Calls for urgent reform of the audit sector have been growing in recent years, spurred on by a slew of high-profile audit failures. In the UK, the publication of the government’s consultation on proposed audit reforms last month brings the sector one step closer to these calls becoming reality.
The proposed changes are far-reaching, aimed at restoring trust in the audit function. They contemplate important changes to the role of the auditor which, in turn, call for a renewed focus on the organisational culture of audit firms. Audit quality can only meet community and regulatory expectations if audit firms develop and maintain a culture that empowers auditors to consistently and courageously do the right thing.
What cultural changes are needed in the audit sector?
1. Make purpose central
Purpose is one of the most important organisational drivers of good conduct. Our research has found that the articulation of a purpose beyond profit is associated with increased employee engagement, improved decision-making, and lower incidences of misconduct.
Worryingly, large parts of the sector lack a coherent purpose that is lived in the day-to-day. As the Brydon Review—an independent review undertaken in the UK by Sir Donald Brydon into the quality and effectiveness of audit—concluded, the sector “lacks a clearly understood and fully encompassing purpose”.
The government proposals, however, envisage a changed and broadened purpose for the sector—one centred on living up to the public’s expectation to scrutinise companies to ensure financial statements accurately reflect financial conditions. This will, in turn, pose significant challenges for the sector—not least reconciling audit’s specific societal purpose with an environment of tight margins and fees paid by clients—and will require the profession to redefine purpose, communicate what it means for individual auditors, and act on it by aligning strategy, governance and operations with their stated purpose.
2. Address unrealistic expectations
Heavy workloads are synonymous with the audit sector, particularly during “busy season”. Indeed, research has found that auditors consistently under-report time during busy season and report that they would not meet budget were they to charge the time they actually spend.
The implications of such excessive time pressures are extensive. Time pressure is closely correlated with both increased error and increased misconduct as staff are forced to cut corners. Data from Principia’s Ethical Culture Index, which synthesises data on ethical performance across more than 400 US and UK headquartered companies, shows that unreasonable expectations are associated with a higher likelihood of misconduct.
A high-profile cautionary tale is the collapse of the British high-street retailer BHS, where it was reported that the auditor who signed off their financial statements spent a mere two hours reviewing the audit file.
3. Reform incentives and enhance accountability
Conflicts of interest sit at the heart of the issues confronting the audit sector. These include the fact while audit firms’ primary obligation is to the public, incentivisation tends to value client retention and revenue under management over audit quality, undermining the likelihood of auditors challenging their clients.
To shape the behaviour expected of their people, audit firms must take concerted action to reward audit quality and ethical conduct in practice, not just in principle, and decisive action to hold to account those whose conduct or audit quality falls below expectations, even where financial performance is strong.
4. Create a speak-up culture
A lack of speak-up remains a critical vulnerability for most organisations today. Indeed, according to Principia’s Ethical Culture Index only 50% of staff who witness misconduct report it. The extent to which staff can raise an idea, concern or challenge in organic, informal settings presents an equally bleak picture: a mere 47% of staff feel they can challenge superiors without fear of negative repercussions, while only 67% of employees believe that when things go wrong they are openly discussed.
A weak speak-up culture in audit sows the seeds for and will inevitably lead to audit failures, given that calling out non-compliance is a key part of auditors role to act in the public interest. Efforts to rebuild trust in the sector must centre on encouraging staff to speak up where they see compliance failures and material misdescriptions in financial statements in the course of the audit.
While interventions abound to seek to remedy lack of speak-up, these often do not go far enough to affect real change, typically neglecting the cultural factors—from leadership role modelling to the existence of safe spaces—that compel individuals to raise their head above the parapet.
5. Support deliberation
Audit firms continuously need to navigate the differences of view and interpretation between management, directors and their own analysis on material aspects of financial statements. While audit is often perceived as a box-ticking exercise, IFRS rules require auditors to exercise judgement about whether an organisation’s accounts are a fair reflection of its financial situation.
This need for judgment introduces grey areas where auditors are required to exercise discretion over whether audit rules have been adhered to. Challenging clients on such matters of judgment requires clarity of view when lines have been crossed.
Making these calls will only become more challenging as audit firms take on an expanded purpose and increase the scope of audits, leading to more grey areas lending themselves to a range of interpretations. Many cases of audit failure start as a poor judgment call. To protect against audit failure, it is therefore critical that auditors have the training, tools, access to advice and discussion spaces to enable them work through such decisions effectively.
A new audit culture
The sustained push for reform of the audit industry in the UK and elsewhere demonstrates that expectations about audit quality are rising. Regulators are likely to prescribe changes to the mandate, systems, and processes of audit firms. They are also likely to introduce new accountability mechanisms. To perform in this changed regulatory environment, audit firms need to develop the culture to match expectations. Audit firms should be proactive in reshaping their culture in line with the broadened purpose of audit.
Given the complexities of conducting an audit, every firm is at risk of making a mistake at some point. Audit firms have the responsibility to ensure that if mistakes happen, these are the rare exception despite having a sound culture; not a frequent event caused by the lack of it.
Sabrina Bushe is professional services practice lead and Marco Meyer is a director at Principia Advisory, a global network of ethicists and practitioners committed to building ethical organisations.