14 Nov Assessing external audit effectiveness
It’s that time of year when Audit Committees need to start thinking about how audit quality has to be made evident, rather than taken for granted. Not as easy as it sounds, and not only because auditors like to keep their work shrouded in professional mystique (and anyway most of it takes place out of the Committee’s sight.
Regulators assess audit quality by looking at audit files. Which means that Audit Committee can rejoice in the fact that it can’t do that, even if it wanted to (amazingly, there are an odd few that claim to want to…)
Instead, the Audit Committee can approach the matter from an entirely different perspective. It knows the company and understands how it ticks, and this will enable it to look at audit in a more holistic way. Here we offer a few suggestions for looking at the external audit process, as well as a few pitfalls to look out for along the way.
Good practices to consider…
When the Audit Partner presents the audit findings to the Audit Committee remember this is merely the tip of the iceberg. It’s a distillation of work done by many people in many places. The quality of that work isn’t necessarily correlated with how accomplished a performer the Audit Partner is. So make sure that the Committee’s judgement is based on a variety of sources of information covering more than just head office.
Things to avoid…
Relying entirely on the Audit Partner’s performance in meetings. Would the Audit Committee have any inkling if the auditors’ risk assessment of the Maldives subsidiary failed to reflect recent developments in the local business, and consequently its work stood no chance of detecting significant issues? (We’re framing this in a way that’s designed to encourage audit committee members to get out and about in the business… especially important during the winter audit season, of course…)
Good practices to consider…
Think hard about what the report doesn’t address. The Committee’s familiarity with the organisation should allow it to probe the extent of the auditor’s knowledge and how they’ve used it. For example, the Committee may be aware that the CFO’s inability to delegate could potentially lead to problems as the business grows. Are the auditors being diplomatic about this or are they just unaware?
Things to avoid…
Focusing only on what the report contains. Yes, it’s important to understand the work that lies beneath the auditor’s conclusions on significant judgements, and if necessary to challenge it. But it’s just as important to consider whether all the significant judgements and risk areas have been considered. That takes a real knowledge of the business, and audit committee members who know their companies well have an important role to play here.
Good practices to consider…
When assessing the quality of external audit, canvass opinions from right across the business and at every level. In all but the smallest businesses, you’ll need a well-designed questionnaire if you’re to get insight from every part of the group. You can get ideas of content from various sources including the audit firms but don’t forget the practicalities of handling and interpreting what can be large amounts of data. Our own Thinking Board® tool comes with content and makes the analysis easy.)
Things to avoid…
Asking only for the Finance Director’s, or even Head Office’s, opinions. They’ve got their own – necessarily limited – perspective on what constitutes a good audit, likely to be revealed along the lines of “some helpful errors were highlighted” and “the auditors didn’t make a nuisance of themselves.” They wouldn’t necessarily know if management in Taiwan think the auditors have no clue about the business (possibly because all the audit teams get changed at the last minute every year…)
Good practices to consider…
The trickiest parts of an audit often involve foretelling the future. The Audit Committee can usefully press the auditors on what underpins their “optimistic” and “pessimistic” assessments. Do they demonstrate a good understanding of the risks and of the breadth of issues that could affect the outturn? Try asking things like, “What needs to go right for the predictions that underpin this judgement to come true?”
Things to avoid…
Don’t rely on the visible nature of the relationship between the FD and the Audit Partner. Yes, the relationship is important and needs to be constructively challenging rather than either cosy or adversarial – but there’s a lot more to audit quality than is revealed by avoidance of those extremes.
Good practices to consider…
Audit tendering and rotation has now become part of an Audit Committee’s business-as-usual. Think about how the Committee can increase its grip on the process. It can help to ensure the best auditor will be appointed by getting a very clear idea of what a good audit looks like in practice, so that bidders are judged against the right criteria. And it can position itself as the commercial buyer, or take other steps to make it clear that fee really is secondary to quality.
Things to avoid…
Allowing the Finance Director to drive the audit tender while the Audit Committee remains gratefully detached from the real work of selection (acknowledgements to that versatile word “oversight”). Who will the bidding firms identify as the commercial buyer? It has long been the Finance Director, despite the fact that this can – and has been – compared to letting the burglars choose the policemen. No-one’s taken much notice so far – but the climate is changing and it’s wise to be prepared for more intrusive, and more sceptical, questioning about the Committee’s role.
Good practices to consider…
Start by assessing exactly what has been good (or not) about the current audit. Is it meeting the firm’s needs? What previously unobserved discontent is identifying unmet needs? Then use this to assemble a clear and comprehensive statement of what you need, what are the nice-to-haves and what you definitely don’t want. (And yes, by “you” we mean the whole company – including the Maldives subsidiary…) Then the ITT should be able to state what you want, in terms that you can use to hold the audit firm to account for its performance in later years.
Things to avoid…
Assuming all auditors are interchangeable and it’s really just a case of finding the one offering the most impressive team – or even just the cheapest one. There used to be some truth in this but it’s much less true now. Audit firms have invested huge – and differing – amounts in technology. More than ever before there are real differences between different firms’ audits.
Good practices to consider…
Ask whether you should consider a medium-sized auditing firm. Historically, from an Audit Committee perspective, there was no real upside to choosing outside of the Big Four. But the public policy climate has shifted and medium-sized firms are back in fashion – as is the idea of giving subsidiary audits to them while retaining a Big Four firm as the overall group auditor.
Things to avoid…
Wasting time by asking a medium-sized firm to bid when it should be obvious from the start that there’s no real chance of them being appointed. Make sure you’re open-minded about the possibility of appointing someone outside of the Big Four before you invite them to compete. And if you like the newcomer but just can’t bring yourself to change auditor, remember that you might have discovered a new provider for non-audit services – that’s an outcome that should satisfy everyone (well, nearly everyone).
Good practices to consider…
Think through the possible reputational risks which could arise from parliamentary, public or investor perceptions. Expectations of auditor independence have reached new levels, as has the level of press interest in it, and Audit Committees now need to consider auditor objectivity not just from the reasonable, informed perspective.
Things to avoid…
Relying on sound, logical arguments (including those put forward by the auditors themselves) to support your position on auditor independence. Twitter won’t take any notice of logical arguments, and nor will Parliamentary Committees or crusading journalists. You need to foresee how things can be (mis)represented by those with axes to grind, so you can avoid giving them the opportunity.