The frontiers of auditing
By Sonny Mabheju
THERE was an interesting article in The Financial Gazette a few weeks ago on the role of an external auditor. The article emphasised the need for the profession in Zimbabwe to continue embracing current developments in order to move together with the rest of the world.
This is in realisation of the fact that external audit underpins quality and credibility of financial reporting and public confidence. In the past few years there has been continuing revolutionary change in how and when financial information is communicated.
Events here in Zimbabwe and elsewhere in the world have led to questions being raised on the relevance of the external audit, trust in the audit profession and also on audit quality.
As a consequence, a number of current global developments have or are taking place, testing the audit profession to the limit. Some of them are discussed in this article but many more are not included.
The new audit report is one significant development that will affect the audit profession for those entities to which it applies. The current audit report has been around for a while and has now come under scrutiny as being “binary” in nature, like an on-off switch.
It is said to give “pass” or ”fail” conclusions without much supporting narrative even in those cases where the report is modified. It is seen as quite formal and predictable in format and content and not adequately entity specific, making it boilerplate and not very useful for the information needs of modern users of audited financial statements, particularly for those large entities with significant public interest.
The modern user needs more information, no longer wants surprises from fraud, governance, going concern, off balance sheet and many other issues.
The modern user is aware the current audit report does not tell the whole story about the entity in these high risk areas and that the auditor knows more than the standard audit report discloses. This is very relevant to what is going on in some audits in Zimbabwe and elsewhere in the world which can be classified as failed audits.
The new audit report is intended to provide more information to the users of the financial statements on key audit matters including; high risk areas, significant audit judgement areas, difficult to audit areas, circumstances requiring significant changes to planned audit approach, significant deficiencies in internal control.
The new audit report requires description of each key audit matter to include; why the matter is considered key, its impact on the audit (to extent necessary), and cross-reference to the financial statement (where applicable). These requirements closely link the audit report to both the audit field work and the audited financial statements.
The report also requires conclusions on going concern both; on appropriateness of management’s use of going concern and on material uncertainty. These requirements make the new audit report less boilerplate and more entity-specific, to the benefit of the users of the financial statements.
The question is whether this is robust enough to last. Given that the form and content of the audit report has been evolving over the centuries to align with information needs of users at each given time, this audit report will most likely change in line with the changing demands for information including non-financial information.
These changes may have implications on audit team leadership and composition. The traditional steep pyramid model of typical audit team is likely to change as a consequence of this and get flatter because of increased need for specialists in audit teams. Hopefully as accountants we will continue to pull it and continue to lead audit teams.
The other development that is testing the audit profession to the limit is the concept of audit quality.
This is a qualitative concept that is subjective, hence defined through a framework of key elements that create an environment which maximises the likelihood of achieving quality audits consistently.
Audit quality is likely to be achieved by an engagement team that has certain qualitative characteristics which include the following: exhibits appropriate values, ethics, and attitudes; is sufficiently knowledgeable, skilled and experienced; has sufficient time for execution; applies rigorous audit processes and quality control procedures within the law, regulations and applicable standards; produces useful and timely reports; and interacts appropriately with relevant stakeholders.
Some of these requirements have significant challenges in practice not only in Zimbabwe but in many other countries both developed and developing.
Failure to meet any one or more of these requirements on an audit engagement has resulted in to poor quality audits leading to audit failures, again here in Zimbabwe and in other countries.
The introduction and acceptance of alternative services that give high quality reports and are value are not audits has affected the audit profession.
The hierarchy of engagement services of the International Auditing and Assurance Standards Board and some regulatory requirements are some such developments and have led to including; replacing the need for an audit, audit exemptions, and increasingly linking the need for an audit with the level of public interest in an entity.
This has brought in competition to the audit profession from other service providers for those services which do not necessarily need to be provided by auditors.
Another significant recent development that has affected the audit profession is public interest.
This is a concept that can also best be defined by considering a framework of matters because a detailed general definition would not adequately address all the individual variable circumstances and may inevitably result in unintended consequences. This is why the definition of a public interest entity (PIE) is also framework based; including both quantitative and qualitative considerations.
