Auditors need to respond by focusing on the relevance of audits – to challenge and add value for the sake of the public interest.
Numerous corporate scandals and economic crises of the last two decades have spurred many structural reforms within the audit market. The European Union (EU), in particular, has taken a bold stride by introducing new regulation to clarify the role of auditors,
safeguard their independence, foster a more dynamic market, and improve the oversight of audits performed in the EU. Regulators and international standard setting bodies are taking on a more significant role by anticipating vulnerabilities and introducing standards to prevent future meltdowns.
In our yearbook 2015, we shared our own beliefs on the role of audit and its value for the business community and society as a whole (1). This year, to foster an open debate on the state of today’s audit, but also to understand the evolutions that will impact the way auditors will do their job in the future, we asked three experts for their insights.
Here is what Eddy Wymeersch, Chairman of the Public Interest Oversight Body (PIOB) (2), Pablo Perez, Senior Advisor on Accounting, Auditing and Disclosure at the Financial Stability Board (FSB)(3), and Joe Perry, Member of the Secretariat of the FSB, have to say about the present and future of our profession (4).
Q. More often than not, regulation is viewed as a burden by the private sector. From your perspective, do you think that this is the case for the audit market?
With the clarification that the FSB is notan accounting or audit standard setter, we view regulation as a matter of incentives. It’s about striking the right balance between preserving the public good on one hand, and respecting private choice on the other. Regulation should not dictate entrepreneurship: it is the management’s responsibility to make decisions on business strategy. The regulators’ responsibility is to preserve the public interest. Sometimes striking a balance between different objectives can be difficult. It really depends, however, on how incentives are developed.
For audit firms, such incentives could relate to firmly basing their reputation on technical expertise and preserving their independence, which improves audit quality and serves the general interest through enhanced investor confidence. In general, I think auditors understand they are in fact providing a public good.
I think the question should be considered differently. Most of the profession recognises that standards are guidelines for auditors worldwide. A point that is rarely mentioned is that standards enable auditors around the world to speak the same language. For instance, if auditors talk about independence, they should know what it really means; and if there is a doubt, they can always refer to the standards. Also, standards create a universal foundation that can be applied anywhere. Each country can then choose to further build upon those standards. Moreover, it allows auditors to be active in different jurisdictions as the same baseline standards will apply.
Therefore, when adopting international standards, it is important to maintain a level of flexibility, as these standards are meant to be applied across numerous countries that have different systems. When standards or regulation are considered as a burden, it is often related to complexity and precision. That is the issue that often instigates complaints.
Q. Businesses are facing challenges as a result of globalisation, technological development, and generational change. Taking this into account, do you believe that auditors are looking at the issues that truly matter? And what will be the issues that will matter in tomorrow’s world?
Indeed, the world is changing at a rapid pace. With advances in technology, the way audits are conducted will no doubt change, especially with the growing use of big data and artificial intelligence, which will greatly enhance tracking and analysis capabilities and likely make techniques such as sampling less relevant. This will particularly affect audit tasks often performed by junior staff –such as year-end inventory. For instance, some audit firms are using drones to more accurately determine the size or volume of inventories in the manufacturing, retail and natural resources industries. However, it is essential to keep in mind that the main goal for auditors will remain the same. Technology will not change the key audit matters in tomorrow’s world, and being able to determine whether financial statements fairly and accurately depict the financial position will still be the ultimate goal.
The introduction of technology may change the way auditors work, but will not change their fundamental purpose.
From my understanding, the audit activity will change from what is today very burdensome verification tasks. The basic, tedious parts of the audit will be performed by computers. Does this mean that the role of auditors will become superfluous? Absolutely not. It’s rather the opposite! Auditors will be more engaged in the judgmental process, in ensuring the critical eye, the decision-making, the documentation of decisions, and the presentation of these decisions to the market.
This is much more difficult, yet at the same time much more valuable and intellectually rewarding. As for the numerous new issues that will be important for auditors tomorrow, the threat of cyberattacks will need to be integrated in the risk assessment part of the auditors’ work. There are more and more cyberattacks today, and auditors will need to check whether the existing procedures, programmes and mechanisms put in place by the audited entity are sufficient. And if any doubts arise, they should point out to the management that additional steps should be taken to make sure that the management improves cybersecurity.
Q. There is a growing perception that statutory audits are becoming a commodity in today’s world. Is this a fair description of the reality? What should constitute the added value of audits for companies and for the public good?
