Audit: The time is right for change

AUDITING AND AUDITORS have been elevated to the front pages, with audit regulation and market reform high up the public policy agenda. This increased scrutiny provides a unique opportunity for the profession to enhance the value of audit to the markets.

We all know that the issues responsible for the financial crisis were complex and difficult to solve. As a profession, we needed to reflect on how we play our part in restoring public trust. However, what is absolutely clear is that quality, independence, objectivity and a responsibility to report to shareholders are the key tenets of an audit and must remain at its heart.

The current changes for the audit market are significant, and I will return to these, but as a profession we need to take some bold steps.

We recognise our responsibility for audit quality and this is one area where we can always improve. The work of the FRC’s audit quality review team and audit firms’ transparency reports have done much to improve audit quality and to increase its visibility, however, both can be developed further. Audit committees and investors have the right to more information on such an important subject.

The time is right to improve reporting both by the auditor and by the audit committee. The level of transparency and direct engagement between the auditor, audit committees and shareholders should also be increased.

Audit committees are required to report significant issues and judgments. To be effective this will include the key issues discussed between audit committee and auditor and how those conversations are manifested in the disclosures and judgments applied to the accounts. The role of the audit committee is vital and should be reinforced and promoted. We support measures to strengthen the auditor’s accountability to the audit committee, and increase the standing and recognition of the committee among the investor community.

The ultimate responsibility of the auditor is to report to shareholders. In its report to shareholders auditors should provide more insights from the audit, not least to satisfy investor demand.

Auditors need to think more about progressive changes that meet the evolving needs of companies and the capital markets of today and tomorrow. PwC has long advocated the value of more effective corporate reporting through our ‘Building Public Trust‘ agenda. The audit of the future, however, has to go further. This might, for example, be achieved by providing assurance on measures that matter to the market, including non-financial areas and on a real time basis, making better use of technology and social media, and reporting information that is clear, complete and transparent. There needs to be a focus on relevance as well as reliability.

Some of these ideas are already being considered in the context of the role of auditors post-financial crisis. However, much of the debate has concentrated instead on issues relating to market structure. Many of these proposals are sound, but some are based on fundamentally flawed assumptions and, if implemented, risk damaging the quality of audits.

With the Financial Reporting Council’s ‘comply or explain’ regime coming into force, requiring FTSE 350 companies to put their audit out for tender at least once every ten years or set out the reasons for not doing so, the wheels of change are already in motion. We support this change because we believe it will help to continue to drive audit quality improvement and innovation, as well as increasing competition and allowing companies to retain choice. It should also help to deal with certain perception issues around auditor independence.

This is a substantial development and while I have seen a significant increase in companies considering audit tenders and actually initiating a tender process, we are yet to see the true longer-term impact on the audit market and the profession as a whole. It would make sense to give the ‘comply or explain’ regime some time to bed down before any further proposals are introduced. After an initial period of increased activity, FTSE 350 tenders will run at an average of 35 a year compared to 8-10 currently. This will have time and cost implications, but there will be benefits reaped.

Some want to go further, either by increasing the frequency of mandatory tenders or requiring rotation of audit firms. If the mandatory tendering period was shortened further by additional rules – say five years and therefore an average of 70 FTSE 350 tenders a year – this would reduce the effectiveness and value of the tender process and cause disruption for companies.

Forcing firms to rotate is likely to damage audit quality and potentially strips those who are engaging an auditor for the benefit of their shareholders of the ability to choose their preferred provider.

The time is right to enhance the value of audit. We must remain committed to working with companies, investors and other stakeholders to provide them with the audit and assurance they need to invest in corporate UK with confidence.

James Chalmers is UK head of assurance at PwC