Humphrey: Audit needs a dynamic repair
Manchester University’s Professor of accounting, Christopher Humphrey talks to Accountancy Age about the future of audit
Manchester University’s Professor of accounting, Christopher Humphrey talks to Accountancy Age about the future of audit
In this interview, Prof Humphrey, a member of Sir Donald Brydon’s advisory board, offers his own reading of the Brydon report, explaining the significance of Brydon’s conceptual reframing of audit and the potential the report offers for meaningful reform.
I hope that people would regard Brydon as an integrating report that compensates for the fact that, ideally, it should have been done before reports on audit regulation (Kingman) and the audit market (CMA). It allows you to take a more conceptual stance with respect to the role and purpose of audit and, from there, to contemplate the implications for the demand and supply of auditing services and their regulation.
It is essential for people reading Brydon not to interpret it from the perspective of the standard, fairly restricted view of audit as just being the ‘audit of financial statements’, but to utilise and to learn to appreciate the value of Brydon’s definition of the purpose of audit being to help to build and maintain deserved confidence in the company, its directors and the information on which it reports publicly.
If you look at that definition, you are in a position where you’ve gone from the audit of financial statements to viewing audit as something much broader. I regard this definition as offering the potential for a more holistic view of audit, opening up different avenues as to the way in which audit can develop in the future. Critical here is the emphasis on ‘deserved confidence’. Confidence is not something that just hinges on the financial statements and the audit opinion on those statements. It is something that also has to be earned by the company and its directors.
For years we’ve tended to stick with a very similar concept of audit – and when things go wrong and people ask ‘where were the auditors?’, we tend to focus primarily on different ways of regulating or adjusting or invigorating the market for the same, standard audit function. We introduce new regulations, we rotate auditors, we restrict non-audit services, we talk of audit expectation gaps and how the audit is misunderstood but we seldom look to fix things by fundamentally changing the concept of audit. The static nature of audit is reinforced by standard setting processes that routinely emphasise or rely on the notion that ‘an audit is an audit’. Consistency of practice is certainly important, but it is not easy to innovate from the conceptual base that ‘an audit is an audit’ (and nothing else).
Firms are competing over whether they can do the audit product in a different or distinctive way, or cheaper or faster, or bigger and deeper (with data analytics), but, ultimately, they are still all focused on giving an opinion on a set of financial statements – which also means that the value of audit depends fundamentally on the information set being audited. If the financial statements lose value, audit, as a secondary function, inevitably does likewise.
When I looked recently at the formal investigations of audit in the Netherlands, I was struck by how the profession itself, in 2014, had managed to identify 53 areas where audit quality and independence could be improved. Can you think of any equivalent comparison where you would even bother trying to fix a product or service with so many problems and at what stage do you conclude that it is better to opt for a different service or buy another product?
In this vein, I have been working with a number of other colleagues at universities in Ireland, Sweden and in the UK, utilising the writings of Richard Sennett and his ideas on craftsmanship and notions of static and dynamic repair. Put very simply, if you’ve got a toaster and the toaster breaks, you can fix it to enable it to make toast again and this is treated as a static repair. Transforming a toaster so that it also functions as a grill would be to make a dynamic repair.
Broadly speaking, a dynamic repair needs to develop the basic concept of audit. The Brydon report is very much a philosophical statement as it is builds and develops from a fundamental definition. Understand and appreciate Brydon’s definition and I think you have the opportunity for a dynamic repair of audit. So, auditors can provide an opinion on the company’s financial statements, but they could be providing opinions on other information made public by the company as part of the ‘audit’ or commenting or providing additional information themselves or getting the company and its directors to do things that collectively help to build and maintain ‘deserved confidence’.
