The Necessary Variables for Audit Quality, Including Joint Responsibility
Audit quality is a very relevant issue today—it always has been but is even more so in today’s business world. As a member of a board of a listed company, I strongly believe that audit quality is the joint responsibility of many bodies.
The Framework for Audit Quality, recently developed by the International Auditing and Assurance Standards Board (IAASB), shows clearly the interactions between the preparers of financial information, those charged with governance, external auditors, users, and regulators.
Whilst there can be absolutely no disagreement that the primary responsibility for performing quality audits rest with the auditors, I believe that the organization, particularly those charged with governance, have an equally important responsibility for audit quality as they recommend the appointment of the auditors and agree on the audit program.
Clearly management, which interacts with the auditors on an ongoing basis and provides information and assurances, equally have a critical role in supporting audit quality. So too does the organization’s internal audit function and the regulator who, in many jurisdictions, oversees financial reporting and disclosures.
I do not believe that external audit is broken.
The financial crises we have been facing for more than six years has clearly led to serious questions being asked of the audit profession. The profession has been under scrutiny and will probably always be—such is the public interest in auditor quality.
And while I welcome the reforms taking place, such as auditor rotation and the enhanced audit report, we must not forget that many of the issues have been the responsibility of management, not the auditor.
In my time in business, I have seen some examples where the auditor should have been more assertive in expressing their views and disclosed concerns, but we need to be balanced in our judgement and not rush to the conclusion that the crises we have been facing are solely due to the external auditor. That would be completely wrong.
It is clear to many of us that poor culture in organizations has led to unacceptable and dysfunctional behavior. Or as Mark Carney, the Governor of the Bank of England, termed it in early June in his speech given at the Lord Mayor's Banquet for Bankers and Merchants of the City of London, “ethical drift.”
Organizations need a healthy culture as this is the only way to ensure that good governance and strong risk management is part of every employee’s purpose, which in turn drives sustained performance within a strong ethical ecosystem.
We all know that when we talk about culture it is often difficult to describe, quite elusive, and rather intangible. But we also normally know when the culture is not right. The leadership of organizations, particularly the boards, need to establish the culture they wish to see in the business.
The UK Economic Social and Research Council and the Association of Chartered Certified Accountants (ACCA) have produced a series of four reports with the aim to assist boards in preparing to assess their corporate culture. All of these reports are useful for discussions with boards, across management, and within audit teams to drive improvements in organizations’ culture.
Culture clearly has to start at the top, but it needs to be aligned end embedded throughout the organization. Culture needs to be monitored consistently and, I believe, validated externally occasionally. We all need to understand the importance of regulations and codes, but must not be willfully compliant superficially.
I used to like the concept of “comply or explain” but there is an increasing danger of believing that if we explain why we are not compliant it is acceptable and needs no further discussion. I now much prefer the emerging concept of “comply and explain”.
And of course we need to reward corporate performance but in a manner where the reward takes into account good corporate behavior as well.
In so far as we talk about culture in organizations, it is clearly important that auditors also need to understand the culture of the entities they audit, and align with that culture.
As audit quality is a joint responsibility and a shared commitment between all players in the financial reporting chain, there are a number of variables that are necessary to ensure audit quality.
We need high-quality audit teams of true professionals who are fairly rewarded (even if these professionals may be more expensive). The audit service should not be seen as a commodity.
We need honest and transparent communication between all parties.
We need a strong internal control environment, and I would suggest that every organization needs a strong and independent internal audit function.
We need to establish financial reporting timetables that allow quality, and continuous, communication.
There are also a number of necessary variables that are the key enablers for audit quality.
We need a strong audit profession that is viable. If the audit practice is only viable because of the non-audit services there is something structurally wrong, and eventually we will face serious issues.
We need effective governance in organizations, with strong, knowledgeable, and effective independent directors. But not so independent that they do not really know and understand what they need to know.
We also need a strong regulatory framework, with decisive interventions whenever necessary.
We need engaged stakeholders prepared to challenge and question boards.
And, of course, we need robust codes of ethics and behavior for both the audit profession and organizations.
The IAASB’s new and revised auditor reporting standards are a welcome development in the desire to improve audit quality.
This article is based on a presentation given by the author at the FEE Audit Conference in Brussels in June 2015.