It is almost a year since the UK government published its response to the White Paper on audit reform. Then, it was viewed as one of the UK’s most pressing regulatory failures following high-profile corporate collapses where audits had been shown to be deficient. Today it looks to all intents and purposes that it is being kicked into the long grass. On May 18th 2023, the government stated it had, ‘not set a date for publication of a draft Audit Reform Bill [but]…is committed to legislating when Parliamentary time allows’. Just what has happened to the audit reform agenda?
One part of the answer may be that audit reform is too knotty, complex and bound up with multiple interests to be reformed radically. This would be a repeat of historic reform attempts where influential audit industry and corporate leaders slowly bowdlerized the detail of reform, rendering it ineffectual. Another may be that proper reform would likely add to audit costs which, if passed onto the consumer, would be politically difficult in the middle of a cost of living crisis and an election on the horizon. Finally, it may be that the Conservative Party are now having second thoughts about their recommendations, as they try to distance themselves from the then Business Secretary Kwasi Kwarteng, who is now intimately connected with the ill-fated Truss government in the public mind.
On this latter point, it is fair to say that the government response received a cool reception a year ago anyway (a ‘missed opportunity’ according to Sir Jon Thompson, chief executive of the Financial Reporting Council) and carried many of the now better-known traits of Kwarteng. It was bizarrely framed within the context of Brexit benefits (pp.7-8), even though the question of EU law did not form any major part of the 2021 White Paper, nor did it feature in the Kingman Report, the Brydon Review or the Competition and Markets Authority report on the audit market. It is difficult for any good faith reading to see quite how EU law created the alleged problems in audit at Carillion, Thomas Cook, Patisserie Valerie and other notable corporate collapses.
The deregulatory benefits of Brexit also confused the objective of reform, which seemed undecided about whether to improve transparency by increasing the information corporations provide to their stakeholders; or to encourage corporate agility by removing certain reporting burdens assumed to carry over from EU law. Similarly, the preference for ‘market-based solutions and non-regulatory options in preference to regulation’ (p8) continued the ‘Brexit benefits’ theme; but made no sense because it effectively expressed a need to ‘trust the market’, just as the market had demonstrably failed
It is unclear whether these precise recommendations will be implemented now Kwarteng’s reputation for policy selection is tainted after his brief, disastrous spell as Chancellor under Truss. But the problem of audit failure has not gone away. In just over a year KPMG have been fined for their role in the Rolls Royce, Conviviality and Revolution Bars Group audits, PwC received penalties for failings in the accounts of Kier and Galliford Try, a large number of energy firms collapsed after receiving clean audits and then there was the debacle around the auditing of the SNP’s finances.
There are good reasons why audit quality will come under more scrutiny as rising interest rates erode corporate asset valuations, leaving firms with difficult decisions about whether to take impairments or cook the books. There is a pressing need for civil society to keep audit failure in the spotlight and to build momentum for audit reform.
That is the core aim of this laboratory. It is an experimental space where we build new insights about what’s going wrong in audit, provide recommendations for reform and encourage an open-ended discussion about what audit could be.
Our demands are not hugely radical. Many have already appeared in the government commissioned reports and reviews of Kingman, Brydon and the CMA. We propose:
- A new mission for audit
- A reformed professional culture of audit
- A new regulator for audit
- Greater partner accountability in audit firms
- A more effective sustainability-focus for audit
- A people’s audit to promote public accountability and transparency
In more detail…
- A new mission for audit: The mission of audit should be to enforce the principles of the 2006 Companies Act: to exercise independent judgement and professional scepticism to verify whether a true and fair view of a company’s assets, liabilities, financial position and profit or loss is being presented. Accounting rules should be subordinate to company law with regard to the principle of prudence and the protection of capital maintenance.
- The Ask: a new written mission for audit that it should enforce the principles of the 2006 Companies Act.
- A reformed culture of audit: The culture of criticality and scepticism needed for effective audits is incompatible with the ‘can-do’ creativity and optimism of non-audit. There needs to be a more effective ying to the yang.
- The Ask: Legal separation of audit and non-audit services; a new professional body for auditors, separate from the accounting bodies to professionally embed the principles of professional scepticism, independent judgement and prudence; new auditor-specific qualifications, skills, and training, particularly in the area of forensic accounting and fraud awareness overseen by that professional body; co-ordination between the professional body and universities to create accredited educational pathways that embed these different norms and skills to provide for a more distinctive professional culture of audit.
- A new regulator for audit via the recommended Audit, Reporting and Governance Authority (ARGA) to replace the FRC.
- The Ask: A new regulator – ARGA – which would have a clear statutory base, enhanced enforcement powers, lines of accountability to parliament, and funding via a statutory, rather than voluntary levy; it would enforce CEO and CFO annual attestations on the effectiveness of internal controls over financial reporting and the legality of dividends and other distributions, which would be audited; it would impose more meaningful sanctions for audit failure and involvement in accounting irregularities
- Greater partner accountability for audit failure: The combination of the partnership system with limited liability gives partners much of the upside of audit and non-audit revenues, but much less of the risk of failure.
- The Ask: There should be a reformed sanction regime to target partner incomes and reduce moral hazard. Limited liability privileges should be removed.
- A more effective sustainability focus for audit: Any prudent audit would view climate risk as a key audit matter. The transition to net zero is likely to impose some costs on most businesses. But whilst climate risks are regularly recognised in the narrative sections of annual reports, they are generally firewalled from the financial statements.
- The Ask: Auditors should provide an opinion on the climate solvency of firms – that is, they should assess the likely costs a firm would incur to reach mandated net zero targets and decide whether levels of provisioning or investment are satisfactory to meet those goals; there should also be reasonable rather than limited assurance when assessing company climate assumptions, and the models used to assess climate risk (including the risk of non-linear, correlated outcomes).
- A people’s audit: creating national and local resources to allow the public to hold public bodies and their auditors to account through a ‘peoples audit’ to enhance public transparency & accountability.
- The Ask: A local authority transparency kitemark scheme; independent reviews of council Audit Committee effectiveness and whether they meet the CIPFA position statement on Audit Committees (2018); a more robust enforcement of public interest report processes and oversight of local authority compliance; public availability of all procurement and joint venture contracts.