Auditing

Restoring trust in audit

Steve Collings explains the importance of audit and how the profession is striving to improve levels of confidence in its findings.

Steve Collings is the audit and technical partner at Leavitt Walmsley AssociatesLtd. The auditing profession has been in the headlines a lot over recent years and not for the right reasons. Critics have lambasted the profession for failing to carry out audits with sufficient rigour and not spotting serious failings by directors. Recent high profile corporate collapses have also brought auditing into question, and it is fair to say that the Financial Reporting Council (FRC) are striving to improve confidence in audit. But should all the blame lie with the auditing profession when a public interest entity fails?

Auditors cannot prevent directors from carrying out unorthodox practices and no auditing standard in the world will stop criminal activities such as fraud or money laundering. There is also the ‘expectations gap’, which is the difference between what the auditor is expected to do to comply with professional standards, legislation and guidance, and what the general public believes the auditor should be doing.

ISA (UK) 200 ‘Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with International Standards on Auditing (UK)’ outlines the purpose of an audit, which is ‘to enhance the degree of confidence of intended users in the financial statements.’

The standard then goes on to explain how this is achieved as follows:

‘This is achieved by the expression of an opinion by the auditor on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework. In the case of most general purpose frameworks, that opinion is on whether the financial statements are presented, in all material respects, or give a true and fair view in accordance with the framework. An audit conducted in accordance with ISAs (UK) and relevant ethical requirements enables the auditor to form that opinion.’

Hence, an auditor carrying out an audit in the UK is required to conduct an audit in accordance with ISAs (UK). Auditors in other countries may be subject to their own national requirements which may be ISAs that have been ‘tweaked’ to be country specific, as is the case for the UK.

Types of audit opinion and level of assurance

In most cases, an auditor will express an unmodified (unqualified) opinion (the types of opinion are discussed later in this section). Here, the auditor is providing reasonable assurance that the financial statements give a true and fair view (or present fairly, in all material respects) and have been prepared in accordance with the applicable financial reporting framework. The auditor is not providing maximum or absolute assurance due to the inherent limitations of an audit as follows:

● Financial statements include subjective estimates and other matters which require judgement.

● Internal controls may be relied upon which have their own inherent limitations.

● Representations from management may have to be relied upon as the only source of audit evidence in some areas.

● Audit evidence is persuasive, not conclusive.

● The auditor does not test all transactions and balances – they carry out audit procedures using audit sampling (see ISA (UK) 530 ‘Audit Sampling’).

It follows that an audit may not detect a material misstatement even if it has been planned and carried out in accordance with professional standards. However, this limitation cannot be used as a justification for poor audit work. At the conclusion of an audit, the auditor is required to express an opinion on the financial statements. This opinion may be unmodified (unqualified) or modified (qualified).

Unmodified (unqualified) opinion

This opinion confirms that the auditor is satisfied the financial statements give a true and fair view (or present fairly, in all material respects) the entity’s financial affairs as at the reporting date. It also states that the financial statements have been prepared, in all material respects, in accordance with the applicable financial reporting framework (e.g. FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland or International Financial Reporting Standards).

Modified opinion

The types of modified opinion include:

● qualified ‘except for’ opinion;

● adverse opinion; and

● disclaimer of opinion.

Qualified ‘except for’

A qualified ‘except for’ opinion is expressed when the effects of a misstatement in the financial statements is material, but not pervasive. This means that the matter giving rise to the qualified opinion is confined to a specific area of the financial statements but does not affect the remainder of the accounts.

Hence, the auditor will state that ‘except for’ the matter giving rise to the qualified opinion, the financial statements give a true and fair view (or present fairly, in all material respects).

Adverse opinion

An adverse opinion is expressed when a misstatement is material and pervasive. A matter is considered ‘pervasive’ if, in the auditor’s judgement, the effects are not confined to specific elements, accounts or items of the financial statements. If they are confined to these specific elements, they are considered pervasive when they represent, or could represent, a substantial proportion of the financial statements. In relation to disclosures, the misstatement must be considered fundamental to the users’ understanding of the financial statements.

Adverse opinions may be expressed in the following situations:

● the financial statements have been prepared on the wrong basis (for example, the going concern basis when the going concern basis of accounting is considered inappropriate);

● non-consolidation of a material subsidiary; and

● a material misstatement exists within a balance which represents a substantial proportion of the assets or profits (for example, where a profit could turn into a loss).

Disclaimer of opinion

A disclaimer of opinion is expressed when the auditor has been unable to obtain sufficient appropriate audit evidence and the effects of any possible misstatements could be pervasive. A disclaimer of opinion is not an opinion in itself because the auditor is unable to form such an opinion and may be expressed in the following situations:

● a failure by the client to keep adequate accounting records;

● a refusal by the directors to provide the auditor with written representations; and

● a failure by the client to provide evidence over a single balance which represents a substantial proportion of the assets or profits or over multiple balances in the financial statements.

Restoring confidence in the audit profession

The UK government is striving to restore confidence in the auditing profession. To that end, the government is carrying out the following steps:

● establishing a new regulator in the form of the Audit, Reporting and Governance Authority (ARGA). It is expected that the transition to ARGA will complete in 2023;

● recognising the public interest in large private entities by ensuring they meet the same high standards of reporting and accountability as expected from larger, listed entities;

● making large companies’ more useful with better information about the risks they face and what information has been assured and strengthened review powers for ARGA;

● strengthening reporting about companies’ internal controls which underpin true and fair accounts, through the Corporate Governance Code;

● improving the quality of audit and making it more informative, driven by ARGA’s responsibilities for standards, inspection and approving registration of auditors for the most significant companies;

● boosting resilience, competition and choice in the audit market, through the introduction of a ‘managed shared audit’ requirement for FTSE 350 companies and requiring an operational separation of audit and non-audit practices;

● making directors of the country’s biggest companies more accountable for significant failures in their corporate reporting and audit related duties; and

● strengthening oversight of the accountancy and actuarial professions to build confidence in the professions and in the UK.

Conclusion

Confidence in the auditing profession has been hit due, in large part, to the high-profile corporate failings which have been seen over recent years (e.g. Carillion and Patisserie Valerie). There will always be an ‘expectations gap’ where audit is concerned but this cannot be used as an excuse for poor quality audit work. Only time will tell if the government’s attempts at restoring confidence in the audit profession are successful or not, but it looks like things are heading in the right direction.