How to improve audit quality

Intro:
Hello, and welcome to the CPA Australia podcast, your weekly source for accounting education and career and leadership discussion.

Claire Grayston:
Welcome to this podcast on the Australian Securities and Investment Commission's audit inspection report, for the year ended 30 June, 2020. And, their report on audit quality measures. I'm Claire Grayston CPA Australia's policy advisor on audit and assurance. And, with me is Doug Nevin, chief accountant at ASIC. To discuss, what audit firms can learn from the 2020 audit inspection findings. The work ethics doing to address the parliamentary joint committee inquiries recommendations, and the audit quality measures, which ethic has reported on. Welcome, Doug.

Doug Niven:
Thank you Claire.

Claire Grayston:
So first of all, perhaps we can discuss the challenges that we've been facing this year. I note that, of course it's been an incredibly challenging period through the COVID-19 pandemic for reporters and auditors. ASIC have acknowledged this in your inspection report, saying that auditors will have had a more challenging time under COVID-19 conditions. Not just due to the need to work remotely, but also due to the increased difficult judgments that they've had to face. Perhaps you can share some of the key areas which auditors should focus on, as the pandemic continues. And, which you expect them to have been focusing on for 30 June year ends.

Doug Niven:
Definitely Claire. And, thank you for the question. So, we have put out both the new [inaudible 00:01:53] report. But also in the frequently asked questions on our website, some information for auditors, as well as directors and [inaudible 00:01:58] around COVID-19 conditions, and the challenges associated with that. You're quite right. The big challenges have been remote work arrangements. Hopefully a lot of that is going away in many locations. But, they certainly have been challenges at 30 June, around that. And, also very important, but the difficult judgments that need to be made. And, a lot of this goes back to the uncertainties. There's various factors at play here, might list them all. But, what's happening with travel arrangements? When will government support cutout and other forms of support in terms of lending, rental arrangements, when we have a vaccine, what does it mean for your supply chains, your customers.

So, there's a whole lot of things that potentially need to be thought about by companies, and also therefore auditor's that underlie what's happening with the numbers in the financial reports. And so, it's not surprising that we've had a focus on asset values, and I should say by the way, there have been companies that are negatively affected because of COVID-19 conditions. There are some that are less effected and some that are of course positively effected as well. But, asset values is a clear area of focus, provisions are for obvious reasons. But, also a subsequent event disclosures, solvency assessments are going concern can be quite important for particular entities.

And, given the uncertainties, one of the things we're emphasising is the importance of the judgments around disclosure of information. From the audit point of view, particularly in the financial report, around key assumptions, underlying things like asset valuations, where are the areas of uncertainties, making sure that there's good disclosure so that investors and other users of financial reports can understand those things.

So, it's not just about the numbers, it's about disclosures. A little bit less so in a sense for auditors, but auditors do read other parts of the annual report. And, also at a half year report such as the directors report, the operating financial overview of operations. And, there are important disclosures there, around risks, strategies, future prospects and so forth. Now, what is [inaudible 00:04:34] at those for material misstatements, inconsistencies. But nevertheless, that's an important area to focus on as well. And, we do recognise it is difficult, because there are certainly those uncertainties we've mentioned before. But, that's why people need to think more broadly now. The good news is that many companies appear as directors, and also their auditors planned and invest the time and you feed your financial ports with a good disclosure, which do tell a story and, where they've also looked at the asset values where appropriate and so forth.

It's probably going to be the case that we'll find some instances where perhaps it could have been done better. We're already making inquiries of companies under course. We're about to start the reviews of audit files under COVID-19 conditions as well. But, certainly pleasing in terms of the preparedness of a firms, large mid tier around COVID-19 thinking about remote stock counts, how they can be conducted, impacts on overseas operations, what it means for audit reports is very important as well. And, not just going for [inaudible 00:05:56] disclosures, whether it's cams or even emphasis of matter paragraphs, thinking about what's specific to the entity and information is useful for the users of the financial report.

And, I shouldn't ignore the half year report. We emphasise disclosure is really important that [inaudible 00:06:22] and half year report because they were often the first reports under COVID-19. It is going to be important to think about half the reports of December, because there can be movements effects during the six month period that it's going to be important to focus on again. So, in a sense, a pattern of back for the good things are being done but, we can't take the foot off the pedal. There are those difficult judgements you've mentioned, and it will continue to be important that firms, invest the time, the resources into this. We did give an additional months time and it's now through to year end steady one December effect the 7th of January.