This is why the Brydon report talks about auditors needing to be able to provide ‘original’ information as part of their role and linking the audit process very much to demonstrating and enhancing the resilience of companies – something which is going to be particularly critical given current concerns regarding the dual risks of climate change and pandemics. A similar spirit applies to the recommendations regarding public interest. PIE’s should demonstrate, in their words and not according to some pre-prepared check-list or template, what they are doing and contributing specifically to meet their self-defined public interest obligations and have this assessed by the auditor.
Included in my formal submission to Brydon, alongside colleagues Prof Stuart Turley and Dr Javed Siddiqui, we discussed an idea around audit and assurance.
A fundamental constraint on the development of audit is that auditing has typically been defined as a sub-set of assurance. This has had the effect of fixing audit conceptually in such a way that service innovation happens in the field of assurance rather than in audit. A new assurance service is not audit – it is assurance.
But what happens if you reverse this assumption, such that assurance is treated as a subset of audit? It immediately frees auditing up to do more than just be an assuror of information credibility. Audit can assume the capacity to be more of a primary or first order function, and not a secondary function whose fundamental purpose depends on the information being assured. Or, utilising the Brydon report’s reframing of the purpose of audit, it becomes possible to see that auditors can help to build and maintain deserved confidence in the company in ways that do not just amount to reporting on information made public. It could be about advising, facilitating, enabling and improving. In essence, audit conceptually could be more about ‘doing’ things than just ‘reporting’ on things.
Brydon is very clear on this. He doesn’t want the audit of everything and anything so that we end up with an obsessive checking and monitoring society. But he wants audit to be purposeful, so that it assures people, it helps to build people’s confidence in a company, it encourages directors to operate in ways that deserve and merit confidence being placed in the company, it helps to build better and stronger companies.
I am less hung up over the notions of auditors having to be fundamentally independent, so long as their work and opinions are informative and trusted. If they are not trusted, that’s a bigger problem. An independent opinion needs to be valuable. Remember, it is possible to provide an ‘independent’ opinion on something for which you have no particular competence or specialist expertise. It is also possible to provide an independent opinion on something that is losing relevance. So, yes independence is important, but audit is not only about independence.
I would look at how we can build trust in audit by the product being seen to be more useful, to be more informative, to be more used. Audit should not be being routinely referred to as boring, staid and conservative. Why are adjectives such as astute, incisive, enabling, innovative, invigorating not readily applied to audit? When I interview younger auditors, even those 5 or so years post-qualified, I often ask ‘When you arrive at the client company’s premises, do people say, I am so glad you are here today, we have so many issues to discuss with you, there are so many ways where we need your knowledge and expertise?’ The typical answer is ‘No, never, people really don’t want us there.’
Audit is better and more important than this.
The profession consistently emphasises such commitments and responsibilities, stressing that what it does in auditing financial statements is in the public interest, although the formal wording in audit reports does represent audit as having a much narrower reporting responsibility.
The typical analogy or explanation is that audited financial statements are like the oil that enables the car engine to turn over smoothly. It helps business to function properly and, in turn, to build strong economies. Its critics, however, will always point to major corporate collapses under the current audit regime (and a long history of them under earlier regimes).
A standard line of travel is to emphasise the risk reduction value of an audit and the impact that this has on corporate value (i.e., if future cash flows are discounted at a lower cost of capital, corporate value increases). And more profitable companies can pay better wages, deliver better working conditions and even contribute to the development of a more equal and harmonious society.
But what happens if you reverse the direction of travel? If you start from desired social goals and ask how best an auditing profession, with a multiplicity of not just current but future skill sets and existing and new, talented, people can directly and most effectively contribute to the pursuit of such social goals. Would you necessarily end up with the same audit function, focused around the verification of financial statements? I suspect not. This is another way of looking at what a dynamic repair to audit could mean. In essence, thinking differently also means contemplating doing things differently.
Fundamentally, this is a question on which the Brydon report’s reframing of the purpose of audit openly invites discussion and development. Instead of assuming that what auditors currently do is in the public interest, or fitting existing activities to existing declarations like the UN’s sustainable development goals, we need to be spending more time asking what it means to work in the public interest and how best to maximise impact and enhance social well-being? Brydon’s notion of a new, independent, auditing profession is an opportunity to review what will make the audit of the future more useful than that of today.
