Latest News on Audit Inquiry – 8 Key Recommendations

Article by Steve Watson, Managing Director, National Audits Group.

On 1 August 2019 the Senate referred an inquiry into the regulation of auditing in Australia to the Parliamentary Joint Committee on Corporations and Financial Services for report by 1 March 2020.

On 27 February 2020, the Parliamentary Joint Committee on Corporations and Financial Services tabled an Interim Report in relation the audit inquiry. CLICK HERE to download the report.

The interim report outlined some key observations and recommendations that will undoubtably be expanded on further in the final report due by 1^st September 2020. These recommendations were based on comprehensive feedback from all stakeholders involved in the delivery and interpretation of external audits.

Key observations from the interim report:

The core function of auditors is to check that the financial are right. However, users of audits generally believe that auditors have a role to play in detecting and preventing fraud and misconduct, and in assessing a company’s economic viability. The relative responsibilities of directors and management in these areas versus that of auditors in these areas are often misconstrued and the outcomes achievable by an audit overestimated.

A recent example is the number of firms that have been found to have been systematically underpaying employees. Who is responsible for this and what role do auditors play in identifying such risks? Auditors are not necessarily aware of the awards for individual employees. Should they be?

Deloitte submitted that stakeholders now look to auditors for deeper insights that focus on risk, operations and financial performance to better understand an organisation’s future viability, as well as insights that contribute to a forward-looking agenda,

CAANZ made the point that an auditor makes an assessment of a company’s financial viability at a particular point in time and cannot predict future events. Circumstances in a company or economy can change quickly and therefore, company failure does not necessarily mean there has been an audit failure.

Generally, efforts to address the expectation gap have focused on better educating the business community, media and other stakeholders about the role and scope of audit. However, the success of this approach has been limited at best, and some argue that the expectation gap is in fact widening with the increasing complexity of the business environment in which the audit profession operates.

There appears to be broad support for an approach that would expand the scope of an audit. Given the rapid rise of technology and the increasing sophistication of auditor and specialist skills, there are a range of possibilities to constructively expand the role of audit and auditors where there is market demand and it is beneficial to the operation of capital markets.

KPMG submitted that they would support additional content being included in audit reports which communicates the auditor’s obligations to detect or prevent fraud, and which further specifies the audit procedures undertaken to address the risk of material fraud as part of the audit.

While of the view that there is no single ‘quick-fix’ solution to holistically improve audit quality, ASIC submitted that ‘good corporate financial reporting controls will assist with audit quality’. They highlighted key points in support of possible policy reforms similar to those implemented in the US to increase the transparency in corporate governance and financial reporting and to formalise a system of internal balances and checks.

The interim report outlined a potential role of Digital Financial Reports (DFRs) in improving the quality of audits. DFRs can be read like a PDF document but also allow users, auditors and regulators to readily extract information electronically for analysis, comparison and risk assessment.  There is evidence that DFRs:

1. increase transparency and led to improvements in financial statement quality;
2. lower information processing costs for users of financial statements;
3. increase analyst forecast accuracy; and
4. improve the information efficiency of capital markets

Evidence to the committee indicated considerable enthusiasm for the use of DFRs. There is also evidence that this could be provided at a relatively low cost by existing software providers.

Key recommendations from the interim report:

1. ASIC will develop and implement a revised framework for reporting inspection findings, with a focus on the transparency and relative severity of identified audit deficiencies.
2. ASIC will publish all future individual audit firm inspection reports on its website.
3. The Financial Reporting Council, in partnership with ASIC, will oversee consultation, development and introduction under Australian standards of:
   1. defined categories and associated fee disclosure requirements in relation to audit and non-audit services; and
   2. a list of non-audit services that audit firms are explicitly prohibited from providing to an audited entity.
4. The auditor’s independence declaration will be expanded to require the auditor to specifically confirm that no prohibited non-audit services have been provided.
5. The Australian Professional and Ethical Standards Board should consider revising the APES 110 Code of Ethics to include a safeguard that no audit partner can be incentivised, through remuneration advancement or any other means or practice, for selling non-audit services to an audited entity.
6. The Financial Reporting Council will oversee the revision and implementation of Australian standards to require audited entities to disclose auditor tenure in annual financial reports. Such disclosure should include both the length of tenure of the entity’s external auditor, and of the lead audit partner.
7. The committee recommends that the Corporations Act 2001 be amended to implement a mandatory tendering regime such that entities required to have their financial reports audited under the Act must:
   1. undertake a public tender process every ten years; or
   2. if an entity elects not to undertake a public tender process, the entity must provide an explanation to shareholders in its annual report as to why this has not occurred.
8. The committee further recommends that such a tender process be implemented by 2022 for any entity that has had the same auditor for a continuous period of ten years since 2012.

The interim report suggests that these recommendations should be in place by the end of the 2020-2021 financial year.

So, what does this mean for auditors and firms providing audit services?

We’ll need to wait for the final report due out in September 2020. However, we can make some observations based on the interim report:

1. It’s likely that further guidelines will be provided in relation to the scope of audits, taking into account expectations of the business community and external stakeholders.
2. It’s clear that there will be clearer guidelines on the distinction between audits, approved and prohibited non-audit services. This is likely to lead to further separation of audit and non-audit services provided by leading accounting firms.
3. There will be stronger scrutiny around the tenure of audit assignments. Corporations will be expected to undertake a public tender process every 10 years or explain why this has not occurred.
4. There will be clearer guidelines preventing auditors from receiving incentives for selling non-audit services to an audited entity.
5. There will be greater transparency around the reporting of audit inspection reports by ASIC.

The National Audits Group is committed to delivering transparency to its clients and external stakeholders in relation to the scope and outcomes of audits. It will continue to work with key industry stakeholders to improve the level of trust that the public has in the quality of external audits.