Challenge audit culture to avoid fines
Poor audit culture is often to blame for fines and non-financial sanctions issued to firms. Julia Penny advises on ways to establish a better audit culture.
In July the FRC issued their Annual Enforcement Review 2020. Whilst the title brings to mind gangsters, and the level of fines involved at £16.5m could certainly be regarded as punitive, the tone of the report is much more constructive.
It sets out the reasons that fines, and other sanctions, have been issued to auditors (or in some cases accountants) and so serves as a reminder as to what areas we should seek to improve to avoid being fined ourselves.
Biggest audit challenges
The six key themes identified by the report which caused most audit problems were:
- Insufficient involvement of the audit partner including insufficient supervision and communication with the rest of the team
- Disorganised work
- Failure to step back and take an overall look at the financial picture
- The auditor being too close to management
- Failure to involve the audit quality assurance partner
- Use of auditors’ experts and specialists without sufficient oversight or understanding of the work being done.
Whilst some of these might require specific training in order to improve performance, and such mandatory training has been part of the non-financial sanctions issued to firms, much of it is ultimately about a quality culture. If everyone in audit is committed to delivering quality above all other considerations, then ultimately quality will improve.
If we take an example from the report, in one case, junior staff were left to do much of the audit work on an entity but were not made aware that the company was about to be sold. This changed risk significantly and meant that the going concern assumption was not looked at in the light of an imminent departure from the group. If there was a true culture of quality at the firm, the partner and senior manager would never have been happy to delegate virtually all the work to a junior team member, even more so when there was clearly a substantial change in risk due to the imminent sale.
Another example cited was with regard to the auditor being too close to management. With some very large audits the team can spend many months at the client and the enforcement division found that staff even started to refer to “our company”, “us” and “we” when talking about the audited entity. Whilst this may not occur in smaller audits there was also considerable focus on keeping the client happy, especially where the audited entity was significant for a particular office or region. It is vital that auditors remember that the real client is the ultimate user of the audit report, so primarily the company’s members, but also, to a lesser extent, other stakeholders such as employees and lenders.
So, if many of these failures are ultimately because of a poor culture, how can you improve your audit culture, to prevent similar problems?
As we saw in a another recent article, about the FRC principles for the operational split of audit in the Big Four firms, one way to help achieve an appropriate audit quality might be to develop a separate audit culture. Outside of the Big Four there is no need to create an operational split, but focusing on whether audit staff and partners have an appropriate culture for audit work might still be effective, so we will look at how you might do this.
Firstly, you might consider what culture or value-set your audit department currently has. If you ask partners and staff about what values they believe have been set (explicitly or implicitly) what sorts of answers will they give? Will it be quality, independence, ethical behaviour, and robust decision-making for example? Or perhaps it will include excellent client service, going the extra mile, or being nice? Why not have a Zoom meeting, or use survey monkey, slido or a similar app to ask what cultural values staff and partners feel they are working with?
How to establish a better audit culture
Once you know what your audit teams currently think you can address any attitudes that might need changing to create a better culture of audit quality. The table below shows some common attitudes regulators have seen within audit departments; the risks to audit quality from the attitude; and a more positive alternative.
Rather than attempt to impose an alternative attitude, try to work with the whole audit department to find ways to establish a better audit culture, along the lines of the right-hand column.
|Current cultural attitude||Risk to audit||Alternative cultural attitude|
|We must maintain a good client relationship||Lack of scepticism and challenge||Always be courteous but challenge management and seek evidence to corroborate what you have been told, recognising that management may have made mistakes or there may be fraud in the financial statements.|
|We must keep the client because the fees are important||A temptation to deliver a clean audit report when a modified one, or a going concern paragraph, is required.||The firm regards independence as the ultimate requirement for audit and therefore if we lose a client due to having to issue a particular audit report, or because we need to ask awkward questions, so be it.|
|We must be nice to the client||Being nice gets confused for not challenging what the audit team has been told, or trying to find a way around the rules to allow the result that management would like.||Always be courteous but remind management that your job as auditor is to express an independent opinion and so you are obliged to ask such questions or are unable to help with achieving the desired result, as it would threaten your independence.|
|We must keep costs down for the client (especially a problem with charities)||A temptation:-not to ask for additional information, such as a valuer’s report, when required;
-not to spend enough time planning or testing, as it is seen as adding cost.
|Audit quality is paramount, so we should be efficient and effective, including spending enough time to plan and conduct the audit.|
|We will work to the client’s deadlines, even if they don’t work to our deadlines||An inability to plan properly, because we haven’t yet got the necessary information or an inability to conduct testing until the last minute, might mean that short-cuts are taken||We will set clients clear expectations as to when we need which pieces of information. If the client still does not stick to the deadlines, we will be robust in moving signing deadlines or in asking for more fees if costs have increased.|
|The expert is always right||Experts can still make mistakes, or lack independence, so taking everything they say at face value risks an incorrect audit opinion.||Everyone makes mistakes and some people deliberately mislead so we must still be sceptical and gather evidence to support what an expert has told the audit team.|
|The partner is always right||An incorrect approach, lack of scepticism or technical error might not be challenged even where other members of the team have doubts.||We value challenging and inquisitive minds. If you see something that you are not sure is right discuss it, either with the individual concerned or the ethics partner.|
|The partner expects the manager and team to do all the work and does not want to be bothered with questions||Insufficient direction and supervision by the audit partner mean the very person who is supposed to have the skills to look at the big picture, is not engaging in the audit, so risking that something big is missed.||Set a culture of quality with an appropriate “tone at the top” which is then lived up to by the partners.|
Audit staff and partners should be rewarded, whether with money, promotion, or kind words, for their contribution to quality. You could even consider a monthly audit quality certificate for someone who has exemplified your audit quality culture. Ultimately, your audit culture must reflect the fact that audit is there to benefit the members and other stakeholders, not management.
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Julia Penny is the principal of JS Penny Ltd which provides technical and training consulting on anti-money laundering procedures, auditing and financial reporting. Julia is a member of ICAEW Board and Council, chair of the ICAEW Ethics Advisory Committee and past chair of the ICAEW...