But, having said that, [inaudible 00:07:09] and market forces and so forth. They will want to adhere to their normal reporting timetables. And, I have to say, we want quality financial information [inaudible 00:07:20] quality the auditors. But also, the timeliness of information to market continues to be important as well. But we also do recognise that there may be an element of fatigue as well. And, that's something that auditors prepares need to focus on as well. I could probably talk for an hour on this Claire, but I think I should perhaps stop there.

Claire Grayston:
Yeah Doug, thank you for that. And, in the inspection report, you do list the focus areas that the firms should be looking at under these conditions. But, also I do note the links are in the show notes to the extensive frequently asked questions that I think really... Looking more broadly now at your audit inspection report which is also linked in the show notes. I see that your findings overall are that 27% of all the areas inspected had adverse findings. Are you concerned that this is showing an upward trend, in the last three inspection periods?

Doug Niven:
Well, to answer your question, it's more about the absolute level of the findings. There can be a slight upwards and downwards movement in the figures, percentage [inaudible 00:08:45] here or there overall. But, it's actually, the level of findings it's of most concerned that, put another way that they're not going down. And so, [inaudible 00:08:58] been good initiatives by firms around, particularly larger firms or action plans and so forth. It's clear that more does continue to need to be done to improve audit quality, to think about new initiatives that can be put in place to improve the results. And, it's possible to do somethings that, short-term measures addressing individual areas of our findings. It's also important to think about more sustainable measures and improving audit quality and focusing on that is something that is continuous, not as though, there'll be a point where we say we're there now we can just not worry about it.

I think we all know that. But, it's certainly about thinking about things like a culture within the firm, around audit quality, that's genuinely supported the right messages, certainly from leadership at right throughout the organisation that everyone embraces the importance of audit quality. It's about having the right experience and expertise. And, recognising that we've got more complex auditors, more complex judgments, not just because of COVID-19, but even pre-COVID-19. More complex standards and evaluation issues and everything else. And, that does require greater expertise. And so, that's always going to be something to think about in terms of making sure individual audits are properly resourced, but it's also a question about having the right resources across the firm to be able to resource things and deal with deadline pressures and workloads and so forth.

Of course, supervision and review is a key element in all this whether it's on the job, part of the engagement Colleen control reviewer has an important role as well. But also post-completion reviews are important part of that as well because there is a lot with our findings and other matters feed into the firm's analysis of root causes from those trainings you mentioned earlier and how they can be best addressed in the particular circumstances affirming the circumstances that were being faced. And, of course the last one we've been highlighting is around accountability and accountability for what a quality. And, so sure that it was right balance of in a sense incentives but also a better accountability does help people focus on the right things as well the right performance measures and everything else.

But, certainly in a came out before COVID-19, but also COVID-19 as I say experience and expertise is so important particularly with difficult judgments. And that does mean more investment by partners. Of course senior managers play an important role as well. And since we probably all prefer COVID-19 didn't occur. The experience around the 30 June reporting has also to some extent help give people some auditor experience around some of these difficult issues which will be of assistance going forward. But, the bottom line is that there's still more to be done.

And, I think everyone recognises that. Certainly there's already been a lot of good work done to focus on improving audit quality. But, these results while I should emphasise as we always say, not necessarily statistically valid in the sense that risk-based selections more number of files, relatively speaking, nevertheless the findings are there. They're important to address because it all about instances where in our view, the auditor in a particular keyword area didn't obtain the required reasonable assurance that the financial port was free of material misstatement.

Now we know that doesn't necessarily mean a financial report was actually materially misstated but that in auditor to it didn't have sufficient basis for their opinion. And that's an important element as well. And everyone in a boarding chain needs to play their part in financial reporting quality and also supporting audit quality because the auditor has the primary responsibility for the audit component audit quality.

Claire Grayston:
Yeah. Thank you, Doug. Now, obviously it's going to be the inspections of audits that you'll be doing now and into the future will be impacted by COVID-19. So it's going to be challenging obviously to get those findings to improve because of the additional challenges. So, certainly as you say, firms are going to be needing to take extra care and attention and probably additional partner time on audits in auditor to ensure that level of quality is maximised. So, Where did you find it in your inspections the greatest number of adverse findings?

