What promotes confidence and trust in the audit function?

Confidence in the financial reporting of established and emerging firms, the credibility of the audit function and perceptions of audit quality are critical to the success of the Australian economy, argue Professor Nonna Martinov-Bennie and Dr Alan Kilgore from IGAP, in an article published in the October 2012 edition of Think and Grow Rich.

?????????????????????????????????????????????????????????????????????????????Increased Scrutiny of Audit

In the wake of corporate collapses and the Global Financial Crisis,  what actually constitutes a high quality audit has come under public and regulatory scrutiny. This has most recently taken form in the establishment of the Advisory Committee on the Auditing Profession in the United States, and the release of key frameworks and documents internationally, including:

  • the International Auditing and Assurance Standards Board (IAASB)’s consultation paper: A Framework for Audit Quality (2013);
  • the Public Company Accounting Oversight Board’s Strategic Plan: Improving the Relevance and Quality of the Audit for the Protection and Benefit of Investors (2012);
  • the European Commission’s (EC) Green Paper Audit Policy: Lessons from the Crisis  (2010);
  • Audit Quality in Australia – A Strategic Review (2010); and
  • the Audit Quality Framework (2008) in the United Kingdom.

As Martinov-Bennie and Kilgore argue, the credibility of the audit function plays an important role in establishing and maintaining an effective and efficient capital market. There are public and private benefits to these efficiencies: the equitable distribution of investment gains; reliable financial statements that encourage a broader range of investors; and the potential for higher investment returns through reducing financial statement risk.

Key Audit Quality Attributes – The Audit Team

However, as highlighted in a recent study by Kilgore and colleagues, with representative users of audit services (audit committee members, financial analysts, and fund managers), perceptions of quality also play an important role in maintaining trust and credibility in the audit function.

The study established that factors relating to the audit team were perceived to be relatively more important than factors related to the audit firm. More specifically, perceptions of five key audit team attributes were found to be relatively more important than perceptions of audit firm attributes such as audit quality assurance review and audit firm industry experience; namely:

  1. the partner / manager attention to the audit
  2. the manager knowledge of the client industry;
  3. knowledge and experience of the audit team;
  4. communication between the audit team and client; and
  5. the partner knowledge of the client industry.

Only audit firm size was considered relatively more important than these five audit team attributes.

In another project, commissioned by Association of Chartered Certified Accountants (ACCA), Dr Kilgore, Prof Martinov-Bennie and Associate Professor Sue Wright are currently undertaking research on perceptions of audit quality among other stakeholders. Preliminary results suggest that while different stakeholder groups have different views, audit team characteristics remain important to perceptions of audit quality.

Implications and Future Research

The implications of these findings are important at both national and international levels for the audit profession, regulators, and standards setters, and for efforts aimed at improving the effectiveness and integrity of the audit process. These findings are particularly important  for regulatory and professional accounting bodies working to improve audit quality, since they have tended to focus on audit firm factors, in lieu of (perceptions of) audit team expertise and experience. Combined, the findings suggest that not only do different stakeholders have different perceptions of the key drivers of audit quality, but also that audit quality is viewed by market participants as a multi-dimensional construct. In trying to better understand what makes a quality audit, we really need to know more about the people who actually perform them.

Internal Audit ‘After the Crisis’

In the aftermath of prominent corporate scandals and the global financial crisis, corporate governance has received close attention from regulators and the public. Regulatory responses have focused on increasing governance requirements and disclosures and this has, in turn, driven increased awareness and demand for internal assurance within organisations. Internal audit is integral to corporate governance, and is well placed to provide this assurance. In a recent article, Dominic Soh and Nonna Martinov-Bennie used interviews with audit committee chairs and chief audit executives to investigate internal audit functions in the Australian context, and to consider how their effectiveness might be improved.

 KEY FINDINGS ??????????????????????????????????????????????????????????????????????????????????????????????

1. The scope of the internal audit function has expanded and refocused in recent years. Internal audit is increasingly involved in risk management rather than traditional “tick and flick” financial audits. There is also greater engagement in operational areas, and increased focus on performing a value-adding role, such as identifying how businesses can increase their efficiency and effectiveness. There is a clear expectation that in addition to its assurance role, this ‘value-added’ emphasis will continue.

2. The changing role of internal audit is largely due to regulatory reforms. Increased sensitivity to directors’ liabilities, particularly of those directors on the audit committee, has meant increased acceptance of the importance and value of the internal audit function as the ‘eyes and ears’ of the organisation. Some audit committee chairs described the assurance and comfort from internal audit as greater, and perhaps more valued, than from external audit.

3. The effectiveness of internal audit depends on its structure, resourcing and organisational status.

  • There was a clear preference for an in-house function (or at least an internal chief audit executive), on the basis that intimate business knowledge contributes to an effective audit function and makes it better equipped to meet the audit committee’s assurance needs.
  • Interviewees highlighted the importance of key competencies (audit, finance, operational, technological, and legal), but especially the capacity of the chief audit executive to ‘command the confidence and respect of the people out in the field so as to be able to gain access and cooperation’.
  • Good relationships with, and support from, the audit committee and senior management were seen as critical to an effective internal audit function. For example, it is imperative that the audit committee supports and protects the status and visibility of the function e.g. by providing a platform for internal auditors to present their findings at audit committee meetings, ensuring the chief audit executive is present in operations meetings, and ensuring that management undertakes appropriate remedial action in response to audit recommendations.

4. Performance metrics have not evolved in line with internal audit’s role. Common measures of effectiveness related to the annual audit work plan and to measures of acceptance and adoption of audit recommendations. Since these measures were similar to prior surveys, it is clear that performance evaluation mechanisms have not evolved alongside the expansion and refocus of the internal audit function.

IMPLICATIONS:

1. Internal audit cannot be evaluated in isolation. The quality and effectiveness of the internal audit function is largely dependent on other parties within the organisation, especially the audit committee and senior managers. Consequently, an ineffective internal audit function might indicate that there are broader issues in the organisation’s corporate governance.

2. Whether internal audit meets stakeholder expectations is unclear. The misalignment between the current and evolving role of internal audit and static performance measures makes it difficult to assess whether internal audit is meeting stakeholders’ expectations. Given that the internal audit function serves different stakeholders (who at times have divergent interests) within the organisation, more diverse metrics are required to measure whether internal audit is meeting the potentially different needs of stakeholders. For example, while audit committee chairs emphasised the value of assurance, chief audit executives emphasised ‘value added’ from the organisation’s perspective.

3. New performance metrics may be required. Given the increasing emphasis on the consulting and value adding role of the internal audit function, alternative metrics such as value tracking by cost savings or value creation may better measure the performance and effectiveness of the function. There is however a potential risk that such metrics would impair internal auditor’s independence and objectivity, with implications for the external auditor’s evaluation and reliance on the internal audit function.

4. The chief audit executive skills need careful assessment. The increasing involvement of internal auditors in consulting and operational areas requires staff with industry knowledge and experience. In addition to strength of character and an inquiring mind, the chief audit executive needs strong communication skills to build bridges with all business areas, and to confidently report to higher organisational levels. Developing these competencies is no mean feat, and would take considerable time. Organisations therefore need to consider how limited tenure or rotation of this role could work, if it is required or even tenable.  These also have implications for what the career path of a chief audit executive would ultimately look like.

See: Dominic Soh’s and Nonna Martinov-Bennie’s article and abstract: