In mid-December, Sir Donald Brydon, estimable London banker and recently retired head of the London Stock Exchange, released a 135-page report, the culmination of his Independent Review Into the Quality and Effectiveness of Audit.
Tasked by the British cabinet secretary for business, his broad-ranging and insightful analysis and recommendations emerge into a UK environment of deep hostility aimed at the accounting profession. Calls for change, animated by a spate of scandals bracketed by the collapse of public contracting giant Carillion in January 2018 and travel icon Thomas Cook in September 2019, range from dissatisfaction with the Financial Reporting Council as the country’s audit regulator to proposals for the break-up or forced reduction in the dominant large-company audit market share of the Big Four.[1]
Having no official authority of its own, the report’s prospects and impact will rest on the limited supply of political and regulatory energy to be devoted by Boris Johnson’s otherwise pre-occupied post-Brexit government.
So far, ahead of a predictable breaking wave of hostile resistance, public reaction to the substance of Sir Donald’s reasoning and advocacy has been a mild ripple of interest. There will be topics to be addressed -- most notably, his proposed new designation and certification of “corporate auditors,” and others including:
- What the report resists – e.g., mandatory joint auditors for large public companies.
- What it avoids – e.g., the financial and structural fragility and instability of the large firms.
- What it would like evolved – e.g., the current unsatisfactory form of the standard auditors’ report.
Here today, a look at the last of those, and the recommendation that the basic binary auditors’ opinion – “pass/fail,” in lay terms – be retained (¶ 2.3.7) -- although replacing the traditional British formulation that company financial statements provide a “true and fair view” with language from the global standards, that they are “presented fairly in all material respects” (¶ 2.3.2).
Herewith a dissent on the retention of “pass/fail”: As I have written elsewhere, the short-form report is an outmoded product that nobody values, at a cost that nobody wants to pay -- archaic, obsolete, unresponsive to user needs, and a candidate for the dustbin of history.[2]
Scrapped altogether, it should be replaced entirely by “bespoke” assurance – that is:
- Useful auditor reporting would be tailored in focus and content to specific user needs as determined in dialog among the company, its providers of capital, and the auditors.
- It would be sourced by the company from whichever supplier is best suited – whether a traditional audit firm, an emerging firm with a specialty niche, or a new form of provider altogether.
- Assurance engagements would be under conditions of auditor liability that allow for initiative, evolution, and appropriate measures of responsibility among the parties.
After all, the investing public has long demonstrated disinterest in the vestigial short-form report -- whose sole surviving purpose is to satisfy the regulators of the securities markets. To make a medical comparison, its “pass/fail” language is the capital markets equivalent of the human appendix.
That is:
- Like the vermiform appendix, the “pass/fail” audit opinion serves no obvious purpose.
- Day-to-day, nobody pays it any attention.
- Very few know where it is to be found, ever seek to locate it, or understand if it actually has a function.
- Nothing in either medical science or audit capability allows for dependable predictions of failure, or the ability to prescribe preventive intervention.
- And yet, when either goes wrong – which inevitably occurs with non-zero frequency – the consequences can be grave, and even fatal.
In the end – like the human appendix that can be removed by safe and uncomplicated surgery – it could be excised and never be missed.[3]
The Brydon report’s endorsement of greatly expanded forms of assurance on publicly valued aspects of corporate performance (see generally Ch. 5) is most welcome and worthy of pursuit.
To that end, however, recognition is necessary that the narrow “pass/fail” audit opinion with its origins in the Victorian era has outlived its usefulness and stands now only as a barrier to progress.
[1] For a detailed view and an assessment of the UK prospects, please see my book, “DOA: Can Big Audit Survive the UK Regulators?” (Amazon, May 2019).
[2] The theme runs through my first book, “Count Down: The Past, Present and Uncertain Future of the Big Four Accounting Firms” (Emerald Books 2d Ed. 2017) – Amazon here.
[3] Before its exposure as a sham, the scandal-riven Theranos in California raised $ 750 million from investors without ever having an audit. In the UK, high street retailer Sports Direct was out of compliance for weeks with its obligation to replace the resigned Grant Thornton firm, all to no effect on its stock price.
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