In the wake of Carillion, we shouldn’t overlook the importance of a robust and trusted audit

 
Helen Brand
TOPSHOT-BRITAIN-ECONOMY-CONSTRUCTION-COMPANY-CARILLION
Source: Getty

In recent years, we have seen some high profile business failures where, as with the recent case of Carillion, the ensuing analysis has, among other things, focused on the role of audit.

It is absolutely appropriate for us to investigate these situations and look for lessons to be learned, and improvements that can be made.

However, we shouldn’t overlook the important public value of a robust and trusted audit. In such circumstances, it is worth revisiting the various factors that give audit its value, and the ways in which auditors, standard-setters, and regulators can work together to improve the process and engender public trust.

There are three broad schools of thought around where the value comes from.

First, is that the value of audit is technical. That is, the value of audit comes from the testing.

For example, when an auditor determines there is a risk of material misstatement from revenue, it is the procedures the auditor designs to reduce that risk that deliver value to investors. Under this approach, greater value comes from greater audit testing.

Second, is that the value of audit is emotional. This means it is the human side of auditing that delivers value. Audit partners sometimes talk about “seeing the whites of their clients eyes”, when questioning management on particularly contentious issues.

It is their skill at reading body language that helps them find out which areas need deeper enquiry. Under this approach, greater value comes from the emotional intelligence and judgement exercised by the audit team.

Finally, some argue that the value of audit is psychological. There is a famous study, conducted in factories the 1920s, which found that productivity increased when managers made the factory floor brighter. Productivity also increased in response to other workplace changes, such as better cleaning and break times. Now known as the “Hawthorne effect”, after the factory where the study was conducted, the hypothesis is that employees respond positively to knowing that somebody is taking an interest in their working environment.

Similarly, we can imagine that knowing that an auditor will be interested in the financial reporting process might stimulate better financial reporting. With this approach, value comes from the extent to which people believe that auditing is worthwhile.

Public confidence

The value of audit comes from a mix of all three, and it’s important that any exercise aiming to improve audit quality starts by identifying where the greatest value lies.

Otherwise, we risk ignoring the activities that really add value, while promoting activities that may add no value – for example, if the human side of auditing delivers the most value, then improvements to the technical factor (like additional audit procedures) will not necessarily boost quality.

Indeed, it may even harm audit quality if it distracts the audit team from spending more time challenging management’s assertions.

Quality remains vital to public confidence. While the Financial Reporting Council’s annual inspections indicate that audit quality has improved and continues to improve, concerns remain both about those audits that fall below satisfactory standards, particularly when it comes to the consistent delivery and the pace of improvement. As a result, there is a keen interest in initiatives to drive better audit quality.

This week, ACCA is publishing research into what makes a good audit. Any discussion about improving quality has to start with an articulation of the features that a quality audit should possess – and recognition that these factors can sometimes exist in mutual tension.

These features include, for example, thoroughness – by ensuring all risks are addressed and issues resolved – versus timeliness in delivering information quickly enough that it retains usefulness.

Independence, versus familiarity with, or closeness to, the client. Standardisation and adherence to rules and procedures, versus the autonomy which is often required to identify and investigate risks of material misstatement. And of course transparency – providing the salient information needed, and expected, by users – versus the confidentiality that is required of an auditor, where disclosure may be damaging to the company and investors.

Standard-setters need to reflect on these tensions when drafting new standards. Balancing them requires extensive consultation with stakeholders, drawing on their viewpoint of the role of the audit, and the value of the process to company, stakeholder, and society. And each individual auditor must then exercise judgement in applying these standards.

Ongoing conversation

Every public company audit must respect what the public wants, needs, and expects – while also recognising that this may change over time. And there is a need for an ongoing global conversation among business, the audit community, government and other stakeholders to tease out these factors and help us understand them better.

There is certainly room for improvement in current auditing standards and procedures, but there is also room to better recognise the importance of the audit function, and to acknowledge the public value that has been and will continue to be delivered.

Let’s use each failure to learn what needs to be done, so we can help standard-setters and regulators steer auditors towards what really adds value in an audit.

Related articles