What does good auditing look like?
Good auditing, just like bad auditing, obviously has a degree of subjectivity to it. But much of the conversation around what good auditing should look like can be reduced down to the idea that audits must be informative and useful to all the company’s stakeholders. Beyond this, there are some common threads in the reforms being called for by lots of different groups.
The first concerns the ringfencing of auditing services so that a firm that provides auditing cannot provide any other services. This should prevent conflicts of interest and incentives to go soft on the books of current or would-be customers. There’s different levels of severity this sort of legislation could take. It could just say that firms cannot provide any consulting services to companies they are also auditing or have recently audited. Or it could demand that the business currently being done by firms like the Big Four is split up into separate, independently-controlled companies.
On a similar note, some people would like auditors to be assigned to companies by an external, independent party, so neither businesses nor audit firms have any say in the matter. In theory, this could also break the stranglehold the Big Four currently has on the auditing industry by deliberately awarding more contracts to smaller firms. However, many people think doing this would require further interventions to ensure small firms were able to handle the complexities of big audits, which they currently have very little experience in. One solution that has been proposed is joint audits, where multiple audit firms work together.
The second thread is around making audits and accounts more accessible. Partly that’s about changing things like the language, layout and jargon used, to move audits away from the current norm of having a bunch of text filled with fancy accounting terms that are hard for many people to understand. And partly it’s about how easy it is to find the audit reports. At the moment, audits are generally only sent to shareholders. Reformers would like them to be sent to (or at least easily requested by) all stakeholders, including employees and customers.
Thirdly, there’s lots of ideas around changing the focus of audits and accounts. For example, what if some of the key points that auditors judge accounts on were around the protection of employees and economies from business failure? One way to do this would be for companies to be encouraged to keep a buffer of money around that could be used to cover their expenses if the business faced unexpected heavy losses. Limits could even be put on some types of companies' spending. Take dividends, which are payments companies make to shareholders. At the moment, companies can pay out large dividends whenever they want. But it’s been suggested that they should only be allowed to make dividends payments once they’ve earned a certain amount of profit, i.e. once they’ve put aside enough money to make that financial buffer.
Another big topic that many people would like there to be a greater focus on is the environment. Stakeholders increasingly want to know the climate risks associated with their companies. That could mean both the risks the company poses to the environment (is it responsible for a lot of pollution when making and shipping products, say) and the risk climate change poses to the company (could more extreme weather close factories and disrupt supply chains, say). There have subsequently been calls for governments to create specific environment-related duties for companies, their directors and their auditors, including obligations to include certain information in a company’s annual report and financial statements. An example would be stating whether and how the company is aligning its business with the goals of the Paris Agreement, a 2015 treaty on climate change in which almost 200 countries promised to limit global warming to “well below” 2 degrees Celsius. Audits could also cover how a company’s commitment to these goals will affect its financial position.
A fourth thread is about increasing responsibility. That means shifting cultural norms so that company directors and auditors feel both expected and empowered to call out any fraud or dodgy accounting practices that are happening at a firm. Many people would like to see this enforced via harsher penalties for letting things slide - including fines being slapped on any individuals who are convicted of severe wrongdoing, rather than just on the companies they work for.
The UK government has put forward what they think could play a key part in finding a solution to audit’s problems: a new regulator for auditors. This would be called the Audit, Reporting and Governance Authority (ARGA) and would replace the Financial Reporting Council (FRC) we currently have. ARGA would report directly to Parliament and be focused on both overseeing the auditing industry and investigating the lack of competition being created by the dominance of the Big Four. It is due to come into force in 2023, although there is already talk that it may be delayed. Although, even if it stays on track, ARGA has already been criticised for not going far enough and for not having enough teeth to force auditors to really change their behaviour.
