COVID-19 prompts rapid conclusion to Australia’s audit inquiry

Author: Dr Jane Rennie, General Manager External Affairs, CPA Australia

Introduction

Rumblings of dissatisfaction with audits in Australia, fuelled by perceived conflicts of interest, poor audit inspection findings and exacerbated by an ‘audit expectations gap’, led to the establishment of the ‘Inquiry into the regulation of auditing in Australia’ in late 2019. 

Only months after announcing its Final Report would be delayed, the Parliamentary Joint Committee (PJC) has tabled a perfunctory 20-page Final Report weeks ahead of schedule, affirming the recommendations in its earlier Interim Report. It seems likely that more pressing considerations – such as responding to the economic havoc wrought by COVID-19 – have overtaken the PJC’s focus. 

While the proposed reforms are appropriate and achievable overall, they are likely to have a significant impact on entities and their auditors. The government must now consider the recommendations, although wholesale implementation seems likely. 

In many respects, this is a similar watershed moment for audit in Australia to the UK experience in recent years, albeit not arising from a series of high-profile corporate collapses. Given the overlapping issues, CPA Australia has been closely monitoring developments in the UK, particularly the response to the Brydon Review, to assist Australian auditors prepare for the forthcoming reforms.

Mandatory audit tendering 

The PJC recommended mandatory audit tendering every 10 years. At face value, this requirement could be onerous for entities and auditors. For entities which require an auditor with specialist or cross-industry knowledge or geographic reach, it can be challenging to find multiple bidders. Responding to a tender is also a costly exercise for auditors. However, the application of this requirement has been tempered.

The PJC recognised that there are both benefits and pitfalls associated with extended auditor tenure. Moreover, there is a lack of evidence to support the notion that audit firm rotation improves audit quality. Consequently, the PJC recommended that entities be required to ‘consider’ tendering and disclose their decision to shareholders on an ‘if not, why not’ basis. Although a tender may not result in auditor rotation, coupled with a recommendation for disclosure of audit tenures, a transparent process will have occurred.

This recommendation strikes a good balance between deterring a ‘set and forget’ attitude and threatening to break up well functioning audit relationships. The PJC has clearly sought to reduce the impact on the audit market by acknowledging that the exact period of time is less important than faithful consideration of the merits of auditor rotation.  

Expanded reporting

In Australia, as has been the case in the UK, there has been a marked misconception about the role of audits. This ‘audit expectation gap’ has extended to the auditor’s capacity for detecting fraud and non-compliance and preventing corporate collapse. Some of these misconceptions were aired during the PJC hearings.

The PJC sought to directly tackle the audit expectation gap in a number of important ways, which collectively have the capacity to make a meaningful change to the quality of and confidence in corporate reporting in Australia. 

Firstly, by recommending more transparent disclosure of firms’ individual audit inspection findings, which was commenced pre-emptively by the Australian Investments and Securities Commission (ASIC) and the largest six firms in 2019, and the results of ASIC’s audit inspection program. 

Secondly, the PJC recommended a review of the sufficiency and effectiveness of reporting requirements for the prevention and detection of fraud and management's assessment of going concern. This issue is currently subject to consultation by the International Auditing and Assurance Standards Board. The outcome of that consultation will be helpful in informing the Australian approach. 

The PJC also recommended the introduction of an internal controls reporting regime, comprising of a management report on the effectiveness of the entity’s internal controls framework, which is itself audited. Such a regime was recommended by CPA Australia to the PJC as an effective means of detecting and preventing fraud and error. 

Digital financial reporting

In other major jurisdictions, financial reporting has moved into the digital era. Australian companies have yet to go down this path, in large part due to the regulatory framework. In Australia, digital reporting is voluntary. ASIC has accepted lodgement of digital financial reports since 2010. However, to date no entities have taken up this option. 