Doug Niven:
So, it continues to be the case that the greatest number of findings are in the areas of asset values in payment, nonfinancial assets, and also around revenue recognition receivables. Now it's certainly true that we look at in terms of the split of key audit areas there is a bias towards those areas and that goes back to our risk-based targeting, but we still have significant percentage of findings on those key audit areas and clearly more needs to be done to address those areas.

The findings do go back to professional scepticism in a sense in terms of what both areas pervades the whole audit. But a lot of it is around and I won't go through all the details. You can read it in our report of course. But, the reason was of assumptions, reason was of cashflow is challenging that particularly where a company hasn't met their forecast in the past. Are you comparing apples with apples in terms of the cash flows and the carrying amount? There's even new issues around making sure that the new lease accounting standard is taken into account with lesser use having right of use assets on balance sheet and of course, different figures for their earnings. And, of course going over effect on the discount rate in a discounted cashflow analysis. So, and revenue recognition is partly the accounting policies, but it's also the quality of the work that's actually being done in this area.

And, of course around the receivables as well. There certainly are a range of other areas that we've listed in the report, but those are two that have featured for a number of years. And of course, as I mentioned before, the asset values is a particular focus with COVID-19. We didn't specifically highlight revenue as an area. It was more around provisions and the like. But, obviously it's something that's still does require attention on an ongoing basis irrespective of COVID-19 conditions. So, they'd probably the ones that probably need most highlighting.

Claire Grayston:
Doug. So, those are also the areas where as I understand lets us see the greatest risks. So, also your work is focusing attention on those areas of impairment and revenue. So you're looking at those areas in the audit far more frequently. So, Do you think that is also... Because of that focus it's increasing your levels of findings?

Doug Niven:
Well, that's an interesting question, isn't it? Because, if you thinking the level of findings in terms of area in percentage, in some respects the course... And, this is actually why we put our focus here as well. We're about improving and maintaining audit quality. It's not about actually finding problems with the audit. So, if audit is no what we're looking at, and it's also why we put out this report around the findings to inform, the auditors inspected and others. About our findings, that can be addressed before we actually look at the audit files. So, in a sense because we're focusing on the area, you would hope that over time, the level of findings would actually go down. Now, do recognise that there are some difficult judgments in these areas.

But having said that, our findings don't include areas where we would form the view that two, professionals could reasonably come to different conclusions. If that's the case, that's not a finding. It's cases where we believe that the audit work was deficient, [inaudible 00:18:18] treatment was not appropriate or, in terms of the estimates and assumptions and so forth that they're not reasonable for various reasons, benchmarking and past performance and all of those sorts of things.

So, which goes back in all of those years of judgement and scepticism as well. So, in terms of answering your question, the fact that we're focusing in itself shouldn't cause more findings if a sustainable initiatives are put in place to improve audit quality. Because in a sense, if we didn't look at those and looked at other areas, yes maybe they're in a sense lower risk area. So, are we adding as much value through the inspection process? But, because are areas perhaps we might be looking at more of, for the first time there's always a potential that you get a high level of findings initially in those areas as well. So, I hope that helps in terms of answering that question Claire.

Claire Grayston:
Yeah. Thanks Doug. And, of course it's a small sample in comparison to all the audits that are done in Australia. But, an a risk by sample as you rightly point out. So, did look at a whole range of other areas in your inspections. Do you want to highlight any of those? The key findings from any of those other areas that you looked at?

Doug Niven:
Well, yes. So, perhaps it mentioned them, I won't go into enormous amount of detail but, as you said, we don't just look at those two key areas. We do look at other areas as well. And so, we did have findings around investments and financial instruments. Some of that was around evaluation questions and, the adequacy of the audit work in that area. It did include looking at values, not just of financial instruments, but also investment properties and equity accounted investments and the like. And, I'll just go through a few of them imageries and cost of sales. Again, some of that surround evaluation, expenses and payables sense, a little bit of a flip side of the revenue question. But, particularly our expenses being deferred that, perhaps should be carried on the balance sheet.