I would not talk about a full, outright commoditisation. However, this is a common concern for regulators, as they see an increasing trend in relinquishing some of the main roles that the audit profession was meant to fulfil. For instance, there is pressure on the managers of audited companies to release financial statements sooner – and ahead of peers – especially in certain sectors, such as financials.
That may in turn press to unduly accelerating audits, but auditors must remember their responsibility is towards the board of directors and the audit committee, not management; they must follow the facts and report any material concerns. Related to this, there is an increasing use of the materiality excuse, especially when auditors become aware of something that might be considered capable of rocking the boat. It is the auditors’ responsibility to determine whether identified red flags are material, and whether they should be further investigated and reported. Crunching the numbers will not suffice. Auditors will have to take into account the qualitative aspect to determine whether those red flags are material.
Also, we observe there is an increasing reliance on management’s assumptions, and this has been flagged consistently. It is one of the main duties of the auditor to contest those assumptions and apply professional scepticism. That is precisely where the auditor adds the most value. Once again, audit should not boil down to merely crunching numbers and determining technical compliance with the accounting standards.
Clean reports provide trust on a company’s financial position, so professional scepticism is a must in determining whether
management assumptions are realistic and whether financial statements fairly represent the business.
I agree that there is a growing perception that audit will become a commodity. Some parts of audit, the parts that can be automated, can become a commodity, but the rest will certainly not. The role of auditors will be upgraded to a much higher level. Indeed, technology will change the audit function and process, but we will need more and more experts. Valuation issues
especially under the new accounting standards, will require deep expertise. Scepticism cannot easily be captured in a computer algorithm. Some judgments will require legal assistance. And increasingly auditors will have to assess business judgments. It is in the public interest that these new functions are well framed.
Q. The audit profession is facing pressure to decrease the cost of audits while expecting to ensure greater quality financial reporting to favour fair and transparent financial markets. How can we achieve these two objectives? What would your recommendations be?
I would not refer directly to costs; the audit industry is not precisely a predatory environment characterised by fierce competition. Rather, I think we have to bear in mind that the business model of audit firms is changing, and the contribution of non-audit services to their overall revenues is increasing. This may be changing the balance of power within audit firms, and putting pressure on audit engagement partners to be more efficient. But even if these ancillary services are more lucrative, they may be considered to affect the independence of an audit firm, and thus also impact its reputation and hence the firm’s franchise value. Again, this puts pressure on firms to focus on their basic assurance goal.
I can tell you that in one of the standard setting boards I attended, I drew attention to this point. I think the fees are clearly insufficient, I don’t know how this will evolve in the new landscape where you have more automation. However, with the fees decreasing, the best people in the audit firms might go to the non-audit services part of the firm because there is more money to be made and, as a consequence, there is a fear that the audit could increasingly be in the hands of those who are not necessarily the most motivated.
To address audit fees, we need to strengthen the procedure by which the auditors are hired. This is a governance issue: the auditors need to be hired by the full board on the proposal of the audit committee at a correct price with a clearly defined scope and mandate. This procedure should not be managed by the company’s human resources, as I was once told! There have been instances when companies have laid off their auditors for lack of quality, which was a response to the audited company’s unwillingness to pay suitable fees. We could compare it to purchasing insurance: if you pay a cheap premium, you are likely to receive cheap coverage.
Q. Europe has taken a bold step with the EU Audit Reform. Do you think that this regulation will improve the way audits are performed in the EU?
I think it is clearly a significant step forward. However, mandatory rotation might create an environment of musical chairs where the biggest firms swap audit mandates amongst themselves. In this sense, there seem to be concerns around the retendering of audit engagements, with firms having created specific departments to deal with the related procedures.
The ideal scenario would be to see this leading to significant improvement in the quality of audits and an eventual increase
in the number of players within the audit sector. Again, I think that we need to focus on the basics: audit quality and auditor independence. Audit firms must never forget they are serving the public good. They should be continuously reminded that their client is not management but the audit committee and the board. Broad changes in the business model of audit firms also need to be addressed, while being aware of the key focus on challenging assumptions, following on leads, and gathering the evidence needed to determine material misstatements.
And in the end, being able to provide an opinion as to whether financial statements are a fair depiction of the financial position of the audited company.
