Auditing in the Era of Integrated Thinking
Dr. Sean Stein Smith DBA, CMA, CPA, CGMA, CFE | February 23, 2017 |
The business landscape continues to change and evolve at an increasingly rapid rate, and instead of moderating, it appears these changes will only continue to accelerate. Technology, increased use of analytics, and a broader scope of measuring and reporting information represent just a handful of the changes sweeping the accounting profession. An idea that originated overseas, integrated reporting, is quietly but surely picking up steam as a growing number of organizations adopt the reporting framework. Embedded within this framework is the inclusion of information linked to sustainability, governance, and other traditionally qualitative information. Auditing is a prime example of an area of the accounting profession that can evolve in practical ways that add value both to the organization and to the accounting profession. For action-oriented practitioners seeking new and innovative ways to keep pace with changing business practices, this article explains and outlines how auditing can evolve alongside broader business practice changes.
A key method by which accountants can leverage changes in business to become more engaged in the business decision-making process is to embed integrated thinking within audit practices. Applicable for both internal and external auditors, the idea of integrated thinking is a logical and practical extension of trends already occurring within the profession. Specifically, and as it pertains to CPAs engaged in audit and attestation services, it is imperative to take into account information not traditionally evaluated with audit practices. Delving into these areas, it quickly becomes clear that not all pertinent data related to organizational performance is currently taken into account during audit procedures. Areas such as sustainability and corporate governance represent areas of growth and opportunity for CPAs willing to leverage and broaden existing skills. The question that remains—and that is continuously asked at conferences, in publications, and in meetings—is as follows.
How can CPAs measure these emerging areas, which are important to management decision making and integrated thinking?
Additionally, the digitization of business is having a profound effect on how business decisions are made, approved, and incorporated into the operations of a business. From point of sale integration with inventory replenishment, to the internet of things monitoring production and operational efficiencies, to customer profitability analytics, organizations have increasingly large amounts of data available for making decisions. It is important, however, that CPAs play a role not only in reporting this growing amount of data and information, but also in the analytics and interpretation of this data. Accounting professionals already possess the ability to ask the necessary questions to make better use of this information. What are the variances? Are there specific items that are driving these variances, and are these variances cyclical or more structural in nature? Regression analyses, excel analysis, and conversing with operational leaders are already part of the CPA toolkit—blending these behaviors with increased information is a logical way for accountants to expand their roles.
Changes and the increased digitization of information, including areas that are not traditionally thought of as business related, can now be quantified, audited, and reported on. Indeed, at the heart of integrated reporting, in use by such household names as Clorox and Southwest Airlines, is the concept of a multiple capital model. This model focuses on quantifying and reporting information related to a broad set of organizational data including the somewhat amorphous ideas of human capital and social capital. By drilling down into specific audit practices, addressing these emerging areas, and quantifying information that is currently only reported on a qualitative basis, practitioners can develop a practical path toward implementing a multiple capital model of measuring and reporting. While the list below is by no means exhaustive, and it is important to remember that every organization is different, the principles can, and should be, applied across organizational boundaries.
1) How is this information initially generated or produced by the organization? Whether it is tracing the processes related to billings and accounts payable, or finding out how emissions data is generated, the concepts are the same. Who generates this initial information, are safeguards in place to offset management overrides, and how is this information secured?
2) What are the best practices in this area? Cyber security is both a headline risk to organizational reputation, and a potentially crippling internal control and client issue. Akin to how best practices are sought out in this area, the same approach should be applied to areas such as governance information. What are the leading organizations, including competitors and benchmarking organizations such as GMI Ratings (a division of MSCI) doing to help standardize and clarify reporting in the broader environmental-social-governance area?
3) What is expected when such audits and attestation services are conducted? For example, for positive confirmation of large receivables or payables, a response is expected confirming the balance and the parties involved. When auditing areas that have traditionally been more qualitative in nature, such as the environmental effects of business operations and of sustainability initiatives, what does management expect? More pointedly, can the presentations made to end users be objectively verified by the audit team?
In addition to the actual audit processes and tests itself, CPAs and auditors (both internal and external) have to remain aware of any changes that occur during the remainder of the business year. Specifically, the development of benchmarks, metrics, and other types of reporting standards related to non-financial information should be on the front burner throughout the year. For example, the Sustainability Accounting Standards Board, an independent 501c3 organization, has been developing and publishing disclosure requirements for publicly traded US corporations since 2011. Other professional associations heavily invested in the analysis of such trends, and development of action-oriented tools and procedures for accountants to implement, include the New York State Society of CPAs, the American Institute of CPAs, the Institute of Management Accountants, and the ACCA. While the idea of benchmarking information related to non-financial areas might seem abstract and not truly applicable to audit procedures, that would represent an incomplete view of how the marketplace is evolving.
Auditing relies, to a large extent, on the documentation of processes and procedures, as well as the development of metrics that can both serve as benchmarks for reporting purposes, and as tools to compare prior period performance to the current audit period. The process and development of reporting tools and metrics also represents an area for CPAs to proactively engage with the idea of integrated thinking. In order to develop meaningful metrics, that is metrics that convey information that is of use to the internal and external end users, CPAs and other accounting professionals working with the organization must be aware of what its informational needs are. Just like an audit requires certain information to be verified, objectively measured, and signed off on by management, the era of integrated thinking requires that CPAs, including the external auditors, take this thinking to the next level. In addition to providing improved insights for management, the value added through being engaged with client decision making and reporting will surely make the client more likely to retain that CPA firm’s services.
A few areas should be evaluated in the development of metrics, to be used both for audit purposes and broader decision making, that also reflect the realities of the business landscape. First, what are the underlying factors that drive the financial performance of the organization? Auditing and financial reporting traditionally focus on the financial results, but those results are generated by the operations and underlying fundamentals of the business. Second, what information is currently distributed on non-financial areas, and is this information consistent across the user base? If different end users are receiving contradictory, or even simply different, information, this sets the groundwork for confusion and uncertainty. Lastly, linking consistent reporting standards and metrics provides a logical, concrete, and practical way for CPAs and audit professionals to keep pace with changes, and add value while doing so.
Business has certainly changed during the last decade or so, and the ways in which organizations report and audit results and performance are also changing at a rapid pace. While the CPA profession has certainly embraced some aspects of this changing business environment via greater integration of technology and analytics, work still remains. Auditors, not always seen as value additive participants in the decision-making process, can and should engage with these changes to improve current processes while also developing practical solutions for this changing environment. These principles and ideas apply both to external auditors brought in for attestation and recommendation purposes, and to internal auditors embedded in current processes within organizations. Change certainly is in the air for the profession, and audit practices and procedures are no exception, but with the right mindset, these changes can benefit both the profession, and the clients we serve.