But, it's also going down to the actual testing this performed in that area and taxation. Because that involves a level of expertise as well. And, you can have gaps between what the auditors and their experts are doing as well. So, you need to make sure they're covered. I probably should mention provisions given. That's a focus here particularly with COVID-19 conditions. So, I just mentioned those few, but it's probably worthwhile having a look at the report for more detail. Or some of the factors that attributed [inaudible 00:21:28].

Claire Grayston:
Absolutely Doug. And, I just mentioned that from the findings, some on those areas that the investment and financial instruments does seem particularly high in respect to the areas that you actually looked at.

Doug Niven:
That's true. The proportion of findings compared to the key auditors we'd looked at. And, it probably some extent goes back to your point about every base selections as well.

Claire Grayston:
Yeah. Right. So, do you think these findings, although they relate to the largest six firms and the largest of audits in Australia, do you think that there's relevance for the smaller medium firms?

Doug Niven:
Yes. Most definitely. So, we put out these reports partly for, firms who were inspected. But, also the ones that aren't. And, auditors can learn from what we observe at other firms. And even, for the firms that are inspected, they may learn something from the findings that relate to other firms. The findings are focused at, to some extent the larger end of list of market public interest entities. And, we do certainly select more files therefore, at the larger firms. But we do also inspect files across the range of auditors of particularly listed entities. And so, while largest number of files do actually relate to those larger firms, we will touch on some of small firms as well. And so, you'll find in the report that we do actually, are at the level of findings. For instance, different tiers or sizes of audit firms.

And so, to some extent I can like the report speak for itself but, it's a small population of course are firms that we expected [inaudible 00:23:33] so therefore, you can have to some degree, a little bit more volatility in your percentages. But, the percentages still showing that there's a need for improvement across the whole market. And just to emphasise, we're about improving audit quality. It's not about since[inaudible 00:23:55] pushing people out of the market. Certainly will be some cases where we see very bad auditors, and we're thinking about enforcement action and so forth.

But, the whole process is about, better informing auditors. And, working cooperatively to improve audit quality, which is a new interest of everyone in the ecosystem, but obviously the users of the financial reports in the end as well.

Claire Grayston:
Okay. So, you also did some thematic reviews on conflicts of interest, governance, accountability, and root cause analysis. So, do you think you could highlight some of the best practises which you found, or which you're recommending for firms, perhaps particularly that might be relevant to the firms that weren't inspected, which they could benefit from?

Doug Niven:
That's right. So, there were those three years where we did a review. So firstly, the conflicts of interests which is around of course auditor independence. It does include some focus on the nonaudit services. And, I should say we looked at this at the larger firms, but following on from the previous point of course it can be relevant in looking at other firms and part of it the honest one findings was firms are often good at applying specific requirements of say the legislation or [inaudible 00:25:23] ethics code. But, it's also important to focus on these are the principles that underlie all this because for example, [inaudible 00:25:35] can't envisage every possible scenario that could arise in practise. And so, what we've found is that there does need to be improved focus on... We may have kicked the box as to whether we've met those specific rules, but have we nevertheless still got an independence issue that needs to be addressed.

Having regard to the underlying principle of independence and that exists in both the legislation and of course in [inaudible 00:26:08] and that does tie into also in some cases need for partners to make better assessments of whether the provision of non-audit services could compromise independence including by the way thinking about the total level of services that are provided.

Not just each service one by one, but also opportunities for perhaps more quality control reviews around some of these evaluations by the firm as well. So, that's briefly around the conflicts of interest from governance. We did have some better practise recommendations there as well. And, some of this is around how you can better achieve all the quality through the governance process. And so, they are just recommendations but one thought is around having an independent person on governing boards who can challenge matters and bring a different perspective to matters that may be having an advisory body around audit quality as well. Just to bring that different bins to matters. And as I say, challenging. It also can be important that whether it's partners, but also staff having the ability to escalate concerns around audit quality in a way.

But, they don't feel threatened as seen as constructive that an independent group can also look at these matters and that's all about improving audit quality and so firms need to perhaps think about some of those where they haven't already by the way. So, and also to some extent where the governing bodies within the firm have sufficient focus on audit quality and the agendas. We know that they've got various things to deal with but that's an element as well. On the accountability side we did look at that as well, as about whether there's sufficient, we clear goals for audit quality how it feeds into remuneration, how much transparency there is around the impacts. Even we often think about the engagement partner and their accountability for quality, but it applies to others for example from specialists who are involved in parts of the audit, the engagement quality control reviewer as well.