The EU has adopted a regulation which is directly applicable in EU Member states at a higher level of proficiency. What I mean is that the regulation is stricter than the international standards and quite different. For example, audit firm rotation has not been introduced in international audit standards, mostly because many countries, and particularly the United States, view this model as too disruptive. The EU has adopted a much more stringent view regarding the audit profession and that is what you find in the new regulation. The United States have a different point of view, and it is important to consider that in practice liability for auditors is much stricter in the US than in Europe. That is the reason why American auditors are afraid of having generally formulated standards. They want to do box-ticking, and they tend to believe this will protect them against liability.
This of course influences the development of international standards. I don’t know if the EU will apply international standards on audit (ISAs). In the legislation, there is a provision saying that the EU could adopt these international standards provided that are subject to sufficient public interest oversight, maybe referring to the PIOB’s oversight activity. I understand that the EU is not, at present, willing to do that because they believe that the international standards are too lax. The United States is now looking more closely to what the EU is doing. But keep in mind that the American administration and essentially the PCAOB (5) do not have the same manoeuvring room as EU institutions. You know that Congress in the United States has imposed a certain number of very strict no-go zones, and rotation is one of them.
Q. Climate change is an immediate concern, and world governments have made an important stride in engaging the international community to limit global warming to less than 2 degrees Celsius. Will auditors play a role in this engagement? If so, in what sense?
Our work on this issue is ongoing. In April 2015 the G20 asked the FSB to consider risks related to climate change and, in response, the FSB proposed the creation of an industry-led task force, chaired by Michael Bloomberg, to develop recommendations on climate-related financial disclosures.
Appropriate disclosures are a prerequisite for financial firms not only to manage and price climate risks but also, if they wish, to take lending, investment or insurance underwriting decisions based on their view of transition scenarios.
The Task Force on Climaterelated Financial Disclosures (TCFD) was launched in January 2016, with the aim of developing a set of recommendations for consistent, comparable, reliable, clear and efficient climate-related disclosures by companies. These recommendations will apply broadly to financial and non-financial firms.
The TCFD published a set of recommendations for consultation in December 2016. The recommendations focus on disclosure of how a firm’s governance, risk management and strategy are impacted by climate change together with disclosure of risk metrics. The final report will be presented to G20 Leaders ahead of their Summit in July 2017.
The Task Force believes that publication of climate-related financial information in mainstream financial filings will help ensure that appropriate controls govern the production and disclosure of the required information.
I see that quite a lot of companies already have environmental reports. What is the content of that and how solid is it? I cannot say for sure. However, I do believe that over time auditors will have to consider such
issues as well. The question then will be about how they will move into this field? I think that most of the time they will not be able to do it themselves. Instead they will have to seek the help of environmental experts who can make the necessary judgment. That is what they often do in other fields.
Audit firms must never forget they are serving the public good. They should be continuously reminded that their client is not management but the audit committee and the board.
Mazars’ point of view: These insights illustrate the real significance of the audit market reform movement in which Europe is playing a prominent role. This reform recognises the value added by auditors in the service of the public interest and as such makes audit committees and auditors more aware of their responsibilities. We believe that the rapid evolution of technology, combined with these regulatory changes, will make audit a better performing and more attractive profession, thereby creating a new dynamic and sustainable business model for the industry.
(1) ‘The Audit Manifesto’, in Creating Shared Value - Mazars Group Yearbook 2015, pp. 16-17. http://www.mazars.com/The-audit-manifesto
(2) The Public Interest Oversight Board (PIOB) is an international body that oversees the International Federation of Accountants (IFAC) and seeks to improve the quality and public interest focus of the IFAC standards in the areas of audit, education, and ethics. http://www.ipiob.org/
(3) The Financial Stability Board (FSB) is an international body that monitors and makes recommendations about the global financial system. It was established after the 2009 G20 London summit. The Board includes all G20 major economies and the European Commission. It is based in Basel, Switzerland. http://www.fsb.org/
The views expressed by the interviewees are personal opinions and do not necessarily reflect the views of the FSB and its members.
(4) These interviews were conducted separately.
(5) The Public Company Accounting Oversight Board (PCAOB) is a private-sector, non?profit corporation created by the Sarbanes–Oxley Act of 2002 to oversee the audits of public companies and other issuers in order to protect the interests of investors and further the public interest in the preparation of informative, accurate and independent audit reports. https://pcaobus.org