Imre Nagy on closing the expectation gap

BRIDGING THE EXPECTATION GAP

The IRBA’s Imre Nagy says the future of financial reporting is comprehensive regulation and accountability.

The future of audit should be linked to the fundamental purpose of financial reporting, says Imre Nagy, the acting CEO of the Independent Regulatory Board for Auditors (IRBA). “The purpose of an audit is to gain confidence in financial statements and reports by investors,” he says. But while the purpose remains the same, Imre says the audit product needs to evolve. It needs to develop alongside business as the world changes, and remain fit for purpose. Imre says that this evolution also needs to address the expectation gap. Referencing a report published by the Association of Chartered Certified Accountants (ACCA), Closing the expectation gap in audit, he details three types of gaps. “The ‘knowledge gap’ is the difference between what the public thinks auditors do and what auditors actually do; the ‘performance gap’ is the difference between what auditors do and what they’re supposed to do; and the evolution gap is the gap between what auditors are supposed to do and what the public wants them to do,” he says. The future of audit also needs to be considered in the context of the broader financial reporting ecosystem, Imre says. Auditors are only one link in the governance chain and cannot replace other controls that should be in place. This is why one of the three focus areas of IRBA’s refocused strategic plan for 2021 to 2025 is comprehensive stakeholder engagement, focusing on driving broader reforms in the ecosystem, including a framework for comprehensive regulation. The other two focus areas are audit quality, and sustainability and relevance of IRBA and the audit profession.

Comprehensive regulation

Comprehensive regulation was one of the pillars of the previous strategic plan and something to which IRBA remains committed. IRBA in itself is a step towards this goal. Previously, the accounting and audit professions were both governed by the Public Accountants and Auditors Board (PAAB), which was self-regulated and had limited powers. Then, in 2005, South Africa became one of the first countries worldwide to adopt independent audit regulation and to create an independent regulator under the Auditing Profession Act (Act 26 of 2005). The newly formed IRBA had powers to lay down regulations and set standards, although it no longer incorporated oversight of the accounting profession. Independent regulation aims to ensure audit quality is upheld, which is why the International Forum of Independent Audit Regulators (IFIAR) was established. South Africa is a founding member and works alongside 53 other countries to serve the public interest, including investors, by enhancing audit oversight globally. Sadly, several high-profile audit failures have again rocked the world over the last few years, proving that there is yet a long way to go. Cases like Wells Fargo in the USA, Carillion in the UK, and Wirecard in Germany show that this is a global issue, not just a South African one, Imre says. However, he admits that the frequency of audit failures in South Africa remains high, and a cause for concern.

Rebuilding trust

As IRBA works to rebuild trust in the profession, Imre believes that the new leadership and new strategic plan will help to bring about necessary changes. The Auditing Profession Amendment Act (APA), signed into law by President Cyril Ramaphosa on 23 April 2021 and gazetted on 26 April 2021, will also help. Imre explains that the amended APA gives IRBA the necessary powers to deliver more effectively on its mandate by strengthening its independence, investigative and disciplinary processes, and removing some of the former limitations of the APA. Significant changes introduced include: • The power to enter and search premises for the purpose of seizing information relevant to an investigation; • The power to subpoena persons with information that is required for an investigation; • The power to refer non-audit complaints for investigation to registered accredited accounting bodies; and • Stricter monetary sanctions in relation to both investigation and disciplinary outcomes. The last point in particular releases IRBA from the previous restrictions of the Administrative Fines Act, which capped its fines at R200,000 per charge. The amendments to the regulation mean that the Finance Minister is able to set maximum fines, which gives IRBA the ability to impose more serious consequences on members it deems to require discipline. It is also now able to establish multiple disciplinary committees, which will increase capacity to tackle complaints and convene more than one disciplinary hearing at a time, thus ensuring that disciplinary matters are dealt with expeditiously and without undue delay.

“The ‘knowledge gap’ is the difference between what the public thinks auditors do and what auditors actually do.”

Referring complaints not directly related to audits to other professional bodies will also free up capacity in investigations. Imre is philosophical about auditor discipline. “If I drive a Ferrari and the maximum penalty for speeding is a R200 fine, I’ll pay the fine to enjoy the car if that’s the worst that’s going to happen,” he says. “Unfortunately, increasing regulation and fines does affect the attractiveness of the profession. But we’re not doing it to make life difficult for auditors or make the profession unattractive. Regulators have to react to what investors are asking us to do, which is to do more to protect them, especially after experiencing catastrophic corporate and audit failures.”

Relooking remediation

IRBA has also relooked its remediation practices. For more than three years, Imre says, the regulator has been working with firms to drive remedial action, with very limited results. “Our Inspections Committee even referred some firms for investigation, as well as to the board, where we’ve seen no improvement,” he says. “The board is empowered under section 4 of the Act to take any steps it believes necessary to protect the public, which can extend to suspending a firm’s licence to take on audit work. Although it hasn’t been done before, we might see that action going forward. The board has the power to embargo firms from taking on new clients, or to put the firm on notice with the intention to suspend its licence if it does not demonstrate an improvement.” He says IRBA has also enhanced its remedial process with audit firms. While it previously required firms to develop remedial plans, it will now be inspecting the firms’ implementation and own monitoring of these plans. It is also motivating for the outcome of these inspections to be made available to audit committees.

Next steps

While Imre says the global journey towards audit reforms has only begun fairly recently, IRBA is already planning for the next steps. “There are three more things that we are looking for in the next tranche of amendments to the APA, which will be considered by the National Treasury within the next two years,” he says. “One is to include the rule on mandatory firm rotation within the Act. We also want to remove the confidentiality restrictions on our inspection reports, and then we’re looking at any other reforms that will strengthen the audit profession in the country.” Digitisation is also on the agenda. As the profession deals with the impact of Covid-19, which has seen audits taking place virtually, Imre says IRBA has also been adapting to new ways of working, with inspections taking place virtually. “The firms have been amazing at providing us with access to data, and we’ve also signed MoUs with other regulators to get access to other relevant data and information. I’d say one of the biggest milestones for us in terms of our previous restoring confidence project has been the introduction of audit quality indicators. We've just issued our second report in March.” As more data becomes available, Imre believes that useful trends for both the regulator and audit firms will begin to emerge. “This will help firms, audit committees and us, as a regulator, to focus on areas where there’s potential risk,” he says. l