So. again, it's worthwhile looking at the report because there's more in there. perhaps just mentioned one other which was the review around the recourse analysis we touched on before. So you've got internal, external findings analysing those what were the causes, the real underlying root causes of the causes and then putting in place action plans to address that. One thing we did find was that, what we said to the firms, it's important also to think about not just from our reviews internally and externally, but also think about where there has been a change to a financial Porter restatement pass because of inquiries from acid to conduct recalls analysis there. And so, what's happened and whether is something that needs to be addressed in terms of the audit process or something else that as a result of those findings.

Claire Grayston:
Yeah. And so, a number of those areas have come up in the PJC inquiry say that was a lot of focus on conflicts of interest. And, I note that some of the firms have put in new governance processes that you were referring to. So, that's very good to see. We did do some work on root cause analysis and issued a guide, which is linked in the show notes, which might be helpful for firms to revisit if they don't have a strong root cause analysis process in place. And, before we go on to talk about the PJC inquiry that I just mentioned perhaps you could just touch on the new initiatives that are six planning to pursue in 2021 in your thematic reviews.

Doug Niven:
So, in terms of new initiatives of the law firstly those reviews, intention is to review culture focused on audit quality at the largest firms. We did defer some of this work by the way because of the COVID-19 conditions and made for firms to focus on the audit work and cleanup preparation and lead up to 30 June. So, that's an important area. It does go back to what we were talking about before about tone at the top but also how it's embraced throughout the whole organisation. And then, also talent is an area given as we said before the need for appropriate experience and expertise, complex judgments and so forth had you recruit train, retain all of those sorts of issues around the talent side and other opportunities for improvements in those areas as well at the firms.

So, this sort of the thematic reviews in addition to that we as a regulator have a range of tools that we employ around quality financial reporting and of course quality audit therefore. And so, we'd been thinking about what do we do differently as well? And, just briefly you mentioned obviously a focus around enforcement in the audit space, the why not litigate approach which doesn't mean litigate always by the way. It just means have a look at matters and think actively about whether enforcement action should be taken. And so, that's one thing the transparency around inspection findings because arguably greater transparency is an incentive getting better results of course.

And, I guess one other way we'll talk to consultant on is, all firms do report our findings to audit committees and directors particularly given some feedback from audit committee chairs as well. Whether we should be actually routinely reporting our inspection findings to audit committees as well. Which ties in with Wildwood has had responsibility for what quality directors and audit committees also have an interest in terms of quality of the audit confidence in their financial reports in the market independent audit. And so, reporting the findings gives an opportunity for the directors to check in with the auditor's how are you addressing these matters and so forth.

Claire Grayston:
And so, Doug, you consult on that if you decided to go ahead with that proposal.

Doug Niven:
Yeah. So it wouldn't be public consultation before we decide whether we're going to go ahead. Yeah.

Claire Grayston:
So now, the parliamentary joint committee that I mentioned earlier I have reported on the 11th of November releasing their final report and it really confirmed it's interim report recommendations. Now those include a number of matters for ACIC to address. So, I just was interested to hear what action asset has already taken with respect to those matters and maybe which it's waiting for perhaps the government's response?

Doug Niven:
Yeah. So, there are 10 recommendations and obviously we've got an interest in all 10 recommendations. The final report appears to continue those 10 recommendations from neutral report was put out in February and a number of those they were specifically the age of Jurassic or ESIC had it was identified as having a greater interest in a couple of those did relate to the inspection reporting. So it certainly was a recommendation in February around greater transparency around the inspection results. And the final report recognises that actually the largest six firms are putting out our inspection reports. They've done that for the 30 June 18 and 19 report. So in a sense that transparency is there that does include information on anonymous basis on individual findings. So in a sense it's a positive that's happened.

