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Open Banking creates huge opportunity for audit

It’s no secret that audit is broken. But what are the problems causing this crisis in the audit industry, and how does Open Banking specifically solve these?

10th Feb 2021
VP of Business Development Circit
Columnist
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Open banking audit
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The FRC’s recent inspection found 38% of audits are in need of improvement or significant improvement. Highlighting the need for change, the new business secretary Kwasi Kwarteng has made audit reform ‘one of his initial priorities’.

This is no easy task, but innovative technological advancements like Open Banking can help address many of the issues around audit reform.

What are the problems for the audit industry that are causing the crisis?

The FRC’s Root Cause Analysis (RCA) review identified five key themes why audit is in crisis: 

  1. audit teams are using a corroborating mindset rather than a challenging mindset;

  2. a lack of resourcing impacting audits being completed in a timely manner;

  3. insufficient levels of training and guidance for audit teams that perform detailed testing of key risks;

  4. ineffective project management ensuring that high-risk audit work is being performed in a timely manner to allow for full consideration of key risks; 

  5. an inconsistent level of supervision and review from senior members of the audit team.

The corroborating mindset is a direct result of the fundamental flaw that auditors are paid by the companies whose books they are scrutinizing. Tackling this requires significant regulation, and there is plenty on the horizon.

Points two to five are all a direct result of inefficiency caused by manual and time-consuming audit testing. This results in a lack of time to complete the audit, train and supervise staff, and focus on key risks.

Open Banking: The basics

Bank statements are a key piece of any audit, and Wirecard filing for insolvency after revelations that €1.9 billion was missing, is a prominent example of what happens when testing in this area is weak.

Open Banking allows auditors to obtain their clients’ bank statements directly from the bank, digitally. This provides auditors with third party evidence in a format that can be analysed instantly by algorithms.

So how does Open Banking improve efficiency and audit quality? To help answer this, let’s analyse three common audit tests. Testing for management override, creditors and revenue completeness.

“The fraud test” – management override

To mitigate the risk of management manipulating accounting records or committing fraud, auditors review clients’ bank statements. The aim is to identify any odd or large transactions and to validate that these are genuine business transactions.

Today, auditors manually review bank statements, transaction by transaction, trying to identify any unusual transactions. Auditors often use paper bank statements, making the process even more time-consuming. On the average mid-tier audit, this takes four to seven hours.

Using Open Banking and data analytics, this entire process can be automated. 100% of transactions are analysed. High-risk transactions are flagged to the auditor, including one-off transactions, transactions that contain certain keywords, large amounts and irregularities such as eleven monthly payments in a year when we would expect twelve.

Creditors completeness testing

Auditors review post-year-end bank statements, going through transactions by transaction, trying to identify payments made after the client’s year-end, but where the expense relates to something before the year-end. These transactions must be treated as creditors in the accounts.

Again, today this is a very manual and time-consuming test which can be fully automated. Leveraging Open Banking and data analytics, all post-year-end payments can be analysed and any potential creditors flagged to the auditor.

For example, if the client’s year-end is December, and there is a payment made in January where the description on the bank statement refers to ‘Dec’, ‘Christmas’, ‘Party’, ‘Gift’ or similar, this transaction should likely be treated as a creditor.

Revenue completeness testing

Revenue is a key area of focus by ICAEW’s quality assurance team. One of the most common areas where QAD reviewers see room for improvement is the revenue completeness assertion.

Usually, this is because the revenue completeness test design was flawed, for example, because it tested back from the accounting records rather than forwards from outside the accounting system.

As Open Banking data is obtained directly from the bank, it is third party evidence gathered from outside of the accounting system. Therefore it is a great starting point for any revenue completeness testing.

Data analytics allows the move from sampling to testing 100% of transactions as all receipts in the bank statements are matched to the revenue transactions in the accounting system.

Does Open Banking and analytics allow auditors to make better use of their clients’ data and hugely improve audit quality?

Yes. Open Banking is a huge opportunity for auditors. The Big Four are building expensive bespoke analytics tools.

What’s great about Open Banking and the three example audit tests above, is that these tests are applicable to almost all audits. This allows all audit firms to adopt data analytics in a standardized way across their entire portfolio, ensuring cost-effective efficiency and quality improvements on every audit.

The audit tests discussed above are just the start of what Open Banking enables and we’re excited to see how far we can take it.

For more on Open Banking, watch Why the future of open banking matters to accountants on-demand where Nick Levine and other industry experts explore how far open banking has affected the workflow of accountants and what the future holds.

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