Beware of unintended consequences

Whenever there are major corporate scandals, one of the first questions asked is ‘what did the auditors know and why didn’t they forewarn us about the risks?’.  This often leads on to questions about the governance and oversight of the standard-setting process, and whether it needs to change to ensure that it best serves the public interest.

The Monitoring Group (MG), a collaboration of international financial institutions and regulators tasked with overseeing the framework for setting international audit standards, believes that change is overdue. It is concerned about the independence of the standard-setting process and whether the standards are still relevant and up-to-date given the pace of change in technology and society. In an important consultation paper, the MG highlights in particular the possible impact on stakeholder confidence in audit standards of any undue influence of the profession on the standard setting process.

 As part of the consultation process, ICAEW hosted an MG event on 15 January to allow a broad range of international stakeholders to share their views. Although there was wide support for a standard-setting system that is transparent, independent and fit for the future, there was a diverse range of views on how this should be achieved. ICAEW Chief Executive Michael Izza sets out some of the important issues that need to be considered in an opinion piece in Economia.

Whatever transpires, the MG will need to try to ensure that there are no unintended consequences from its reforms. Reports on topics like KPIs and carbon footprints are rooted in principles-based standards that allow auditors to use their professional judgement and experience. There is a risk that if more rules are imposed on auditors their role will become less flexible and valuable, and this may act against innovation and improving audit quality. A move to a more rules-based approach might also create a reactive sort of process where standard setters are always playing catch-up.

Being able to attract and retain highly-qualified auditors is crucial to achieving quality. A rules-based set of standards may make the profession less attractive. Education standards are alluded to only briefly in the consultation paper, but we need to think through the impact of any reforms on the supply of people with the necessary competencies to ensure high audit quality.

The pros and cons of rules-based standards are only one aspect of the proposed reforms. Would having one board to set audit standards and audit ethical standards be a sensible consolidation of work in one highly complex area, or an unmanageable combination of technical and behavioural standards? If there is to be a new board, what should the scope of the standards setting they take on be? Regulators and investors tend to focus on public interest entities, but in many countries other entities need to be, or choose, to be, audited. Collectively they are also important, but audit needs for SMEs can be different than for larger organisations.

Whatever the final outcome, any new or revised board will also need to ensure that it is both responsive to, and supports innovation in, the audit market, for example by taking account of the growing use of data analytics and technology. This was a key point that was made by ICAEW’s Audit and Assurance Faculty in its paper on the Future of Audit: Technology which highlights the need for auditing to embrace the major technology advancements already taking place.