Audit Q&A: You cannot serve two masters

Audit in the UK has been under a critical lens in recent years, from the Kingman and Brydon Reviews to CMA’s 2018 Market Study.

Amidst calls for reform, academics and industry participants have sought to find a solution—and Remko Renes, assistant professor of corporate governance at Nyenrode Business University believes he and his team have found one.

From 1990 to 2009, Renes worked within KPMG’s audit function, receiving postgraduate degrees in economics and accountancy along the way. Since leaving the firm, he helped author several papers on risk, investment, compliance monitoring and accountancy, leading to his latest work: “Auditing in the public interest: Reforming the profession by building on the strengths of the existing accounting firms.”

Accountancy Age sat down virtually with Renes to discuss the report’s findings, the proposed changes to the audit profession, and where the industry is headed in the next few years.

What spurred you and your colleagues to start investigating audit quality?

The paper we published in Critical Perspectives on Accounting has a background in an international, recognisable problem. There’s a lot of criticism—in the Netherlands, like in the UK, like in many countries around the world—on the role of auditors in society, and where the auditor was when a company or corporation collapses.

And we said, ‘Well as involved academics, can we do something about it, on a more positive, constructive way of dealing with it?’ The main problem we focused on was [the idea of] serving two masters. Auditing is a public utility, because it’s mandatory in law. In corporate law, it is mandatory for companies of a certain size, but it’s mandatory for most medium-sized and large companies to have an audit. So, there’s one thing, like water or telephone lines, you can only get it from utility companies.

On the other hand, the organisation, performance and delivery of audits is being done in private firms. And they have to make at least enough money to deal with all their costs, and perhaps a little bit of work—and this is serving two masters, because you are also serving the public interest. So, who is your master? Is it public interest, public society at-large, or is it the company and e.g. their executive and non-executive directors? So we said, ‘Can we solve this problem on a theoretical basis?’

Throughout your research period and subsequent stakeholder dialogues, how has the “Audit Board” idea changed?

This Audit Board, as a separate, quasi-government agency issuing the auditor’s report at the top level, has remained. It’s not only introducing something new, but also building on the strengths of the existing accounting firms, because both [co-author] Herman and I have worked in the accountancy sector. We know the strength of these accounting firms.

Our model, as we have published in the report, has become richer and more detailed. The objections we have been listening to has enabled us to make a more sophisticated model. We asked people, ‘To what extent do you think this Audit Board model is feasible for you, and also for partners and partners of the future?’

And we have experienced a significant difference speaking to over 100 people in 20 stakeholder meetings. For the partners of the future, this might be a more feasible model, whereas in our conversations with younger people and other stakeholders, there were some quite interesting discoveries. People surprised us.

In your paper, you mentioned Sir Donald Brydon’s review, which raised a number of questions about how to regulate audit in the UK. Do you think the way forward is through regulations and legislation, or is there also a moral and ethical issue here?

If a person has a perception that auditors and accounting firms are just making money and trying to sell consultancy activities, instead of doing the audit for a public cause, that’s a perception you cannot fight, at least not as an auditor.

On the other hand, when we were discussing it with audit firms, we realised that some audit firms have already been very strict in people working on the audit side, or doing other work for public entities—and that’s something that the public doesn’t understand, because it’s only one firm, and still from time to time accidents still occur with auditors involved. And we discovered that at least for some, fatigue came in to the auditors.

We also had one of those discussions with people involved in the Dutch Institute, [similar to] the Institute of Chartered Accountants in England and Wales. I think they’re doing their level best to explain transparently how auditors are working, especially in the public interest. … It’s an uphill battle against perception—you almost cannot win.

What would be the best way to measure audit quality, then, and keep the correct levels of transparency? What would that type of Audit Board look like?

In our Audit Board model, the audit methodologies is really based on the international standards of auditing. Currently, the global audit methodologies of accounting firms are also, however all accounting firms have designed their own firm methodology which sometimes results in interface problems when you have to share auditor reports.

When we designed [the Audit Board], we made one audit methodology, supported by an open-source methodology tool because in our model—at least at the group level—the audit’s being done by the Audit Board. But on the subsidiary level, not public interest entities, they’re being audited by existing accounting firms, using the same open source methodology.

But if you are using an open source audit methodology, it’s just plug and play. There’s no reconciliation problems, there’s no interfacing problems, and of course, the accounting firms can design and add their own features and applications built on the general applicable open source methodology.

In this model, what would spur firms to keep their ‘competitive advantage’?

From a public perspective, it’s all about a high-quality audit opinion. If you have some mistakes, and you can filter them in an interim review from an oversight authority, like we already have now—we have independent reviews within firms organised. Then, there’s back-office work, which says that you have found a mistake, so you can repair it before the auditor’s opinion goes public. It’s errorless and leads to Total Audit Quality Management.

On the other hand, you might say, ‘Well, this is the sixth mistake we found at [a firm], and now we should have a conversation on how you’re going to improve this one.’ Of course, you can take it into account, and you might say to the Audit Board as an oversight authority, ‘We have seen these kind of flaws—they were repaired, but the license is being withdrawn.’ So they cannot do any audit work for the Audit Board, for any public interest companies.

That’s one thing, but on the other hand, you still have the enforcement activities—I mean the regular, once in two or three years that you have an enforcement audit of the whole quality system of an accounting firm.
I think because it’s based upon audit quality, and one open-source audit methodology applied by everybody in the industry, there are no differences between those firms.

If you have the same footsteps, the same methodology, you all learn from the same mistakes.

In a perfect world, what would audit look like to you?

We have started something critical, something new. We started with a blank paper. We came up with the Audit Board model in combination with the existing accounting firms. In a perfect world, the audit is a utility function and builds on the strengths of existing accounting firms.

It is not by chance included in the law as a mandatory rule, mandatory obligation for companies of a certain size to have a mandatory audit by an accounting firm. On the other hand, we also know the existing strength of accounting firms on a global scale. Accounting firms are very successful in having the same methodology, the same working process, and an efficient delivery process all around the globe. It cannot be done or organised by some government or quasi-government agency.

So, if you combine the strength [of firms], and an institutionalised public role of the Audit Board, so that they set the level, which is discussing at the general meeting for listed companies, or banks, or insurance companies, or whatever it is—it’s the best of both worlds.