Speaking exclusively to Accountancy Age in the first of a two-part series, Sir Donald Brydon - author of the report into the effectiveness and quality of audit in the UK, which has made key recommendations to the Government to improve the industry – discusses the report, and warns the government and regulators that this is ‘last chance saloon.’
When Sir Donald Brydon set out to write an independent report into the quality and effectiveness of audit, a task that would take almost the whole of 2019 to complete, he insists he had no pre-conceived agenda or goal other than to improve audit for its users.
However, the result of Brydon’s undertaking was a 138-page report that makes 68 recommendations on how to not only improve audit, but to redefine it and to make it a profession in its own right.
Speaking in his office in The Shard, with views of the City of London to the North and Canary Wharf to the East he discusses his report and how important it is to get this definition right.
“You may not believe this,” he says, “but I really did start with a completely blank piece of paper. I had one view, which was that I wanted there to be more information available to the users to interpret what the audit says. Everything else flowed from the learning process.”
Despite his exhaustive list of business accomplishments, he admits that when he was first asked to compile the report, he felt he didn’t know enough about the subject to write it. But learning was part of the process. “Rapidly I discovered that it required real study from whoever was to do it.
“Because if you’re going to reimagine audit in some way, you’d have to go back to ground-zero and rebuild your knowledge base.”
As part of the learning process, he reached out to the industry for consultation, speaking to more than 120 people and receiving over 2,500 responses from audit stakeholders.
From there, ideas began to emerge, “one of which was around this whole concept that there isn’t an audit profession today,” he says. “People talk about it as part of the accountancy profession, but actually, I think it’s different to accounting.”
This led to perhaps his most significant recommendation – to create a separate audit profession, with its own governing body and set of standards.
Brydon’s review, published on 18 December, was the third in a series of reviews into audit in the UK.
It followed on from The Independent Review of the Financial Reporting Council (FRC), led by Sir John Kingman and published in December 2018 and The Competition and Markets Authority’s study of competition in the audit market, published in April 2019.
As per a recommendation made by Kingman, the government will soon replace the FRC with the Audit, Reporting and Governance Authority (ARGA). Many of Brydon’s recommendations hinge on that body.
“ARGA is really important. There’s a lot in the report they could do without any legislation, but ARGA needs to be absolutely fit for purpose to do it. Kingman made very clear he didn’t think that FRC was in the right state to do these things, so ARGA is very important.”
Brydon says the FRC has been quick to highlight the negative performers in the industry, and rightly so, but has not done enough to demonstrate, and to help others “understand what’s good, and what good looks like.”
“I think it’s quite disappointing that one senior auditor said ‘the FRC only look at the difficult audits – that they choose and find ones that they can criticise.’ I don’t think that’s true.
“But the fact that such attitudes have been allowed to bubble up needs to be killed by professionalism of the regulator. There’s a raising of standards in the regulator that’s important.”
His vision for ARGA is for it to become the regulator for this new, stand-alone profession. It would set clearly defined standards auditors would be required to meet. To set these standards, a new definition of audit would have to be established.
The first words in Brydon’s report are “Language matters.” This highlights his belief that it is vital that this definition clearly establishes what is expected of audit by its ‘users’; those who rely on the work done by auditors that determines confidence in a business.
Language is also important among auditors, who often debate technicalities. “Every word is fought over with subtle nuances,” says Brydon. “But the users don’t spend their time thinking about those subtle nuances.”
“If auditors are communicating in a language that users don’t understand, there’s a real challenge there. Material, significant, important, relevant. They’re all used in different contexts. To an auditor, they mean very precise things. But to the user, very imprecise things.”
There’s a perception that auditors can use language as an excuse, such as claiming an ‘expectation gap’, but Brydon thinks there’s more to it.
“I think a lot of it is a degree of wanting to protect yourself. Saying ‘I want to be as precise as possible so there is no room to criticise me afterwards’ is definitely a theme that runs through auditing,” he says.
“And it’s completely understandable and perfectly human. However, it doesn’t meet the objective. It’s another reason for redefining the purpose of audit clearly, upfront, so everyone knows what they’re trying to achieve, and measure achievement against that standard.”
The report states the definition should be as follows: “The purpose of an audit is to help establish and maintain deserved confidence in a company, in its directors and in the information for which they have responsibility to report, including the financial statements.”
Another key element of auditing is forecasting, and it is important that it is to this definition that upholds “establishing and maintaining confidence” as its key principle.
“The other thing that really surprised me was, that I knew audit involved lots of consideration of estimates, and forecasts. But I don’t think I had really taken on how much about audit is about the future,” Brydon says.
“In the evidence, a lot of people said audit is too backwards looking, but when you dig deeper into it, a lot of it is about affirming the estimates and forecasts are all reasonable. That got me thinking about truth. How can you say something is true, about the future?
“And that got me thinking about the expectation gap, so called. There is a disconnect, but it’s not helped by the language that’s used. And that’s how the thinking process took hold.”
This idea that the aim of audit to be ‘right’ is another thing Brydon wishes to dispel. “One FTSE100 chairman said to me, Donald – ‘I just want to know the numbers are right.’ And I said, ‘well I’m very sorry there aren’t any right numbers.’ There are numbers that are based on rules, but there aren’t any that are right.
“And that leads on to – what do the users of audit want? – They want to be informed. And if auditors begin with the mindset that the core purpose of audit is to inform people about the company they’re investing in or dealing with, then that changes the mindset dramatically from one which says an auditor’s duty is to say things that obey arcane accounting rules.”
