Audit's purpose is to bring clarity and assurance

This article was first published in the May 2020 UK edition of Accounting and Business magazine.

In these uncertain times, the true purpose of audit is becoming increasingly clear. As the Covid-19 crisis unfolds, businesses and their stakeholders need clarity and understanding amid the confusion

They need clarity on their financial figures, an understanding of what those figures mean, and assurance over the integrity of this information.

The purpose of audit has been under scrutiny since long before the current crisis. In the UK, we have had the Brydon review, which set out a long, thorough and thoughtful appraisal of audit, where it has come up short and how it can be improved for the future. And, most importantly, it has put the purpose of audit firmly on the agenda.

It is a review that ACCA has welcomed. The wider role of audit has been laid bare – it should not look backward, but rather play a role that allows stakeholders to make informed decisions for the future.

In his report, Sage chairman Sir Donald Brydon called for a redefinition of audit and its purpose. The call for reform has been echoed around the world, but there is also a fundamental recognition that audits already play a crucial role in how capital markets and the wider economy operate.

Brydon identifies the need for a clear, easily understood and all-encompassing purpose for audit. Audit exists to give users confidence in companies, and the purpose reflects this – it is a public interest function, but one that verifies so much more than simple compliance with laws and rules. In the words of Brydon: ‘The purpose of an audit is to help establish and maintain deserved confidence in a company, in its directors and in the information for which they have responsibility to report, including the financial statements.’ As Maggie McGhee, ACCA executive director – governance, says: ‘The numbers only tell part of the story; it is about interpretation of the numbers.’

Picture of resilience

A high-quality independent audit can give stakeholders assurance over a business’s liquidity and ability to carry on as a going concern. It helps build a picture of resilience. It will challenge management’s assumptions and judgments – a vital function at times of high pressure, but equally as important in times of strong economic growth too. A high-quality audit will ask how realistic the business’s growth is, and how realistic the management’s judgments and assumptions are. Every business and management team will have their own idiosyncrasies – every audit should, as its core purpose, cut through these to provide an informed opinion.

As Brydon says: ‘Good audit will respond to such idiosyncrasies and should ultimately lead to a lower cost of capital, and lower costs from unnecessary corporate failures, through increased and deserved confidence in business.’

So is the real purpose of audit to reduce the cost of capital and of corporate failure? If one were to take a narrow view of stakeholders and see them purely as investors, then that may well be true.

But the term ‘stakeholder’ encapsulates much more than this. It covers employees, suppliers, customers, government and the wider public. It covers those with an interest in the environmental and societal impact of business. Many of these will turn to a company’s annual report for details of its activities in these areas, the actions that it is taking to address certain issues and the success or otherwise that it is having in tackling them.

Of course, all these groups will ultimately benefit from a lower cost of capital, as they will all benefit from the success of a business. This could be in the form of lower prices, reliable service, secure employment, increased tax revenue, and increased social and environmental awareness.

Legal liability

However, as Brydon acknowledges, the discussion of the role of audit and its relationship with other users of its reports, other than the shareholders for whom the report has been contractually prepared, has been bedevilled by anxieties about auditors’ legal liability.

There needs to be a separation between risk of liability and acceptance that users other than shareholders may and will make decisions based on the audit report.

Here, decisions to take action or not are equally important. Society has demanded a publicly available report and, in consequence, non-shareholders will also make use of it.

But if an audit is to fulfil this wider purpose, then auditors should have regard to this reality without any extension of legal liability beyond that owed to the shareholders as a body. It’s a difficult balancing act, but one that needs to be addressed if the full potential and purpose of an audit is to be realised.

Beyond the financials

Irrespective of this, there is clearly an opportunity for the audit profession to extend the purpose of an audit to cover the assurance it can give to the wider community. This will increasingly encompass non-financial reporting.

This is not just about what management says at the front of its annual report tallying with the numbers. It is about whether the reported actions of management align with what the auditors see in reality. Whether that is a commitment to treating customers fairly, closing the gender pay gap, decreasing an entity’s environmental impact or demonstrating its adherence to good governance principles, an independent auditor’s view could prove invaluable. It can marry tone and culture, and provide challenge and insight.

This will become increasingly important as the purpose of audit shifts from a backward-looking report to one that addresses the future. At a time of unprecedented challenge, this could prove to be the real purpose of audit.

Philip Smith, journalist