Recognising that legislative intervention was necessary to deliver change, CPA Australia called for the introduction of mandatory digital reporting in its submission to the PJC and, pleasingly, the PJC adopted this recommendation. While this is a positive development, there is another obstacle to be overcome – cost. 

Cost is an issue for both entities reporting digitally and users seeking to access financial reports. Presently, there aren’t enough technology providers who offer XBRL-enabled software to prepare financial reports using the Australian Accounting Standards taxonomy. However, digitisation of business operations is being accelerated by COVID-19, which may precipitate greater accessibility and affordability. 

Conflicts of interest

The PJC discussed at length the adequacy of prohibitions in Australia regarding the provision of non-assurance services to audit clients. The Final Report makes several recommendations in this regard, including establishing a list of non-audit services that audit firms are explicitly prohibited from providing to an audited entity, as well as defined categories and associated fee disclosure requirements in relation to audit and non-audit services. 

In its submission and in evidence, CPA Australia called for clearly defined categories of fees for audit, audit-related and non-audit services in financial reports, which reflect the prohibitions on non-audit services. CPA Australia also called for greater clarity around services which fall into each of these categories, so that auditors and their clients can be confident that they are meeting expectations.

Although the Code of Ethics for Professional Accountants already explicitly prohibits a key audit partner from being evaluated or compensated for their success in selling non-assurance services, the PJC recommended the Code be revised to include further safeguards to prevent incentives for selling non-audit services.  

As with a number of other recommendations, the PJC sought to increase transparency, in this case by recommending that the auditor’s independence declaration specifically confirm that no prohibited non-audit services have been provided. 

Insolvency reform

A chapter in the Final Report on insolvency reform seems anomalous at first and, taken out of context, has a tenuous connection to audit regulation. But the Australian Government is presently undertaking the largest program of insolvency reform the nation has seen in decades – a trend also observed in other countries. This has been triggered by a predicted wave of corporate insolvencies when temporary government supports are phased out in the new year. 

Giving due regard to the economic importance of an effective insolvency system, the PJC acknowledged concerns that asset valuations will have been eroded and that this will affect going concern and solvency assessments. Related aspects of managements’ assessments of supply chain and cash flow uncertainty are also highlighted as matters demanding sceptical rigor from auditors.     

In the Final Report, the PJC has flagged a review of the impairment standard, a topic more commonly considered in the treatment of business combinations and goodwill disclosures and, more recently, in the context of existential threats such as climate change. Its inclusion here reinforces the sense that the PJC has turned its focus to more pressing concerns involving economic repair.

Implementation

Now that the Final Report has been tabled, the Australian Government must consider which recommendations to implement. It is likely that the recommendations will be adopted in large part. Therefore, the timing of the reforms and their application to different sizes and types of entity are the key considerations and must be considered in light of COVID-19 and Australia’s economic situation. 

Australia is currently experiencing its worst economic outlook decades. Following the release of the nation’s April to June economic data, the Reserve Bank of Australia declared the economy was in recession. By the following quarter, Australia was technically out of recession, however, it remains vitally important that the reform process not distract businesses or the audit profession from the task of economic recovery – a consideration which was acknowledged by the PJC.

This means that new or revised regulations may need to be staged and restricted to public interest entities, at least initially, to ensure they do not impose an unnecessary burden. Continuing to monitor the UK’s progress implementing the Brydon reforms will enable Australia to evaluate and moderate any potential pain points for implementation.

Conclusion 

With over 166,000 members world-wide, CPA Australia is the largest professional accounting association in Australia and actively participated in the ‘Inquiry into the regulation of auditing in Australia’. Many of CPA Australia’s concerns were reiterated in the public hearings and the most critical have been incorporated into the Final Report. 

Overall, CPA Australia considers the Final Report to be appropriate and balanced and will generate a welcome increase in confidence in the quality of auditing in Australia. CPA Australia will now consult with the government on the final form of the reforms and assist Australian auditors to prepare for the forthcoming changes.