Investment in technology will help firms improve audit process

Recent reports have revealed that companies perceived as high risk are struggling to appoint auditors, who are concerned by the reputational impact of issues down the line.

The truth is that no firm can afford the reputational damage of another botched audit, not least the smaller, challenger firms who subsequently cannot compete with the dominance of the Big Four. This trend has seemingly been exacerbated by the coronavirus, which has thrown even more firms into troubled waters.

The cost-cutting measures that are needed to survive the pandemic, such as making redundancies or forcing staff to take holidays, will always hit smaller auditors harder. They will also be less able to compete for bigger clients, and less inclined to take on riskier audits, since they cannot afford to take the hit to their cashflow if something goes wrong. The Big Four are therefore left unchallenged at the top, with little incentive to do the best possible job.

But this is all symptomatic of a much wider problem: why do audits fail in the first place? The problem is twofold. First, audits have become more complex than ever before; off balance sheet ‘knowledge’ assets continue to rise, large contract revenue and cost recognition is a continued challenge and the speed and quantity of transactions in the ever-growing global market means data points continue to expand.

Secondly, audits are post event reviews, creating a challenging dynamic between management, who already have a story to tell based on decisions made, and the auditor who is responsible for qualifying that story, but who’s re-appointment is generally also significantly influenced by management themselves.

Some say that change should start with the Big Four: we need to break them up and make moves to distinctly separate their audit branches from other advisory services, similar to the bank’s ringfencing regulations following the 2008 financial crash. Others suggest increasing competition will help firms deliver better results for clients because they fear being outperformed or replaced.

It is far too simplistic to lay all the blame at the feet of the Big Four, however.  Forcing these firms to separate their advisory work from their audits will not reduce the number of issues seen in the industry. Firms do not win additional advisory work through a failed audit, so this solution does not address the central issue. No firm is getting it wrong because they don’t care enough; they are getting it wrong because audits are getting much harder to do.

Adding more players to the market will not improve quality either. If anything, quality will decrease through a race to the bottom on price and the resulting pressures on cost with multiple players offering the same service. The Financial Reporting Council (FRC) found that the UK’s seven main accounting firms failed a third of quality tests in 2020.

The only way to resolve these issues is by approaching them differently. As things stand, with greater audit failure, the government will have to step in and appoint auditors – because no one wants to take on an audit that no one else wanted – and any idea of competition will be lost.

A fundamental change

The pandemic has forced some audit firms to consider a blanket approach to going concern statements across audits,  citing a material going concern risk as a result of the pandemic. This is using the pandemic as a ‘get out of jail free card’ in order to avoid the reputational liability of getting it wrong. An auditor’s job is to analyse the likelihood of a company’s going concern challenge, based on the future of its market and business model. Clearly not all companies will be exposed the same risks in the same way as a result of the pandemic. If auditors cannot apply their analysis and judgement to differentiate, it’s because they are either lacking the right tools to do it effectively or taking the easy option in the face of the escalating challenge of getting audits right.

The pandemic has shone a spotlight on the need for a more proactive audit process that leverages technology. Currently, three siloed processes running at different times to produce management information (MI), statutory reports and assurance that numbers are correct means issues hard to spot and resolve.

It means that audit is getting much harder to do. Assets off balance sheets continue to rise, there’s more data, and businesses are moving faster to keep pace with the socio-economic climate. At the same time, there remains a fundamental lack of alignment between auditors and management teams whilst accounting treatments have become increasingly complex so that they muddy the water rather than clear it.

The real solution is to start using technology more to assist auditors and to conduct auditing in real time, not after the event. Technology exists now that can flag issues when they arise, rather than way down the line when it’s already too late to do anything about it – automated cash reconciliation, exception reporting, variance analysis, and other predictive or prescriptive analytics can all help. Taking advantage of this technology in real time would give auditors and management enough time to discuss and resolve any issues before the decisions have been taken and the story has been decided upon.

But one issue remains, especially when it comes to the Big Four. The partner business model is fundamentally ill-suited to a technology-based offering – the delivery model is based on manual processes that need human oversight. With a tech-based audit, people are still needed to make judgements and retain a sense of accountability, but they need to be served at a base level by an algorithm, not a team of staff who are much more likely to get something wrong or miss a fundamental error.

Changing the model is no mean feat. Ultimately, these are not tech companies, so they will need to partner well to see benefits from this approach. A tech-driven business can help firms to challenge the status quo. Greater scalability would not only allow fewer people to oversee more audits, but firms could also begin the process of leveraging historical data and joining that up in real-time with automated processes.

Taking a digitally transformative approach to audits is clearly the way forward.  Management teams don’t want a failed audit; they want to back up their story of performance. However, the whole point of an audit is to give shareholders a complete picture and ensure the veracity of what management has reported.

If audits continue to fail, shareholders lose dividends, management lose jobs and the audit marketplace shrinks. This will continue to be a problem well after the pandemic. As such, firms need to make investment required to future-proof the auditing process, as that is the only way to make it fit for purpose for the long term.