When we put out our phone reports just recently we did also publish the June, 2020 reports on our website as well as the firms publishing those. The other thing that was mentioned was around are there other ways to report the inspection findings. So, we have findings that aren't in the area of the Sage measure. It's not about those. It's the ones that are in a percentage of measure where in our view[inaudible 00:35:58] Temporaries were friends of the financial board is free of material statement. Now I think everyone acknowledges it. All of those findings are important and there it's important that all of them are addressed, but in terms of communication, are there other ways to categorise them. For example, as some more severe than others that's not to say that we don't already have a lot of information that points to how important or how serious particular findings are.

Partly that's through the transparency needed visual film reports that I talked about before. Around the findings and obviously information around the findings in the aggregate report. But, it's also things like, number of inches of where the financial was actually materially misstated and so forth. But, we can probably talk further about severity if you have any further questions on that. And then, they certainly was an interim report recommendation around non-audit services. And, it was partly allocated to the financial point council and partly to ask about disclosure of fees. Jordan was around non-audit services and even questions about what non-audit services should be provided. I think the final report probably gives greater emphasis to the FRC role in that part, but as you're aware in a document we put out on the audit quality measures we've already with the cooperation of firms got better information around the split of the audit fees.

Claire Grayston:
And yes, we can turn to that audit quality measures report. Now, I just mentioned that in your report last year, which was the first audit quality measures report. I think noted that it was at the forefront of developments internationally in this space by publishing such measures and indicators and that neither IOSCO nor PCOB for example had done. So I'm just wondering whether that's moved in the last year. Have any other regulators followed suit in publishing this kind of information?

Doug Niven:
Generally speaking, there hasn't been a great deal of movement. I'm certainly aware of one or two other regulators who have put out measures. But, it's not as though it's greatly widespread practise as well. I think it's probably something will develop over time. There's clearly an interest in this area. It's partly about giving a broader picture of other indicators around all the quality. We'd always say, the best indicator is... Are inspection findings, subject to what we were saying before about being risk-based and so forth. But these other things can be useful to... I just created discussion around elements of things that can help to improve audit quality. There's no in the end right answer as to what the measures are and of course, I should emphasise it even though we've published some audit quality measures, indicators and other information.

What's actually relevant for a firm to measure will depend upon his specific circumstances. So, we talked about root cause analysis before leading into actions. And, obviously to be accountability for putting those actions in place. But, one of the things you might do is in a particular area, have an indicator or measure that helps you track how you're progressing in a particular area. And so, that's why we're careful to say we're not specifying indicators that necessarily firms should using transparency reports or internally. It doesn't need to be focused on what's important in terms of their initiatives to improve or the quality.

Claire Grayston:
And so, in this year's report on audit quality measures, you seem to have refined a couple of those measures. So could you explain why you did that?

Doug Niven:
Okay. So, it was really because when we put out the first report last year, not all of the information we would have liked to have put out was available. Now, we always said, we'd perhaps change the measures over time with feedback so discussions go on. But, the measures that we've put in this year were actually ones which we would've liked to put in last year, but the information just simply wasn't available. And so, we work with the largest firms who assisted in collecting the information or encouraging the audited entities to disclose information. So, the first measure that we've put in for the first time this year is one around the instances where auditors have cause material changes to financial ports before they're issued. Associated with that is a measure around matters reported to audit committees about nontrivial misstatements which may be corrected or not corrected.

Now both of those are indicators that an audit is in a sense doing their job. What the right figure is obviously hard to tell but it certainly is showing that if I talk about the first one particularly we probably should figure out across the largest 300 companies by market capitalization. Leo's exit are auditored by the six largest firms and their networks that there were 78 material changes now obviously it can be challenging sometimes to figure out who is responsible for a change. So, this discussion about a contract early in year and whatever who caused the change and who didn't. But, there are other cases where it will be very clear as great that the firms have captured that information afforded it choice. We obviously didn't validate it but I think it's still an important indicator to put out into market. The other category...

Claire Grayston:
Could I Just ask about that 78 adjustments? Some of those could be adjustments to the same company. There wouldn't necessarily be set 78 separate companies that had adjustments?

Doug Niven:
Yeah. So, that's absolutely right. We don't have the sketch on that but it could be that there are more than one adjustment on a particular company. So it's not the case that it's 78 companies. And, just to emphasise these are all matters were addressed before the financial report was issued.

Claire Grayston:
Yes. Right. So, it's an indication of the level of impact that the audit has... The auditor has before the financials are released.

Doug Niven:
That's right.

