Audit needs a revolutionby
Rather than audit quality meeting the ‘flawed’ standards of the regulator, Richard Murphy argues that accounting and audit requires an almost revolutionary reform to meet the needs of society.
It has been reported that once more audit firms in the UK have failed to match the quality expectations of the Financial Reporting Council (FRC) in its annual audit quality inspection results.
KPMG, Mazars and BDO were rated worst, which is not good news for those hoping that smaller firms might transform the audit market. In total 29% of audits have been deemed unacceptable.
But what has interested me most about comments flowing from this year's announcement is that they reveal tensions within the profession on the subject of these audit quality reviews, and in turn (albeit implicitly) the crisis that exists about the nature of audit itself.
The standards are flawed
What the FRC is reviewing is compliance with their auditing standards, which in reality are those of the somewhat obscure International Auditing and Assurance Standards Board (IAASB). The difficulty is that these standards are fundamentally flawed.
In use since their EU wide adoption in 2006, what they require is that auditors express opinion on whether the accounts on which they report comply with the requirements of International Financial Reporting Standards (IFRS). If they do then they are deemed true and fair. And if they do not, then they are not true and fair. And that, in essence is all auditing has been reduced to. This criterion, though, is a false standard.
IFRS accounts are solely intended, according to the IFRS Foundation, to meet the short-term needs of investors in financial markets. That body says that they are only intended to provide the information that those in such markets require to inform their buy and sell decisions. It is stated that they have no other purpose. But in that case it is very apparent that these accounts are bound to fall short of society’s expectations of auditors.
Not only is such a narrow perspective in conflict with UK company law, it also means that many stakeholder’s expectations are not met, meaning that auditors are bound to fail as a result.
Outmoded shareholder focused approach
This leaves auditors in an invidious position. If they try to meet the expectations of society they fail the regulator. If they audit solely to the false standard of expectation that the regulator has created their audit quality will be deemed inappropriate.
I stress, I am not exonerating auditors here. I rather strongly suspect that there is much audit work that is of inadequate quality. I also suspect that there is much work required to remove inadequate audit partners from the ranks of audit firms.
But my point is that even if they do that the resulting audits will, if undertaken within the existing auditing framework, result in substandard audits that do not meet expectations. That is because IFRS reflects a shareholder focused approach to large corporate responsibility that is hopelessly outmoded and which does not reflect the spirit of society, whilst auditors are being forced to comply with standards that are wholly inappropriate.
A new purpose for accounting
The simple fact is that both accounting and audit now require almost revolutionary reform to meet the needs of society. IFRS has to meet stakeholder needs, and if it is to meet the demands of climate change reporting it has to both put that issue in the balance sheet and make the ability to survive the transition to net-zero carbon the criteria for being a going concern in the future.
The whole logic of accounting does then need transformation to support this goal. Its purpose needs to be redefined. As my colleague Prof Adam Leaver of Sheffield University Management School and I suggested in our submission to the government’s current audit review, a new purpose for accounting must be proposed. We suggested:
The purpose of accounting is to provide the stakeholders of a reporting entity with financial statements that include relevant, reliable and sufficient information which allow them to make informed decisions.’
We then related the purpose of audit to this purpose for accounting, suggesting that:
The purpose of the audit of a public interest entity (PIE) is to firstly report on whether the financial statements on which the auditor offers an opinion deliver relevant, reliable and sufficient information to users of those statements and to secondly, where there is a shortcoming, remedy that shortcoming or, if it is not possible to do so, to report why that is and what its consequences are.
This purpose would fundamentally transform audit. As it stands auditors are forced by regulation and regulators into a passive, box ticking role that confirms compliance with inappropriate accounting standards. In the approach that we suggest the auditor has a dynamic role in appraising what stakeholder need might be with regard to the entity upon whose accounts they are reporting. They would then be given the obligation to ensure that reporting need is met, whether the reporting entity wishes the required disclosure, or not.
Auditors need to meet expectation
Of course, there will be basic requirements to ensure comparability between financial statements. But the assumption that there is one set of disclosures that meets all stakeholder demands and that auditors can fulfil their obligations by meeting a basic criteria has to be consigned to history. Auditing’s history reveals that it was auditors who developed reporting frameworks and that they did, for many decades, act as agents to enhance disclosure. We need to return to that era.
The job of the auditor has to be to reach up to meet expectation, and not to dumb down to ensure compliance with the limited horizons of IFRS reporting. Then, and only then, might we get decent audits and, even more importantly, accounts that provide meaningful information on the role of our major corporations within society.
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Richard Murphy is a practising chartered accountant and director of the Corporate Accountability Network. After twenty years in industry and commerce, he co-founded the Tax Justice Network and Fair Tax Mark before moving into academia as a professor of political economy. He co-authored the original Green New Deal in 2008 and is still engaged on...