Directors’ reporting and the statutory audit have taken a battering in light of recent corporate catastrophes such as Thomas Cook Group plc, Carillion plc and BHS. In response, the government commissioned three independent reviews in 2018: Sir John Kingman’s Independent Review of the Financial Reporting Council (FRC), the Competition and Market Authority (CMA)’s Statutory Audit Services Market Study and Sir Donald Brydon’s Independent Review of the Quality and Effectiveness of Audit.
- The FRC Review recommended that the current regulator, the FRC, be replaced.
- The Brydon Review concluded that statutory audit needs to become more informative and helpful to users.
- The CMA Market Study called for new measures to increase quality, competition and resilience in audits.
The government has now published a consultation paper, Restoring Trust in Audit and Corporate Governance, that addresses the findings of each review and includes new measures in relation to four areas:
- Auditors and audit firms
- The audit regulator
This post focuses on the purpose and scope of an audit.
Audits are a well-established part of corporate life and, as the Brydon Review found, the approach to audits has not changed significantly for decades. The traditional audit formula consists of auditors checking the financial statements and directors’ compliance with their legal obligations before signing off that the accounts give a true and fair view of the company. However, this approach misses out on swathes of information that could provide a far more meaningful assessment of the company’s health.
Coupled with this lack of dynamic development in the audit process itself is the domination of the UK audit market by the Big Four – the consultation states that 97% of FTSE 350 audits are undertaken by just four audit firms. This concentration is further compounded by the fact that the Big Four compete to offer large companies a range of other complementary business services.
Given the fundamental purpose of audit is to give investors the comfort of knowing about a company’s state of financial well-being, there is a need to build integrity and resilience in the audit space. The consultation paper proposes to create a new, stand-alone audit profession with a clear public interest focus, backed by new regulations to increase competition and reduce the potential for conflicts of interest. It envisages exciting new opportunities to be opened up for challenger audit firms and for audit firms to separate their audit and non-audit practices.
The government is proposing to introduce a specific statutory duty for auditors to consider relevant director conduct and broader financial and other information in forming their opinions. Whilst the “statutory audit” looks at financial statements, it is proposed that the audit function be expanded to create “corporate auditing”. It is proposed that companies publish an “Audit and Assurance Policy” (AAP) which will set out and define what additional information has been subject to audit. The AAP will be company specific with the directors taking into account the views of shareholders and other stakeholders such as employees, suppliers and lenders. The consultation paper seeks to engage debate around the role the new regulator Audit, Reporting and Governance Authority (ARGA) should play in regulating these wider auditing services and whether its role should extend beyond setting, supervising and enforcing these proposed new standards.
The government is also proposing to introduce new legislation requiring directors of Public Interest Entities (PIEs) to report on the steps they have taken to prevent and detect material fraud. This would be reinforced by further new legislation requiring the auditors of PIEs, as part of their statutory audit, to report on the steps they took to conclude whether the proposed directors’ statement (regarding actions taken to prevent and detect material fraud) is factually accurate. The auditors would also be required to report on the steps they themselves took to detect any material fraud and assess the effectiveness of relevant controls.
The deadline for responses to the consultation is 8 July 2021. The government aims to pass primary legislation to introduce the proposed reforms as soon as parliamentary time allows.