Audit committees should brace themselves for significant change after a new report prompted the UK audit watchdog to suggest it provides support for the introduction of new audit standards.

According to the Financial Reporting Council, the research supports a case for standards that would promote audit quality after audit committee chairs told interviewers they need to improve their understanding of what makes a “good audit”.

It seems the understanding of audit quality may differ from one committee to another. There is also a concern that audit committees—or auditcos—challenge auditors when their work is in the planning stages but are less likely to turn the screws when it comes to their findings.

Mark Babington, the FRC’s head of regulatory standards, said the research “reveals there is a lack of consistency in how to approach audit quality with insufficient focus on challenge of management and professional scepticism”.

The report’s timing may be prescient. The entire audit industry is braced for the arrival of a final government consultation which should offer a detailed indication of which direction Whitehall wishes to head after three years of debating reform of the audit market, its purpose and its regulation. The consultation is expected at any time though some observers believe it could slip to the New Year.

Audit market reforms

Debate about fixing audit has been a long-running saga, though the current chapter was triggered by the collapse of construction firm Carillion in January 2018. That kicked off a round of parliamentary hearings and government reports probing the audit market, regulation and the content of audits. Perhaps the biggest proposal to emerge from the investigations was the abolition of the FRC, to be replaced by a new body with wider responsibilities and new powers. Others include the introduction of joint audits and seperating audit firms from other advisory functions.

However, there were also proposals for audit committees. The Competition and Markets Authority suggested the new regulator should have powers to write standards for the appointment and oversight of auditors. It also proposed watchdogs be able to demand information and reports from auditcos, as well as the power to place a regulator inside the room at committee meetings. There were also proposals giving watchdogs the power to publicly reprimand audit committees and report them to shareholders. The CMA also called for a closer relationship between auditcos and shareholders.

The FRC’s new report works to unearth the views of audit committee chairs on audit quality. After interviewing 54 committee chairs researchers found approaches to audit quality varied, with some chairs wishing to “improve their understanding of what makes a good audit”. They also called for clarity on the “scope” of audit.

“Such findings suggest that while some audit committees may be very focused on the quality of audit, there could be inconsistencies in how they go about promoting audit quality,” the report says.

“This lends weight to proposals for reforms in the audit sector, including the introduction of standards for audit committees.”

There were other findings. Not all committees identified “challenge and scepticism” as key ingredients in an audit and it wasn’t always clear if they “distinguished between a good quality service and a good quality audit”.

“In some cases a high-quality service appeared to be a proxy for a high-quality audit and for a majority, good service was seen as a necessary facet of quality,” the report says.

Auditco challenges

Mike Suffield, director of professional insight at accountancy body ACCA and a former head of the FRC’s audit quality review team, said the latest report provides key intelligence, including the need to draw lessons from audit failures and the difficulty faced by audit chairs attempting to shop for audits outside the Big Four firms who dominate the market for big audits.

He also praises the report for highlighting shareholders’ lack of involvement in the audit process and the need for defining audit quality indicators.

But he warns that the introduction of audit committee standards would be tough. Standards might increase the strains of running audit committees and discourage top talent from taking on the work. Although, he adds, new standards could improve accountability, depending on the accompanying enforcement regime.

“By definition standards will be more prescriptive,” says Suffield. “What standards do give you is potentially something against which to oversee more clearly. And indeed, if desired, [something] to enforce if a chair or committee member has been found to fall short of those standards.”

Any reform proposal depends on the consultation document expected from the Department for Business, Energy and Industrial Strategy (BEIS). For their part, audit committee members are expecting change. There is a recognition, according to Jock Lennox, chair of the Audit Committee Chairs’ Independent Forum, that there is a loss of trust in audit and that changes to audit committees must play a part in rebuilding faith. “The die is cast,” he says.

Lennox is expecting proposals for regulatory oversight of audit committee and potentially an idea for intervening in audit committees in extreme circumstances. However, he rejects one CMA suggestion of placing a regulator in audit committee meetings as impractical. “I would hope we don’t end up where there’s a regulator second guessing every single decision that an audit committee takes. That would not be sensible,” he says.

“We’ve got to get behind the BEIS consultation in a constructive way so that we can all move forward. Change is coming.”

The latest report forms an important piece of evidence for changes to the way audit committees. Auditco chairs can expect to learn the precise changes soon.