|
Promoting
Audit Quality: U.K. Financial Reporting Council Discussion
Paper
By
Mary Ellen Oliverio
FEBRUARY
2007 - In November 2006, the Financial Reporting Council (FRC),
the United Kingdom’s independent regulator for corporate
reporting and governance (www.frc.org.uk),
issued a provocative discussion paper, Promoting Audit
Quality. Audit quality is a hot topic among accounting
practitioners and in regulatory circles in the United States
and elsewhere. The FRC prepared this discussion paper in the
context of the financial reporting framework in the United
Kingdom and the Republic of Ireland. The FRC is soliciting
the views of parties interested in the audit process with
regard to three themes:
- Identifying
the relevant drivers of quality audits;
- Identifying
the threats to the drivers, and ascertaining whether there
are threats that have not been identified; and
-
Suggesting additional action that could improve the “likelihood
of audits being of a consistently high quality.”
The
discussion paper was motivated by the FRC’s objective
to promote and maintain users’ confidence in the audit
process and in the resulting audit report. In order to do
this, according to the paper’s introduction:
[T]he FRC believes that users of financial reports must
be able to rely on an audit report giving a robust and
objective opinion that the financial statements concerned
…
- [Show]
a true and fair view;
-
Have been properly prepared in accordance with the applicable
accounting framework; and
- Have
been prepared in accordance with the relevant legal
requirements.
An
Assessment of the Current Environment
The
overall description of the current environment is especially
valuable to U. S. auditors and others interested in the
subject. It provides a thoughtful summary of the view of
contemporary auditing from the United Kingdom. A statement
in the introductory paragraph makes clear the impact of
the recent U.S. auditing scandals:
Following the high profile collapses of Enron and WorldCom
and the demise of Andersen, the quality of financial reporting
and the effectiveness of the audit process have been the
subject of unprecedented analysis, review and reform over
recent years.
The FRC states explicitly the important role that financial
reporting plays in effective operations of capital markets.
It also states its belief that “the audit is fundamentally
sound and appropriate to achieve its objective—namely
a reliable and objective audit opinion.” The developments
in the United Kingdom are outlined and reflect thoughtful
consideration of U.S. auditing failures, especially during
the past six years.
Drivers
Identified
The
discussion paper presents what the FRC considers the drivers
of audit quality and related threats in each of four main
areas. It then provides the thinking of the council to date.
The following are brief summaries of the drivers and related
threats.
The
culture within an audit firm. The principal
indicators identified include:
- Whether
the firm’s leadership effectively promotes the importance
of auditors’ discharging their professional responsibilities;
-
Whether there is compliance with standards of ethics and
professional conduct;
- Whether
the firm’s human resources initiatives promote personal
characteristics such as integrity, objectivity, skepticism,
and robustness;
and
-
Whether the firm avoids short-term decisions that have
a negative effect on quality.
The
principal threats identified include:
-
Leadership of the audit function has insufficient input
into management decisions because of competing interests
of other components of the practice; and
- An
overemphasis on winning audit engagements and on retaining
clients.
The
skills and personal qualities of audit partners and staff.
The principal indicators of this driver include:
-
The skills base of partners and staff;
-
The training given to audit personnel; and
-
The approach to appraisal of partners and staff.
The
threats identified include:
-
Failure to develop necessary personal characteristics
through effective mentoring;
-
Failure to retain experienced and expert staff;
-
Allocating capable staff by client prestige rather than
audit risk; and
-
Insufficient or ineffective training.
The
effectiveness of the audit process. The principal
drivers identified include:
-
Structure, experience, and knowledge of the audit team
is appropriate for the engagement, and resources are sufficient
for iissues that may arise;
- High-quality
technical support is provided to audit teams;
-
Audit methodology is structured to provide an appropriate
framework and procedures that ensure compliance with standards,
including requiring appropriate documentation and review;
and
- Objectives
of ethical standards are achieved.
The
threats identified include:
-
Increased use of computerized audit methodologies may
shift focus away from evidence gathering, due to time
spent coping with technology;
- Overly
prescriptive auditing standards, regulation, and audit
methodology; and
- “Client
capture”—the relationship between the auditor
and client is so close that objectivity is impaired.
The
reliability and usefulness of audit reporting.
The principal drivers identified are:
- The
form of the auditor’s report is highly codified
and standardized; and
-
Good communication with audit committees is likely to
contribute to high-quality outcomes.
The threats to confidence in audit reporting include:
-
Whether auditors are properly fulfilling their legal responsibilities
to consider the adequacy of the client’s accounting
records;
-
Whether auditors’ reports should be more informative
about key audit issues; and
-
Whether the scope of the meaning of “true and fair
view” was restricted with the introduction of International
Financial Reporting Standards of the International Standards
Board (IFRS; this is specific to U.K. requirements).
Outside
Factors Affect Audit Quality
The
final chapter of the discussion paper recognizes that external
factors also impact the quality of audits. The paper includes
brief discussions of: 1) the approach taken by management;
2) the contribution made by audit committees; 3) the role
of shareholders and commentators; 4) the role of litigators;
5) the approach of regulators; and 6) the pressures caused
by the accounting reporting regime.
The
FRC Welcomes Comments
The
discussion paper includes questions at the end of each topic,
but the FRC states that “commentators should not feel
that they are constrained by those questions or required
to answer them.” Views of those stakeholders and other
parties interested in the audit process are welcome.
As
noted above, the discussion paper is provocative; it outlines
critical aspects realistically and wisely; overall, it is
an exceptionally impressive first approximation to the topic
of determining audit quality. Nevertheless, the paper has
many aspects for which comments are justified. For example,
the nature of the evidence that is most likely to reflect
the effectiveness of the specific drivers is yet to be identified.
Under “The Culture within an Audit Firm,” the
following driver is listed:
[W]hether
the firm’s leadership effectively promotes the importance
of discharging professional responsibilities as auditors.
.The question
still to be answered in the guidance that is expected to enhance
audit quality is this: What evidence provides valid, reliable
information to give the person responsible for oversight confidence
that the audit firm indeed promotes professional responsibilities
as all members of the audit team perform their assigned tasks?
An inquiry of the leadership of the audit or of the firm’s
human resources executive is not sufficient for appropriate
and sufficient evidence to satisfy that the driver is indeed
reflected in the culture of the firm. The
discussion paper is available at www.frcpublications.com.
Comments should reach the FRC by March 31, 2007, and should
be addressed to:
JEC
Grant
Financial Reporting Council
Fifth Floor, Aldwych House
71–91 Aldwych
London WC2B 4HN
U.K.
(or
via e-mail to j.grant@frc-apb.org.uk)
Mary
Ellen Oliverio, PhD, CPA, was formerly a professor
of accounting at the Lubin School of Business, Pace University,
New York, N.Y. |