Claire Grayston:
Yeah. So, perhaps if we could talk about the fees for services non-audit services provided to the ASX 300 entities because you have that new measure in place on those fees where you broke... Broken it down into greater detail than in the past. So, perhaps you can explain is that to feed into the PJCs request for greater clarity or transparency around non-insurance services?

Doug Niven:
Yeah. it's in some respects it tied in with the PJC and the recommendation. But again, it was when we were thinking about the report last year, we actually thought about what information needed to be collected to put in measures. So, that discussion actually took place before the hearing was actually called and firms were good enough to encourage the audit entities to collect and categorise the fee information in financial reports that we could then extract it for this particular measure. So, there are four categories and by the way, it's not to say that there wasn't information this in the director's report and the Nossa financials, but more clearly disclose and categorise. So, obviously you got the fees for the audit services but then in addition three categories just to give a better perspective on the nature of the services.

The first one is where there's a requirement for the audited for a particular assurance services might be you're under legislation or subordinate legislation. The third category is assurance services that it's not actually quite that the audit performance but it happens nevertheless. And, the fourth category is pretty much all the other services. It can be, you have a taxation relation related services whatever. And, the reason for doing it that way was in a sense to say the second category is a category which hhe auditor had supervised and it's probably something that's fairly closely aligned to the role as being an auditor. Just some extent, it's a bit of the third category as well. And so, it's really just trying to separate out those categories so that if there's any focus it's probably more that last that fourth category.

And so, I guess in relation to that as well, it's important to highlight that there's no magical formula on the non-audit services. It's not just about size in total. It's also about the nature of the model. So, you can't just say it's below a certain percentage or whatever that therefore it's okay. It may not be. So, it's just trying to get a bit better perspective on what's actually happening.

Claire Grayston:
So, it's that fourth category Doug, that there could be threats to independence in that category of non-insurance services. And, I do see that that has fallen. Although you said one shouldn't focus just on the pure volume of those fees, but it has fallen in 2020. So I don't know if firms are getting more wary about taking on that kind of work.

Doug Niven:
It can be how to do the comparison on that measure because we didn't have the same information last year. And so, it wasn't clear.

Claire Grayston:
Sorry Doug, the categories could have been slightly different because there were different three categories instead of four last category may not be the same.

Doug Niven:
Yeah.

Claire Grayston:
So look, just to touch quickly on a couple of other things that came up in your audit quality measures the key audit areas with adverse findings, I see that 45% of files that would be company audits had no adverse findings which would indicate that 55% of companies did have an adverse finding at least one anyway. Now that does sound like a high number. However, I do see that that has actually come down from 2019. So, I don't know if you want to comment on how that figure or that start compares to other jurisdictions.

Doug Niven:
Yeah. And, we do measure the findings on different basis which we think is a better measure of what a quality would choose to measure it on key what it is within a foul rather than a foul but you ride internationally a common measure is on audit files. And, there are differences between jurisdictions in nature. The findings are the same but it can be a difference in levels to some extent. And in some cases findings going up, some cases are same and some cases they may be going down as well. But it's what ways. An interesting question in making these sorts of comparisons course of potential differences in the risk space selection approach. And so, for so in the population that you're looking at some regulators have larger numbers of house.

I look at some who published percentages have a smaller Facebook ads as well. So just need to caution a little bit about the compare ability as a result of that. The other thing that can happen is and we saw this a few years ago in one country, the inspection findings were going down and we're trying to figure out why that was, until they decided to change their inspection approach. And, it actually turns out that they were reviewing the same audit files every year at the very largest end of the market. And, you might think that would work because if you had findings on say impairment, a firm would say or might just suggest reset on the largest files, I would dress that on all of my auditors but what happened was when they looked at the next chair down in size and audits their inspection findings went through the roof.

And so, that's why I say it can be about how they are actually conducted as well. But we certainly do a lot of work to benchmark against other regulators understand how they approach it and make sure we're consistent three case studies having regulators review, anonymized findings there's whole range of things we do in those areas. And so, it's not coming out of differences so much in what matters are identified although we do to be honest he was reading some things from EFA and other regulators don't exclude from their percentage is but it can be other things such as misplace selections. And, do you repeat the same fall reviews.

