Throughout the BEIS report on the Future of Audit there is recurrent emphasis and subliminal blame on audit committees for their role in corporate failure and the seeming inadequacy of the current audit process. There is a danger of ‘one-size-fits-all’ thinking here as any audit committee can only ever be as good as its appointed directors with their differing experiences and biases.
Despite the growth of audit committee expectation since the seminal Cadbury report in 1992, there remain two core areas of focus and accountability – figure integrity and external audit, this is clear in both the FRC Corporate Governance Code and their aligned Guidance on Board Effectiveness. That is not to denigrate other audit committee responsibilities such as internal audit, internal controls and oversight of reporting, but these areas ultimately feed into the veracity and audit committee oversight of the accountability of the organisation to its shareholders, as underpinned by its financial reporting, and as verified by its external auditors.
The BEIS report asks two pertinent questions:
- Are audit committees independent?
- Do audit committees represent shareholders?
There is no doubt that more effective audit, challenge, scrutiny and scepticism is required. However, one of the biggest dangers to the robustness of the audit process might be the suggestion that the external auditors are appointed by ARGA, the new regulator, totally by-passing the audit committee and the shareholders.
The report suggests that external auditors are too often picked by audit committees for their ‘cultural fit’ and ‘chemistry’ rather than their professional scepticism, but why should the two not comfortably co-exist? The ‘cultural fit’ is required to ensure that the auditors fully appreciate the idiosyncrasies of both company and people, the ‘chemistry’ is fundamental. Scepticism is not cynicism, nor is it antagonism.
The most effective way to bring sceptical challenge is to understand the biases of the other person and then be able to probe accordingly. The report hints towards some sort of clinically remote approach to the appointment of the external auditors, but then also criticises the audit committee for being too remote from the audit process. The disconnect of the former could result in far less robust scrutiny and challenge, whilst encouraging the latter would equally risk reducing the scrutiny and challenge that does currently exist in the majority of well-structured audits.
Nothing in the process is or can be totally scientific. The very nature of the ‘true and fair’ principle requires judgement from one or more people. That judgement can and should then be challenged by the judgement of other people.
The role of the audit committee must remain pivotal, holding the balance between an informed understanding of the business, the appointment and oversight of the external auditors and external audit process, and ensuring appropriate challenge to the financial and narrative reporting. If the new regulator can help to find a more accessible route to figure and word alignment then this would enable both the audit committee, and the external auditors, to sceptically challenge how and why the viability of the future can be reasonably and transparently justified from the realities of the past.
Mark Wearden MSc FCCA FCIS delivers consultancy projects through MSB Governance (www.mbsgovernance.com), a private strategy consultancy, which he has run for the past 22 years, following 12 years in International Banking as an analyst and eight years in industry as a finance director. Mark is the author of Practical Guide for Audit Committees is also a regular contributor for Croner-i eCPD ®.