Audit Reform—What Is the Optimal Way Forward?
Across the globe over the last 20 years, far-reaching auditor-related reforms have sought to restore confidence in the role of the audit in ensuring the reliability of reported company financial information. These reforms include the enhancement of auditor reporting, limiting tenure, audit partner rotation, and restrictions on nonaudit services. Despite these reforms, questions linger on how to sustain and perhaps even enhance the long-term value of audit. Inextricably linked to the value of audit is the notion of audit quality, much as it is difficult to come to a consensus across stakeholders on exactly what audit quality means.
To help shape thinking on the way forward, CFA Institute recently conducted a member survey [CFA Institute Member Survey Report: Audit Value, Quality, and Priorities] with a focus on assessing factors that influence investors’ perceptions of the value of audit, factors investors apply when assessing audit quality, and investor views on what ought to be the priorities of audit standard setters and regulators. Response rates ranged from 186 to 211 per question.
Key takeaways from the survey findings, coupled with findings from other surveys, are provided below.
Value of Audit: Insightful Communication Topmost Factor
To assess the value of audit, the survey assessed seven factors identified after consulting audit practitioners and expert users. Respondents were asked to rate the importance of each factor ranging from 1 (not important) to 4 (very important). An average score per factor (with a maximum score of four) was calculated after excluding respondents who had no opinion. Below are some of the key findings on factors influencing perceptions on the value of audit.
- Insightful communication to investors was rated as the most important influencing factor. The survey results show that the quality of firm and engagement-level communication, including the information contained within the auditor report (score 3.65), disclosure of audit quality indicators applied in the auditor oversight role by audit committees and regulators (score 3.48), and audit firm transparency reports (score 3.40), were rated top across the subset of assessed factors assumed to influence investors’ perception of the value of audit. This finding underscores the importance of the enhanced auditor report requirements enacted by the International Audit and Assurance Standards Board, the Public Company Accounting Oversight Board, and the UK Financial Reporting Council.
- The role of technology in enhancing audit quality is a more pertinent consideration than its role in reducing the costs of conducting audits. Enhancing the use of data analytics and artificial intelligence during audits had a score of 3.02; leveraging technology to reduce audit costs had a score of 2.77.
- Reasonable support exists for expanding the scope of audit. Although expanded scope did not emerge as the top-rated factor, the survey provided evidence of reasonable support for expanding the scope of audit (i.e., score of 2.91). Worth noting is that previous CFA Institute surveys show support for assurance on XBRL (50% expect audits at par with the rest of financial statements), non-GAAP financial measures (NGFMs; 80% expect greater assurance than is currently the case ;), and environmental, social, and governance (ESG) information (69% expect independent verification of ESG disclosures).
- Audit fee level is a lower-order consideration in influencing perception of value of audit. Audit fee level had the lowest score of the seven assessed factors (i.e., 2.66, with 16.7% considering it as very important and 13.9% considering it as not important). It also had the lowest score of the 28 factors affecting the assessment of audit quality.
Audit Quality: Financial Reporting and Audit Process Outputs Heavily Influence Perception on Audit Quality
Twenty-eight audit quality factors were selected, including input factors (e.g., the quality and level of resourcing audits), process factors (i.e., factors that affect auditor judgments during audit such as methodologies and quality control procedures), output factors (i.e., observable outcomes of the audit and financial reporting process such as audit opinion and accounting quality), and context factors (e.g., incentives and pressures, including audit partner compensation, nonaudit fees, and auditor tenure). The factors were identified and selected from academic and practitioner literature. Respondents were asked to rate the importance of each factor ranging from 1 (not important) to 4 (very important). An average score per factor (with a maximum score of four) was calculated after excluding respondents who had no opinion.
The survey results, which provide a relative ranking of output versus input/process/context factors, affirm that investors give the most weight to outputs or outcomes of the financial reporting and audit process (e.g., restatements, information within auditor report, regulatory deficiencies) when assessing audit quality. These results concur with the assertion made in the academic literature that investors judge audit quality based on outcomes. This finding again underscores the importance and usefulness of the enhanced auditor report.
Audit Standard-Setter and Regulator Priorities: Safeguarding Auditor Independence Topmost Priority
The survey assessed the prioritization of 13 topics identified after consulting a selection of audit regulators, standard setters, and investment practitioners. Respondents were asked to assign priority to these topics on a scale of high, medium, or low. An average priority score per factor was calculated after assigning 1 to low priority, 2 to medium priority and 3 to high priority, and excluding respondents who had no opinion. The maximum score possible was three. Below are some of the headline inferences.
- Strengthening independence of audit process rated as topmost priorities. The topmost-rated priorities were standards for auditor independence (score of 2.88) and the need for a fully independent audit standard-setting process (score of 2.78). This finding underpins the importance and desirability of auditor independence. It also highlights the need to mitigate the effects of any institutional setting and audit business model features as well as audit process factors that undermine auditor independence.
- Developing ability to monitor audit quality is a high priority. Developing and monitoring audit quality indicators was one of the top-rated priorities (score 2.71), affirming the importance of a sustained focus on the development of actionable audit quality indicators.
- Support found for strengthening specific audit standards (accounting estimates, going concern, and subsidiary audits) and wider adoption of international audits standards (ISAs). The survey found support for the specific audit standards that it sought views on (i.e., accounting estimates, going concern, and subsidiary audits) as well as the wider adoption of ISAs, as shown by a majority of respondents considering these as being high priority (scores ranged from 2.5 to 2.68).
- Support found for expanding assurance, including for NGFMs and nonfinancial information. The survey found strong support for auditor consideration of noncompliance with laws and regulations (score of 2.78; rated as third across the 14 topics assessed). Many respondents considered developing assurance for NGFMs and nonfinancial statement information reported outside the primary financial statements to be either a high or medium priority. Assurance of NGFMs (score 2.46) had a slightly higher priority than assurance of other financial and nonfinancial information (score 2.39).
- Timeliness likely trumps need for assurance of preliminary announcements. The results on the need for some comfort or assurance on preliminary announcements show that it was the least priority topic (score of 2.21) across the 13 topics that this survey sought views on — 12% of respondents deemed it low priority and many more respondents considered it only medium priority (46%) rather than high priority (36%). It is likely that the desired timeliness of such information trumps the need for the related assurance.
In sum, the overarching messages from the survey responses are the importance of quality and insightful communication to investors, as such communication influences investor perceptions of the value and quality of audit; the need for measures to strengthen the independence of auditors; and the need to develop actionable audit quality indicators that enable effective monitoring of auditor effectiveness. The survey also demonstrates that reasonable support exists for the expanded scope of audit and assurance service, with stronger support for some areas (e.g., consideration of noncompliance with laws and regulations, NGFMs) than for others (e.g., auditor comfort on preliminary announcements).
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