Should we liberate the audit from accounting?

Accounting Weekly asked Bernard Agulhas, CEO of the Independent Regulatory Board for Auditors (IRBA), for his take on the recent Brydon report suggesting major reforms in the way audits are carried out. You can read about the report here.

There were some controversial recommendations, for example, making the audit voluntary, as suggested by Professor Piet Delport, retired professor of mercantile law at Pretoria University, and the establishment of an independent board to appoint auditors – taking this decision out of the hands of companies themselves (on the basis that the company paying the auditor can influence the outcome). Nicolaas van Wyk, CEO of the SA Institute of Business Accountants (Saiba), recommends amending the Companies Act to remove compulsory audits on the grounds that these are no longer addressing the needs of stakeholders. “We need to move away from boilerplate audits to audits determined by the users of financial statements. In that way we will avoid generic reports that do not address the real but hidden risks the current audit reports seem to miss. Fund managers, credit providers and shareholders should decide the exact process and focus areas they want to be addressed in the audit.”

Bernard Agulhas, CEO of IRBA, supports many of the recommendations of the Brydon report

Agulhas supports many of the recommendations of the Brydon report, as you can see below.

  1. Brydon’s key recommendation is to make audits more informative to users:

IRBA already adopted the standard on Key Audit Matters for the year ended December 2016, which has already made the auditor’s report more useful to shareholders as it requires auditors to assess key risks and explain how the audit approach dealt with these risks.  

  • Delport recommendation is to make the audit voluntary

The IRBA would not support making audit voluntary for Public Interest Entities, as the external audit function has a key responsibility to protect the public and investors.  What we need to focus on is independence of auditors, audit quality and further strengthening the standards to ensure that it meets the requirements and expectations of shareholders.  Given the nature of some of the recent business and audit failures, in particular, we may need to consider how to improve the standard around fraud risk identification, as auditors may need to do more work around fraud in the course of the audit, than what is currently prescribed in the standards.  We are also looking at auditor training, skills and competencies, to determine whether the curriculum should be adapted to include further competencies to meet public expectations.  The critical requirement is that auditors need to remember their primary responsibility  to be independent and that they serve the public not the client, and so we must also work on auditor behavior and ethics.

The audit was also introduced centuries ago when organisations grew to such an extent that the owners could no longer also be the managers. When management was separated from owners/shareholders, the shareholders/investors required external, independent assurance that their affairs were managed properly. In the absence of an audit, there is no independent assurance and there can therefore not be confidence in and reliance on the accounts produced by management.   

  • Independence – Cost of MAFR

Mandatory Audit Firm Rotation (MAFR) is key to guarding the auditor’s independence and preventing auditors getting too cozy with clients over a long period of time.  At September 2019, 21% of companies on the JSE have already rotated auditors with 41% of those companies citing the early adoption of MAFR as the reason for rotation.  The cost of rotation has not been raised as an issue by these companies and we believe that those that have adopted MAFR already see the value in ensuring the independence of auditors. As more companies rotate, we will be able to gather costs associated with rotation.

The lead time allowed for the introduction of MAFR of five years has allowed companies and audit firms to plan for this process and for firms offering other prohibited services to cool off in compliance with the Companies Act in order to be eligible to take on audits where they previously did not audit.

The cost of MAFR will always be insignificant when compared to the cost to investors and pensioners when there is an audit failure, resulting in billions of Rands lost, as illustrated by recent failures.

  • Here’s a brief summary of Brydon’s recommendations.

Recommendations for the reform of the audit

Recommendation IRBA Comment
A redefinition of audit and its purpose The IRBA supports this and in particular has been stressing the importance of aligning the audit function to investor needs.  Projects are underway to look at strengthening the fraud risk identification standard, as well as  auditor competencies It may be that more training and competency is required in the area of identifying fraud, which up until now has not been an auditor’s responsibility. The current standards do not include a responsibility for the auditor to discover fraud – merely to develop procedures to address the risk of potential fraud.
The creation of a corporate auditing profession governed by principles The IRBA has recently adopted a new code of ethics which has been updated and strengthened. The Code of Professional Conduct and auditing standards adopted in SA are already principles-based.
The introduction of suspicion into the qualities of auditing This is not really new; essentially it is professional skepticism which the auditor is required to exercise as an element of independence.  However, an auditor who has had a client for 100 years is not perceived to be independent and be perceived to exercise professional skepticism sufficiently well if the auditor/client relationship becomes too cosy.
The extension of the concept of auditing to areas beyond financial statements The IRBA has already been looking at ways in which it might be possible to audit non-financial information and what level of assurance the auditor could provide on this information.  It is a new area of external audit and internationally there already are projects to develop assurance on on non-financial information (Other forms of external assurance).   
Mechanisms to encourage greater engagement of shareholders with audit and auditors The IRBA has already taken significant steps to engage investors, shareholders and audit committees.  As the regulator, we see it as part of our mandate to educate the market on what they should expect from auditors and the audit product. The IRBA has a good relationship with the Audit Committee Forum and are working closely with them to better understand the audit and audit quality. One of the initiatives from the IRBA has been to develop a set of Audit Quality Indicators to assist audit committee members in assessing audit quality and evaluating auditors.
A change to the language of the opinion given by auditors The IRBA has already adopted the International Auditing Standard on the new audit report and Key Audit Matters have been reported since 2016. 
The introduction of a corporate Audit and Assurance Policy, a Resilience Statement and a Public Interest Statement We support more assurance provided by the management and will do research on how auditors can provide assurance on these additional statements, once there is a framework for these statements.
Greater clarity around the role of the audit committee The IRBA has already begun engagement with the Audit Committee Forum and aims to educate those charged with governance on the importance of their role in the lines of defense.
Suggestions to inform the work of BEIS on internal controls and improve clarity on capital maintenance n/a
A package of measures around fraud detection and prevention See above
Improved auditor communication and transparency The IRBA has launched two initiatives, Audit Quality Indicators, which are standardized measures for audit firms to score their audit quality. This is the first set of  indicators which audit committees can use in the evaluation of auditors.  This will also assist in structuring communication between the audit firm and the client on issues around audit quality. Further, the IRBA has issued a call for audit firms to produce transparency reports, which will also be an important means of communication with audit committees. This is currently voluntary and suggested guidelines for reporting have been provided. This will be refined in conjunction with feedback from audit committees as to what they find most useful.  In future it may become mandatory. 
Obligations to acknowledge external signals of concern
Extension of audit to new areas including Alternative Performance Measures The IRBA has already contributed to a project which seeks to determine how assurance can be provided on non-financial information, and what level of assurance could be offered. 
The increased use of technology This is an important area of audit quality advancement for the IRBA, and the advances in technology and 4IR are viewed as being a step forward in addressing the concerns which arise out of  current methodologies. The ability to handle large volumes of data and transactions will become easier and improve audit quality.  
  • Other initiatives

Although Brydon has not specifically mentioned audit only firms, given the issues and concerns around audit firm consulting businesses, the IRBA believes that this remains a remedy that must be considered in order to focus auditors on the primary service of public protection and public interest.  It is a solution to improving audit quality which the IRBA will continue to investigate.

The IRBA has also made proposals to the Minister of Finance to extend regulation beyond auditors to other role players in the financial reporting chain, so that they too must comply with certain standards and can be held accountable for business failures. 

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