The short answer is yes! At a very broad level, we have had a lot of regulatory activity intent on building confidence in audit and yet confidence, on the basis of financial press coverage and the string of investigations and inquiries, is low. It is also worrying that many regulatory proposals tend to be backed more by belief statements (and the pursuit of a belief consensus) that they will work, even when the empirical evidence on their impact is, at best, mixed.
Some regulatory solutions, such as joint or shared audit, are seemingly put forward and rejected as a viable solution every so many years. We appear to pay more attention to the notion of an audit market and the importance of choice, yet struggle to recognise the conceptual questions as to whether a statutorily required product is something we are really ‘choosing’ to have and what we are making choices on if auditors are all working in compliance with International Standards on Auditing (ISAs)?
We also worry about growing levels of commercialism in the field of auditing – yet we seem to believe in markets, but also struggle to respect market outcomes. It has to be asked whether an audit market with the attached current scale of regulation is really a ‘market’? And whether we have become more concerned with repairing the market for a static, statutory audit function and forgot about dynamically developing audit?
I would suggest that audit and the auditing profession is going to be best able to flourish and develop under a dynamic repair scenario than it is under a more dominant regulatory and market competition framework. While the Brydon report is talking about creating a new audit profession and there are various issues to consider as to how this is best approached, metaphorically, it is a report that is putting the ball very much in the profession’s court and saying, ‘run with it’. If audit really matters to you as a profession, make it stand out. Make it a career that more people look to stay in rather than something they move out of and on to ‘better’ things. The Brydon report is not claiming to have the solutions for everything but it clearly wants to see better and different auditing.
I would identify a number of critical signs that emphasize the importance of dynamic responses being made by the profession. For instance, it is important to ask whether the conception of audit that is underpinning the current prominent pursuit of ‘audit-only’ firms is premised on the broader purpose of audit specified in the Brydon report or is just intent on establishing a ‘financial statement-only’ audit firm? If any such change is to be made, the former is a far more attractive proposition than the latter. There also are questions as to what is driving the strategic responses of the major audit firms? Are their actions now more of political necessity rather than representing a strong belief that such an institutional change will deliver better quality and more socially purposeful audits?
Such firms insisted for many years that audit quality can be enhanced by providing non-audit services to audit clients but now seem to have dropped such an opinion. Have they really changed their views? Is there completely new convincing empirical evidence of the benefits in terms of enhanced audit quality? I am sure the firms’ critics are actively thinking what other things they could be persuaded to drop or abandon. The same can be asked in terms of regulators and market competition authorities and the extent to which their actions are premised on a sound conceptual framing or are being undertaken as ways of legitimating and bolstering their own position and standing?
Areas where the Brydon review struggled to get detailed responses related to evidential positions on the nature and scale of auditor liability and the strength of the business model under which current financial statement audits are delivered. These are likely to be critical issues going forward, not just because of the nature of recommendations in the Brydon report but also because of the practice related questions that continue to be raised by regulatory inspection reports and even the firm’s own transparency reports. I suspect we are not far off from having a serious debate, not just on what is the public interest contribution of audit and the enhancements that could be made by a dynamically repaired audit post-Brydon, but on asking what is the appropriate remuneration level of audit partners working in the public interest? And would we attract very different people, and even better auditors, if the audit function was delivered under a very different business model? These are all issues that currently fascinate my students as they contemplate a career in auditing. The Brydon report has given us a great deal to think about in terms of how we in universities and as a profession educate and train our students. We all need to play our part in seeking to change the ‘compliance mindset’ that Sir Donald identified as characterising audit today.
For more information on understanding the Brydon report, Prof Humphrey also wrote ‘Reading the Brydon Report’.