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OK Computer – audit embraces technological innovation

IN the 14 months since the European Comission’s (EC’s) audit reform shook up the profession, compelling large-listed companies to change their auditors every ten years – albeit with the mild caveat of tenure extension if certain criteria are met – other, equally seismic changes, have been afoot.

It’s been a somewhat quiet revolution, but a definitive status quo destroyer, nonetheless. Massive shifts in technological innovation have been advancing at a rapid pace and the Big Four have been at the forefront of this trend, where deeper pockets can provide an instant market advantage.

Just four months ago, in November 2014, KPMG announced that it had forged a decade-long strategic alliance with Formula One doyennes, the McLaren Group, to use its McLaren Applied Technologies’ (MAT) predictive analytics and technology to help give KPMG’s audit and advisory services a competitive advantage in an increasingly competitive market.

It has combined the technology outfit’s expertise in predictive analytics with its own audit and consulting capability in a bold bid to underscore its competitive advantage.

Tony Cates, KPMG’s UK head of audit, says it was this fusion of technology, data and analytics that was a key driver in the firm’s growth strategy both in audit and across its wider business offerings. The firm is set to make more investments in technology and data analytics through acquisitions and strategic alliances and recruitment, he adds.

“Within the audit process technology allows for automation of evidence gathering, analysis of ever-larger populations of data, as well as enabling the team to focus on actual exceptions, rather than sampling the data set – ‘audit by exception not selection’,” Cates tells Accountancy Age.

“Our strategic alliance with McLaren is a prime example of how important this is to us. This alliance has the power to radically transform the audit process, helping to deliver more effective and insightful data analysis that produces actionable intelligence for clients and help audits to become more relevant and forward-looking.”

KPMG’s work with MAT to create more automated tools to codify the firms existing proprietary knowledge and expertise, will, he believes, translate into higher quality audits, “delivering greater consistency and efficiency, and providing greater insight to management teams, audit committees and investors”.

“We will be using proprietary predictive models to support lead audit partners as they make critical accounting judgements on the most significant audit issues,” says Cates. “These tend to involve multiple variables and by developing predictive models that can process and analyse huge quantities of complex data simultaneously we will be bringing an element of science to support lead audit partners as they apply their experience and insight to make these judgements.”

But while Europe’s audit reformation may have driven this renaissance of innovation and increased competition it appears – at first glance at least – to have had little, if any impact, on choice.

Creating differentiation in the market

James Roberts, assurance partner at BDO, believes that the significant upfront costs required to invest in top-flight software, could actually lessen the pool of players able to pitch for – and successfully work on – the bigger audits, still further.

“The numbers we spend will probably be smaller [than the Big Four] but we will try to be intelligent about the way we do it. I think it will be, further down the market, a bit of barrier to entry to the larger company audit market. It’s an unintended consequence in a sense, because if you’re going to buy a large piece of software, it’s going to cost a bit of dough.

“We don’t regard it as optional to innovate in this way – because I think if we’re going win in the market we have to show the right quality, and to show the right quality we have to have the right tools.”

Another impact of the changes in tendering rules, says Roberts, is that when prospective audit client ask ‘what is audit quality?’, firms embracing software innovations can tell them that “rather than get a few youngster to flip through a sample of your documents, we have been able test the entire population of your journals and find out that 23% of them were posted on a Sunday evening – people are getting some value out of that.

“You are doing it to improve the quality of information that you are able to give an audited entity to improve its business and that’s a good thing. All this will create differentiation in the market. And that’s got to be a good thing.”

The competition watchdog rules, which build on ten-year ‘comply or explain’ measures implemented by the FRC in 2012, had an almost immediate impact on the UK audit market with a number of high profile and lucrative contracts changing hands.

High street retailer Marks & Spencer for example, changed its auditors for the first time since it became a public company in 1926 – the year of the General Strike. While cynics may see it as little more than a reshuffling of the same deck, it did see a definitive shake-up of what had become more than a cosy relationship, in fact quite dynastic.

Panos Kakoullis, Deloitte’s managing partner for audit in the UK, says the audit landscape will look remarkably different by 2021 and will be one of the profession’s areas most impacted by technological-driven change.

The job will look very different and be performed by less people, Kakoullis explains. To think audit will not be affected by the archetypal teenager writing an audit programme in a Californian garage as per all the other industries out there, would be ‘ludicrous’, he posits.

Deloitte began investing heavily in automation, analytics and technological innovation four years ago, explains Kakoullis. The technology now empowers his audit teams to examine 100% of the data, where previously firms might have taken a sample of say 70 out of millions. Auditors can now quickly discover if there are any materiality issues.

“Before it could be like looking for a needle in a haystack – now we can simply blow away the hay to reveal the needle,” he says.

Another example cited by Kakoullis is that when looking at a fixed asset population – even if the team can’t find anything material – the software can find that it has been on the books for two years with no recorded depreciation, allowing them to interrogate the reasons why.

“You can test simultaneously and continuously and alert the CFO to what you have discovered,” says Kakoullis, adding that the firm had found its first fraud through the tool. “We have taken it out of technologists’ hands and put it in the hands of the auditors.”

Unearthing anomalies

New technology has been a core driver of innovation in audit, giving EY the ability to search through enormous quantities of data. Hywel Ball, its managing partner for audit, UK & Ireland, says that many of these technologies were originally developed by its forensics practice to help sift through ‘unstructured data’, like emails.

Such techniques are now being applied to audit and by melding them with reviewed ‘structured data’ like official records and reports, it can build up a more comprehensive snapshot of a company’s business operations and unearth where anomalies may lie.

“These are techniques we are continually looking to evolve as the sources and variety of data available continues to expand,” says Ball. “As auditors, we are primarily focussed on the information within a company’s business, but social media has created vast pools of data that could also have relevance to an audit.”

PwC, the UK’s dominant audit player, is developing and already piloting a software tool called Halo. Created in-house by PwC staff across the world, it analyses millions of ledger entries at once instead of the more traditional methodology of examining a much smaller sample and extrapolating.

With a broad palette of sectoral applications, when applied to fund oversight for asset management companies, for example, it can enhance oversight effectiveness by organising data against thresholds and criteria, and then reflecting that determination of risk instantly, as applied to huge volumes of information.
Clear presentation of the data then allows companies to focus on the area that matter to pricing quality.

James Chalmers, PwC’s UK head of assurance, said the traditional focus of assurance and audit on historical financial information is expanding into non-financial information, such as operational and strategic data, and into information that is increasingly real-time and even predictive.

“We’re actively creating and enabling that future, by developing sophisticated new software tools that will take the scope, speed and quality of assurance and audit beyond anything previously possible. Halo is our intelligent software for analysing the reliability of information that drives key business decisions,” Chalmers explains.

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