More corporate failures – what does this mean for auditors?

At the moment it can seem as if hardly a week passes without more news of corporate failures or rescue attempts, with all the consequent job losses, costs and disruption. In the current climate, media coverage of these incidents is moving ever more quickly to point the finger at the auditors of the failed company, when seeking to understand what could have gone wrong and, to put it crudely, who can be blamed.

There are a few strands to follow here when understanding what the effects are likely to be on auditors and their work.

Who is responsible – directors or auditors?

Firstly, it is worth noting that since 2018 there has been an explicit requirement in law for directors of companies producing a strategic report to describe how they have complied with their obligation to promote the success of the company with regard to a whole range of stakeholders. This has been a useful reminder that ultimately the directors are responsible for what happens to a company, and are answerable to the shareholders as well as others with an interest.

However it would be naïve to argue that auditors do not have a significant function here. There has been much talk of the “expectation gap” between what auditors do and what the public, or those who rely on company accounts, believe that they do. Public education is one matter (and the FRC recently published a Citizens’ Juries report which made interesting reading on the way that members of the public view financial statements and corporate standards) but Sir Donald Brydon, who has been reviewing the quality and effectiveness of audit and is expected to publish his findings at the end of this year, has made it clear that identifying and blaming this gap is not enough. The Brydon report will discuss the purpose of audit, including whether its scope should be widened, and will also examine questions of audit quality, the communication of audit findings, the role of auditors in detecting fraud, and auditor liability.

Changes are already happening

We wait to find out what will come out of the Brydon review, and how the other reports on and reviews of the audit market will suggest changes in terms of the structure and regulation of audit firms. But in some areas we can already see change, such as the amended version of ISA (UK) 570 Going Concern which tightens up requirements for auditors in terms of both the work they do and how they report, and makes it clear that auditors need to stand back and  look at the whole picture when assessing whether the going concern basis is suitable, instead of restricting themselves to what they have found in a self-contained “going concern review”.

While the development of auditing standards is not directly linked to the outcomes of the various reviews taking place, it is not hard to connect this increased focus on the audit of going concern with the higher levels of scrutiny that accounts are being put through. Where a company is wound up because it runs out of cash, or because it becomes clear that stated asset values are not recoverable, then it is natural that all eyes will turn to the most recent balance sheet and apply the benefit of hindsight to identify issues. It is becoming increasingly important for auditors to be truly robust in their questioning of management and then in their documentation of exactly what supported their conclusions. This should mean – when ISA 570 is applied carefully – that if going concern issues do come to light after a company’s accounts are signed, the auditor can demonstrate that they did what they could at the time based on the information available.

The FRC is watching

Auditors are also finding themselves under increased scrutiny from the FRC, evidenced by the issue of its first Annual Enforcement Review (see Newswire, October  2019).

Realistically it seems likely that investigations, fines and sanctions will only increase, at least in the short term, as the FRC then ARGA increases its resources and works on the principle that sanctions, as well as transparency, improve corporate behaviour.

Keeping the public informed

And finally, this ties in to the work on transparency reports, which are required of any audit firm that audits Public Interest Entities. Done properly, they should be a useful resource for users of accounts to understand more about the principles of the firms upon whose audit opinions they may be placing some reliance. In practice, this is not yet working, as a recent report described: even where audit committee chairs knew that a transparency report existed, many saw it as just being another piece of marketing material.

In summary, audit firms are facing increased levels of scrutiny, regulation and public interest, and this is only likely to increase in the coming months and years.