Claire Grayston:
Now I noticed that your audit inspection findings triggered 3% of financial reports that you inspected to be adjusted subsequent to the audit. Now, I think you've indicated that this is a one way that could be indicative of the severity of your inspection findings. The most severe findings would trigger an adjustment. Do you think that's the best severity rating or do you think as it could look at the individual files and actually rate them in some way on severity with respect to the findings?

Doug Niven:
So, severity is a really difficult subject and how you do it where working hard at figuring out ways to measure severity and [inaudible 00:51:38] whole range of indicators around severity in our report. Even just disclosing the nature of the individual findings with that background it's probably also useful to illustrate the difficulty by saying that internationally, other regulators have said measuring severity is off the table. And, part of that is because all findings are important and need to be addressed. And, probably also recognising some of the challenges in trying to sub classify the findings. Having said that, you're right near the quality measures and indicators document. We have been publishing a graph which shows what percentage of falls would we look at. Second would be we found that the financial report was actually materially misstated.

Now, you'll see that the numbers have actually gone down quite significantly in recent years. And, that's because we changed our approach. So, if we've already found a material misstatement and a financial report, we don't look at that area in our inspections on the basis that will... The firms should be conducting root cause analysis and addressing the findings themselves. So, that's actually why that percentage has gone down. To be honest, you may well see the percentage go up again. And, the reason for that is in part because the firms weren't actually conducting that root cause analysis we[inaudible 00:53:23] we won't exclude those cases from inspections going forward. So, it could be that we've identified through our financial brief surveillance. Your company's address it a material change to the financial report and then we go and look at what the auditor did and that will then perhaps again feed into their percentage.

So, we always need to be careful about what is behind those easy to measure severity. That's a really difficult question. In some respects you might say it is because it's clear in this case, there was a material misstatement. The problem is and this will never be the case but let's say hypothetically, you had two identical audited entities and two auditors. And, there was some deficiency in the audit work on both of those works, the same deficiency in one case extra there's nothing wrong with the financial report. And, the other case there was a material misstatement in that area. Does that mean that the finding about the audit work was more severe in the second case than the first case when in fact the audit work Was equally deficient in that particular area?

So yeah, just a note of caution around it. Certainly wears a material misstatement. It's easier to evidence and we'd also the caveat about corporate collapses. Just because a company collapses doesn't mean there was something wrong with the financial report or the audit and it could be cases where something wrong with the financial report theoretically where the audit is okay. But, given that auditors are looking for reasonable assurance financial what's not as feeling misstated obviously that needs to be borne in mind as well. But, it's an interesting question around that measure. Sorry It's been so long. Explain that.

Claire Grayston:
Thanks you so much Doug, so look to wrap it up, Do you have any concluding comments for auditors?

Doug Niven:
Yes. So, really just to highlight some of the things we've already covered clearly the inspection results and some of the other activities we undertake such as financial pointing surveillance. where we do find a level of material misstatements in financial reports. And so, some our enforcement activities as well clearly while good work has been done focusing on audit quality. I think we all recognise that more needs to be done to improve the quality. That's not to say that people shouldn't have confidence overall in financial pointing process and information in our markets. But, certainly there is more work to be done. I think it's recognised we everyone to improve audit quality and it's something that we need to continue to be worked on.

Having said that, we've also now got the COVID-19 conditions. And so, in a sense, COVID-19 just even more emphasises the importance of focusing on some of those different areas for auditors judgments, the amount of time that perhaps needs to be devoted to the difficult areas around asset values, provisions, solvency going concern and disclosures. And so it's great. The investment that's been put in but we're not quite through at COVID-19 conditions. And so, it will continue to be important that auditors as well as the course directors and preparers continue to focus on those areas.

Claire Grayston:
Thank you so much, Doug. And, thank you for speaking to us on a six work in publishing audit quality measures, responding to the PJC inquiry and most important is sharing insights from your audit inspection programme. Thank you very much.

Doug Niven:
Thank you. Claire.

Claire Grayston:
So to read more about the audit quality measures and the audit inspection findings, please look at the links in the show notes.

Outro:
Thanks for listening to the CPA Australia podcast. For more information on today's episode, please visit the show notes at www.cpaaustralia.com.au forward/podcast. Never miss an episode by subscribing to our podcast on Apple podcasts, Spotify, or Stitcher.