Call for action on audit reform

Why focus on audit?

The COVID-19 pandemic has highlighted just how important the financial health of companies is for a strong and prosperous society. We rely on companies to produce the goods we need to live and thrive, to provide employment, and to drive innovations that can make our societies healthier, happier, and more sustainable. Yet companies can also perpetuate inequality, abuse workers, harm consumers, and prioritise the interests of a very narrow set of stakeholders - the shareholders and management - over the interests of its employees, its customers, and society.

Secrecy around a company’s financial position is often sweepingly justified in terms of commercial competitiveness. However, it can be used to hide poor performance, low productivity, and even criminal behaviour, putting both investors’ capital and workers’ livelihoods at risk. Auditors play a crucial role in assessing whether a company’s books are in order and whether the company is prepared for shocks and market changes. Robust audit practice also makes it harder for management to defraud shareholders or launder dirty money.

Audit failure

There is a real human cost when audit fails. Corporate collapse can cause redundancies, project shutdowns, major losses for suppliers and company pensioners; and in the case of bailouts and public contractors, it can incur significant costs to the public purse. The decisions made based on financial audits affect us all, through our pensions or savings, or as customers or suppliers of companies.

Audits are also a vital contributor to the trust and confidence that is required in a modern economy. Failure in audit undermines public trust both in the companies being audited (and often delivering public services) and in the state institutions that should be regulating them. Accountancy appears to have become compromised through increasing conflicts of interest in the firms who carry it out. A string of corporate failures like Carillion in the UK have been linked to audit failure, questioning whether audit practices for major companies are fit for purpose. Many calling for audit reform are specifically seeking the prioritisation of capital maintenance (i.e. fully recuperating operational costs during an accounting period before identifying excess income as profit).

Time for reform?

Audit reform can also be viewed in the broader context of re-purposing the company and changing the way companies operate. Discussions about corporate purpose have taken on greater urgency in the wake of COVID-19 and the growing movement to “build back better”. Audit should play an important role in how we measure corporate success and sustainability.

There is also a clear window of opportunity for reform in the UK. The Government has signalled its intention to address shortcomings by welcoming the hard-hitting recommendations of three reports it commissioned: the Kingman Review that called for replacing the Financial Reporting Council with a strengthened Audit, Reporting and Governance Authority (ARGA); the Brydon Review of the quality and effectiveness of audit; and the Competition and Markets Authority review of the audit market. UK regulators are also showing increased appetite to hold major auditors to account for perceived audit failures. The Insolvency Service’s unprecedented move to sue KPMG for £250m over alleged negligence in its audits of Carillion is just one example of a growing momentum for accountability and meaningful reform of audit practices.

Luminate's interest in Audit Reform

Luminate funded the Auditing with Accountability report, a collaborative research project by academics at the University of Sheffield (Adam Leaver) and Copenhagen Business School (Duncan Wigan, Saila Stausholm and Leonard Seabrooke). It was commissioned in collaboration with the Joffe Charitable Trust. It explores the major systemic weaknesses in auditing and sets out a vision for audit - that it “should be objective, sceptical, prudent, and confrontational when required.”

The report demonstrates that there is an “accountability gap” around audit: the shortfall between what the wider public might legitimately expect auditors to do and what the audit process currently delivers. It also highlights the lack of attention paid to audit reform and the likelihood that reform measures will be greatly diluted.

We are now seeking opportunities to support work that will further the audit reform agenda both in the UK and globally. Please refer to our open call for expressions of interest here. We look forward to hearing from you.