Overhauling audit reform

A string of eyebrow-raising company collapses, including retailer BHS and construction company Carillion, have prompted three independent reviews in the past two years to recommend a radical overhaul of British auditing.

Yet the UK government has done little. Audit reform has been talked about for so long that business school students now produce dissertations on the history of ‘future of the audit’ studies. Indeed many of today’s issues were raised in the McFarlane report in 1992 and there is no lack of consensus around the need for change. Auditors have repeatedly failed to warn investors of looming problems. But politicians have failed to deliver substantive reform that serves the public interest.

Public costs

Every company collapse is a potent reminder that society is the auditor’s ultimate client. The public, not just shareholders, typically bear the costs of mismanagement. Carillion’s 2018 collapse threw 2,000 staff out of work and landed taxpayers with an estimated bill of £148m.

Government departments and regulatory bodies issue seemingly endless “calls for views” to establish what reforms need to be pursued and implemented. This is problematic because it puts officials under pressure to identify the “ideal” reform and encourages those with material financial interest to criticise and eliminate radical reforms.

We end up with the l owes t common denominator. Over the years, every aspect in the audit environment has been tinkered with – a few more standards here, a bit more oversight there, some additional independence and competition arrangements, a tweak of the professional training curriculum and a shopping list of extra items that auditors should tick off.

But the core concept of auditing has not been updated in decades. It remains largely backward looking, standards driven, and financial statements focused. Contrast that with an economy that aspires to be digitalised, sustainable and fairer – no wonder auditors fall short.

Assurance

As Britain recovers from a global pandemic, delivering proper audit reform has never been more important. Society needs assurance that the companies it depends on for jobs, investment returns and tax revenues are being run responsibly.

I believe last year’s review by Donald Brydon which I worked on, offers a coherent road map for change. First, fundamental audit reform starts with the concept of audit, not the market for audit services, nor its regulation. If businesses are to fulfil richer purposes and values, then those of auditing must shift too.

The government should enshrine the Brydon review’s broader definition of audit in company law: “The purpose of an audit is to help establish and maintain deserved confidence in a company, in its directors and in the information for which they have responsibility to report, including the financial statements.”

Second, we need to create a safe space for experimentation, true problem solving and innovation. This would broaden the possibilities for reform and allow us to look beyond the standardised definitions of an audit.

Third, if we want auditors to do more, we should make the case for a new, vibrant audit profession. Intellectually, it has long been argued that the auditor would serve the public interest if they acted as a form of moral arbiter in business. In that case, we need to change the auditor’s benchmark for judging whether confidence in a company, its directors and the information they produce is “deserved”. Rather than just checking that the numbers are correct, they should decide whether the company is abiding by the terms and conditions by which society grants companies a licence to operate.

Now, more than ever, auditors should be inspired by the role they can play to help restore trust in corporate Britain, enhance its resilience and, ultimately, build back better.