Many countries across the world have or are in the process of defining PIE. The definition requires periodic review as situations and circumstances in the country change.
The PIE definition is important in order to correctly and effectively comply with the current generation of international standards and good practice, codes, laws and regulations which require entities to report according to the framework applicable to their situation and circumstances.
This proportionate application of reporting requirements based on the applicable framework assists in better compliance and reducing the cost of reporting to being a normal business cost and not a burden, particularly for those small entities where the public interest may not be significant.
The majority of entities in Zimbabwe and the developing countries in general fall into this category. This has also called for proportionate application of International Standards on Auditing by auditors of such entities while meeting audit quality framework requirements.
Small and medium sized audit practitioners are also expected to proportionately apply international standards on quality control when running their practice firms. These developments show that for most international standards, the old one size fits all concept is no longer adopted and there are windows for proportionate application where situations and circumstances justify.
Regulation of the audit profession is a significant recent development that has also affected the audit profession. It is intended to focus on protecting the public interest.
The regulatory function can be structured in different institutional setups including; (a) being exercised from within a professional accountancy organisation (which brings in perceptions of lack of independence from the regulated profession). This is quite common in East and West Africa. (b) Setting up a regulatory body that is independent of the accountancy profession. This is the direction most countries are taking and is perceived as independent of the regulated profession and can truly focus on protecting the public interest. The board of the regulatory body should ideally be independent or not influenced by practicing members in order to be truly independent and free from possible regulatory capture. (c) Setting up a regional regulator, and this is appropriate where there is a number of small countries with small in-country accounting professions making it not sustainable to have regulatory bodies in each of the individual countries as is the case in the Caribbean Islands.
Africa is another fertile ground for this type of arrangement after singling out the larger economies that can sustain an in country regulator that is truly independent.
In a number of countries the profession has reacted differently to developments in regulation including; regulatory capture, regulatory resistance, and indeed regulatory arbitrage in those countries where there is more than one professional accountancy organisation and are differently regulated. These adverse reactions are common in those countries where the regulatory function has legal, institutional and capacity weaknesses.
It is probably necessary to take stock of the audit profession itself. It has been around for a very long time largely doing the same thing over and over again, to ever changing clients and environment.
A typical audit firm is a solid business. It is however in some cases perceived as having loyal clients who in some cases are not proactively and appropriately serviced. Revenues are mostly recurring and guaranteed (in the absence of audit firm rotation). This business model can lead to apathy and complacency in some firms.
In addition the profession is seen as seamless, with firms within the same strata looking and acting pretty much the same only differentiated by name. Globally the profession is still composed of largely a large number of small businesses competing against each other. The globe still talks of “big 4”, a few “mid tier” firms and the rest are largely medium and small practices of 1-3 partners.
This is against the background that there are 1 to 1,5 million firms globally. This means there are too many firms and far too many small firms. Approximately 65 percent of firms employ less than 5 people and this has serious implications on quality and variety of services that can be competently performed by the small firms.
his points to the need for restructuring to reduce the number of firms while increasing average firm size to enhance capacity to offer a wide range of services at firm level. This problem is global and a number of countries I have been to have adopted various measures to encourage small audit firms to merge. This has its cultural challenges, particularly here in Africa.
Motivation in the profession is key to attraction and retention of appropriate talent. The next generation of partners is the current “Y” generation, growing up in technology and will want faster results. They are far less patient and in a performing economy the bright ones will not wait for decades for partnership appointment.
In summary, the audit profession has in recent years seen and been influenced by developments some of which were unthinkable in the past. Most of the developments focus on making and influencing the profession to be better able to provide high quality services that protect the public interest. It is no longer just a question of serving shareholder interest. The profession will continue to evolve in line with global and country changes and the demands on the auditor will progressively get more taxing.
Those that remain in the profession must gear up for continued challenges and aim to stay above the curve, just like in any other modern day profession.
Sonny Mabheju is an international independent consultant in financial management, reporting and governance. He has consulted for various organisations including the World Bank in Africa, Caribbean and South Asia regions. He can be contacted on email@example.com