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The Audit Quality Forum, a government-established body, has commissioned a fundamental review of auditing in the U.K. that could result in legal changes to expand auditors’ responsibilities.
The review could also recognize that financial statements have a broader audience than just investors.
“The government is supportive of a review into the future of audit,” Michael Izza, chief executive of the Institute of Chartered Accountants in England and Wales (ICAEW), one of the main backers of the Forum, told Bloomberg Tax, “and it needs to be supportive in case there needs to be a change in legislation.”
Under U.K. law, audited financial statements are aimed at a company’s owners—the shareholders—alone.
“We need to ask whether they should address a wider stakeholder audience,” Izza said. That would require a change in the law.
The investigation follows a spate of auditing scandals in recent years, including over the construction and outsourcing company Carillion PLC, which collapsed in January after issuing clean accounts for the previous year.
“I said after Carillion that this was a watershed moment for the auditing industry,” Izza said. “Things must change.”
“Auditing is a system designed for the Nineteenth or Twentieth century, not for the Twenty-First.”
He pointed out that new technology allowing auditors to check all transactions could have prevented some of the well-known frauds of the 1980s, when it would have been too expensive to check more than a sample of things.
“It is not an auditor’s job to look for fraud,” Izza said.
Traditional practice has led to an “expectations gap,” and investigating ways to narrow it is one of the audit review’s central tasks.
“Companies have stakeholders well beyond investors—from creditors to government, the tax authorities and employees,” Izza said.
Such stakeholders expect to see information in the annual report that goes well beyond a simple statement of financial performance over the previous year, Izza said.
They expect to understand a company’s future prospects, and both investors and a wider audience increasingly scrutinize things such as the environment and the exploitation of cheap labor.
“Relatively few parts of the annual report are audited,” Izza said. “For example the chairman’s and CEO’s statement are not audited, even though they often contain forward looking statements and projections.”
Nor are viability statements, a requirement in the U.K. where company boards must state in the annual report whether the company is viable over a certain time.
Requiring audits of such elements could both satisfy the wider stakeholders ignored by today’s narrow definition of the audience for annual reports and force companies to give reliable, verified information on their future prospects.
“If the U.K. fundamentally changes the purpose of audits, it would have international significance,” Izza said, adding that changes to reporting standards would need to be replicated internationally.
The International Accounting Standards Board, which sets global standards, declined to comment on the effort when approached by Bloomberg Tax.
The ICAEW has hired headhunters to find someone to lead the review, “who must be independent” of accounting firms and government, Izza said.
This will be the fourth large-scale investigation into auditing practices in the U.K., with inquiries already underway into the dominance of the largest accounting firms in public company auditing; the effectiveness of the Financial Reporting Council as a regulator; and a separate, independent review of how the audit market operates, commissioned by the main opposition Labour Party.
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