Report: Auditors concerned over “market-wide capacity issue”

New audit reforms put forward by the government in March are expected to shake up the industry, but boosting and streamlining quality standards may prove an elusive goal as paltry resources remain a crucial concern for the sector, market participants warn.

While the government’s whitepaper seeks to consolidate regulatory requirements and oversight, audit firms are busy grappling with a dearth of present and future resource capacity, according to Carol Warburton, head of audit at Azets.

“From an operational point of view, that’s very, very important because that capacity dictates what we can do, the breadth of what we can do as individual firms, but also the extent of what we can do. So that’s pretty critical for all of us right now,” Warburton points out.

David Herbinet, head of audit at Mazars, says the set up of a new regulator envisaged by the consultation – the Audit, Reporting and Governance Authority (ARGA) – also raises critical capacity issues.

“The whitepaper has the potential of turning ARGA into one of the most powerful regulators in the world.

“Power is a good thing, but control is important as well,” Herbinet warns. “We need to look at practicalities because I think [that], if the scope of ARGA ends up being what is proposed in the white paper, the resources that ARGA will require are just enormous.

“The obvious question is where are these people going to come from. There is currently a market-wide capacity issue.”

BEIS whitepaper: a group effort

The Department for Business, Energy and Industrial Strategy (BEIS)’s paper, titled Restoring Trust in Audit and Corporate Governance, looks to step up corporate governance across a considerably wide range of areas, according to Simon Cleveland, head of public policy and regulation at Deloitte.

“[Audit] is an ecosystem and it’s really important that each party plays its part,” said Cleveland. “If you want a high-quality audit, you do need high-quality inputs. Therefore, you need each party to be operating at their optimal.

“The consultation document is trying to achieve that; it’s got a balance across each of the areas. It’s a very large consultation covering a lot of areas, and therefore, there’s no doubt implementation is going to be going to be a challenge.”

David Lineen, director at Haysmacintyre, points out that incremental changes in requirements and guidelines are another challenge facing the industry.

“It’s quite challenging for auditors and even for the Financial Reporting Council, because it feels like the bar is increasing but the clarity around what exactly that looks like is kind of being filled in incrementally as we go.”

The changing role of the auditor

Meanwhile, with a batch of new proposals and the adoption of new technologies rushing in from both the EU and the UK sides, auditors have evolved from crunching numbers to providing insightful reports, in turn demanding a whole new skill set.

“An auditor is potentially no longer to be a qualified individual that has gone through a big-firm training regime,” says Warburton. “It could be somebody from left-field areas of expertise we have not yet even really thought of, or we’ve thought of and sort of dismissed on the periphery.”

Mazars’ Herbinet says the biggest change firms will have to adjust to stems from the broader remit of items and data they will have to cover.

The EU Corporate Sustainability Reporting Directive (CSRD), for example, introduced in April, extended existing reporting requirements for large companies to include sustainability risk and corporate impact on society.

“Most of the value of the company doesn’t sit on its balance sheet. It will be on non-financial aspects of the business. That’s a new area that auditors have to respond to [in order] to remain relevant in the market,” Herbinet said.

The managed shared audit debate

Another element that stirred a debate is the BEIS paper’s lack of clarity around the managed shared audit recommendation allowing smaller and mid-tier firms to work with the larger firms in the industry, which prompted scepticism among market participants around its practicality.

The recommendation comes in response to the Competition and Markets Authority (CMA)’s 2019 Review and the FRC’s response favouring managed shared audit over joint audit, “which will enable ‘challenger’ firms to participate in the audits of larger companies, leading to them building additional capacity to take on more FTSE 350 audit mandates”.

“The consultation, as it stands, is asking questions about whether you agree in principle with […] managed shared audit, but it’s not really telling you how it will be implemented,” says Paul Winrow, technical partner at MacIntyre Hudson. “So yes, in principle, managed shared audit might sound like a good idea.”

According to Mazars’ Herbinet, the recommendation would provide an opportunity for challenger firms to come into the market and demonstrate their capability and enable them to raise investments into capacity and capability.

“There needs to be some form of mechanism in the UK and outside the UK because this is trying to address the issue that the market is far too concentrated,” he says.

“When you have a very concentrated audit market, such as with only four major firms in it, then you have issues of resilience and issues of regulation, because the market could not operate with one of these firms leaving the market.”

However, Herbinet sees managed shared audit as a short-term fixture that would require a reassessment in “five to seven years to see if it needs to be tweaked again or if it needs even more impactful measures”.

Limited resource in smaller firms could lead to a senior-junior relationship between the principal auditor and the other firm, according to David Smith, audit quality and technical director at Azets.

“Some firms will have a way to go before they are capable of realistically auditing a FTSE 350 businesses given the global reach of many FTSE 350 businesses,” he says.

“It’s not the case of necessarily just UK infrastructure that needs to be clearly defined for those firms and road mapped out. It’s also the international infrastructure that would give them the capability to be able to support the firms that are already on that pathway.”

The trickledown effect

Meanwhile, the FRC’s plans for operational separation, which would unbundle audit services from non-audit services in the Big Four, could see something similar trickling down to the rest of the firms in the market, according to Andrew Moyser, head of audit innovation and vice chairman at Macintyre Hudson.

“At the end of the day, if the big four start moving towards operational separation, the rest of the firms will want to start going that way if they want to be regarded as having the same mindset as the large firms,” says Moyser.

However, the regulator may also be looking at extending operational separation through to mid-tier firms, according to Lineen.

“It feels very much like they’re creating a whole new profession, almost the auditing profession, as distinct from the rest of the services, where there’s a much bigger focus on the wider societal impact of an audit, rather than just – are these numbers in the accounts correct?” says Lineen.

Technology stand off

According to Macintyre Hudson’s Moyser, technology can move the auditing profession “an awful lot” but needs to be done in the right and safe way, with the skill sets and standards to go with it.

While auditors are keen to adopt new technologies, standard setters are unintendingly “stifling innovation”, adds Winrow.

“They’re generally way off pace with what’s possible, which means [that] as an audit firm you can’t always do the things and use the tools that you want to because you’re not allowed to use them under the current standards,” says Moyser.

“The standard setters going forward need to be much more agile and able to […] get a standard out there and be ready to adjust it to go along with the technology, because you can’t wait for the technology [and] then start writing an auditing standard,” adds Winrow.

Moreover, auditors are beginning to ask questions on how to audit those technologies.

“What the impact of technology is going to be on us as auditors, on our clients and how we will respond to those technology developments over the next few years is going to be quite an interesting one,” says Winrow.

“We’ve been talking this week about blockchain and how are we going to audit blockchain and things like that. Those sorts of technology challenges will be a big, big factor for us going forward.”

Shaping the future

Alongside technology playing a greater role in audit, increased diversity will also make its way into in the market, according to Mazars’ Herbinet.

“We’re going to see an audit market with far more choice and far more firms within it,” he says.

“Each firm is going to bring [its] own views on the future of audit and it’s a compilation of all of this that’s going to make the audit of tomorrow even better than what it is today.”

Overall, with the BEIS whitepaper addressing the wide scope of the audit ecosystem, auditors seem positive about upcoming developments.

“The future does look bright for the profession if we embrace these changes, but it’s got to be supported by the right changes across the ecosystem, because that’s where you get to balance and how you know that the whole system is working,” says Deloitte’s Cleveland.

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