By raising the standards to which audit is judged and ensuring that all forms of audit must meet these higher expectations, Brydon says that this will improve the profession from top to bottom.
New students learning audit would be taught to meet these standards, and work to the new, clear definition of what is expected from an audit.
“I’ve come from chairing the Medical Research Council where there are very clear principles: Do no harm, for example,” Brydon says.
“It seemed to me quite sensible that if we developed the idea of a new profession, opened it so that people could audit other things, other than just financial statements, but use the same overarching architecture so that everyone behaved to a set of principles which would define their behaviour subsequently, then you could move things forward quite a long way.”
He gives the example of a driving license. While a standard license gives you the right to drive a car, a specialist one is required to drive a heavy goods vehicle. A similar principle could be applied to different forms of audit.
But Brydon feels that he does not need to prescribe everything from top-to-bottom of the industry, and that by introducing a new professional focus, and by raising the standards that all forms of audit must meet, improvements will be made globally.
“With a new professional focus – things will start to happen that I don’t need to prescribe,” he says. “But if there’s a new profession, someone will start thinking about how to educate that profession. And then they will start thinking about the curriculum, and then they’ll start thinking about what’s not in the education of auditors today that would be valuable.”
“I don’t know what they all are, but relationship management might be an issue. How do you find out the best information? What’s the psychology of your interaction with people? Should psychology be somewhere in the training of the auditor? I don’t know.”
He sees an opportunity for universities or training institutions in this potential change, too, and calls on them to be proactive in their approach: “I would be really disappointed if there isn’t one university in the country thinking about – well if there is going to be such a thing, then that could be a fantastic opportunity for us – can we think about how we can be helpful?
“I hope this is the beginning of all sorts of creative thinking by other people.”
Prior to the release of his report, a quote from Brydon was widely circulated that suggested he was only defending auditors. Speaking publicly at the ICAEW in October 2019, he said: “I am a little troubled by the current mood that reaches for a shotgun aimed at auditors every time there is a corporate problem.”
This quote even made it as far as Australia, with Tony Johnson, EY’s Oceania CEO citing Brydon and this quote as defending auditors in a parliamentary enquiry.
But Brydon explains that this was not what he meant, and that people have used this quote out of context. “There was a curious moment. I did only one speech after the launch of the consultation – and that was October to the ICAEW.
“I used a sentence in there that got lifted and used everywhere. They said I was worried about the fact that people ‘reached for the shotgun to point at the auditor’ every time there’s a corporate problem, and I think people read that to mean that I was really sympathetic to the auditor, that auditors were doing a terrific job and that it wasn’t fair.
“Actually, they missed the point. It’s not healthy that the shotgun is pointed at the auditors all the time – but the auditors have a responsibility to make sure that doesn’t happen.” By improving audit in the UK, Brydon argues, the industry will come under less criticism.
Another defence used by auditors is that of the expectation gap – the idea that there is a difference between user’s perception of an auditor’s role and what the auditor is actually responsible for.
While he references the expectation gap throughout his report, Brydon thinks it is a distraction from the core of the issue, and what’s important is that there is widespread dissatisfaction with audit, regardless of how this is defended.
“What we tried to do was make that dissatisfaction less by making audit better. If that fills the gap of expectation, that’s great, but I think the expectation gap is polarising people,” he says.
“There are those who say that the expectation gap is an invention of the Big Four, who say it’s all the fault of the users that simply don’t have an understanding of it. The users who are saying that it’s all the fault of the accountants because they don’t communicate in a way that is helpful to them. It doesn’t matter which of those it is. What matters is that it gets better.”
After a quiet January following the release of Brydon’s report, momentum behind audit reform looks like it could once again be picking up.
The Big Four are reportedly holding private talks with the FRC about separating their audit and consulting operations. In response, the CMA has again called on the government to introduce legislation to do this.
Rachel Reeves, a long-term critic of the Big Four, has also been re-elected as Chair of the Business, Energy and Industrial Strategy (BEIS) Select Committee.
The wheels feel like they are in motion, but Brydon hopes for substantive change.
“Various promises were made to me when I took on the job,” he explains. “I’ve read everything that the Secretary of State has said, and she has made it very clear that they are going to legislate.”
“I get the impression they are taking it very seriously. There’s a lot of work going on. I don’t imagine every single one of my recommendations will get adopted, but 90% of it is a unified whole, and it depends on every actor playing their part in that to make the change.
“The government’s one of those actors, so if they give it the right leader, that would be very helpful.”
If the government doesn’t implement them, however, he says “Then somebody else is going to be sitting in front of Rachel Reeves getting lacerated, I suspect – when the next disaster happens.”
“I’m overwhelmed with the positive response the reports had. There were a few little negatives, but 95% of the responses have been extremely positive. People seem to be saying – let’s try and do something now. This is last chance saloon.”
One of his recommendations is for a review in 2025, to look back at the coming five years that will follow the three UK audit reports and assess how the other recommendations – as well as those made by the CMA and Kingman – have been implemented.
While he doesn’t want to do the review himself, he knows what he would like to see: “I don’t want to do the review. But I think if there has been a directional change, and the core piece of this is in process, then that would be pretty good.
“An output of the process, you could say, would be for auditors to be less in the firing line than they were in 2020, that’ll be pretty good outcome.” But who should be in the firing line? “Anybody who does wrong,” he says. “It’s not auditors who make companies go bankrupt.”
This is the first part of a two part series in which Accountancy Age spoke to Sir Donald Brydon about his report. Check back next week for the second part.
