Ten sensible, measured steps that will restore faith in auditors

Ten sensible, measured steps that will restore faith in auditors

Senator James Paterson – The Australian Financial Review – Tuesday 03 March 2020

The Parliament’s Joint Committee on Corporations and Financial Services is taking action to restore trust and confidence in the auditing industry in Australia. In its first seven months of inquiry, the committee did not uncover any grand conspiracies imagined by some of the industry’s feverish critics. But we did identify areas for improvement which, if acted upon, should silence all but the most unreasonable detractors.

Last week, the committee tabled its interim report into the regulation of auditing. It did so because despite the Senate extending the final reporting date to September, committee members agreed the policy recommendations from the inquiry were already clear from the evidence collected to date. The committee did not want to delay the action required by the industry, regulators and government to address the issues identified so far.

The committee did not find any new evidence of systemic audit failure in Australia. Although existing data available from the Australian Securities and Investments Commission’s audit inspection reports does pose concerns, ASIC and others during the inquiry were at pains to point out it is a risk-based sample, not a representative one.

This is entirely appropriate for a conduct regulator. However, it means great caution must be exercised in drawing lessons for all audit files. Audit inspection reports also include all issues in audit from the minor to most serious. One of the committee’s recommendations is for ASIC to grade the severity of its findings in a revised reporting framework, taking into account international best practice.

In place of new empirical evidence, the committee heard anecdotal evidence about audit failure and fears were raised by a number of witnesses about the risks of wider failure in the future.

Because audit is systemically important to providing confidence in financial statements made by listed companies, and therefore the entire financial system, it is a case of perception is reality. In a market economy, investors base their decisions on these financial statements and must be able to trust them. That is why audit needs not just to be high quality, but equally to be seen as high quality by its stakeholders.

It was therefore clear to the committee that action is warranted to address these concerns. The 10 recommendations made are modest, measured and targeted. They are designed to remedy this trust deficit by providing greater transparency, clarity and confidence in the auditing industry in Australia.

The recommendations are drawn from the more than 110 submissions, 32 witnesses at four public hearings, and more than 100 questions on notice. They drew broad support from witnesses during the hearings including academics, industry and regulators.

Among them is a requirement for listed companies to either hold a tender if they use the same auditor for 10 years, or explain why they should not do so to shareholders. It does not preclude a board retaining its auditor for longer than 10 years if they believe that is appropriate, but effectively ensures boards are required to consider the wisdom of doing so.

This approach was preferred to more radical measures like mandatory audit firm rotation or structural separation between audit and non-audit arms of accounting firms. Similar measures have been abandoned or rejected overseas because they undermined audit quality or threatened competition in the audit market.

The recommendation with the most far reaching potential is the roll out of digital financial reporting, which has been standard practice in the United States since 2009, and will soon be adopted in the European Union. This has the capacity to not just assist auditing but the efficient and transparent functioning of financial markets more broadly.

It requires the financial statements be machine-readable so that they can be easily and accurately analysed not just by audit firms but any interested third parties including regulators and academics. This would replace in some cases the remarkably outdated practice of manual data extraction which is expensive, slow and prone to errors.

Other recommendations include mandating disclosure of ASIC’s individual firm inspection reports, clear definitions of audit and non-audit services, expanded auditor independence declarations, and formalising existing restrictions on audit partner remuneration.

While the committee will hold two further hearings and hand down a final report by September, the action required is already clear. These sensible steps towards restoring faith in the audit industry should start now.

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