On balance, annual reports must be called to account
Audit needs reimagining. Confidence has been eroded and statements fail to meet stakeholders’ needs
It was said that General Franco and Ho Chi Minh could run on Richard Nixon’s election platform without either having to compromise their stance. The same lack of precision applies to the numbers reported by companies in their annual statements. Imagine the directors of a company stating Goodwill at £1bn while their auditors view it as worth £0.5bn. As both estimates reflect judgments of the future trading of the company, neither can be wrong today. But what to put in the accounts?
Any number between those estimates could be reported without either directors or auditors breaking accounting rules. The auditor today would opine that it is “true and fair”. But how can anything about the future be “true”?
Obeying rules simply does not give the information that readers of the accounts need. They need to be informed about the range of possible estimates when the auditor gives an opinion.
Who are the auditors? It is a surprise for some that there is no such thing as the auditing profession. There are accountants who audit and their present role is constrained by the rules. In my report into audit I have recommended that a new profession be established with its own distinct set of operating principles. Auditors need to be educated in how to apply appropriate suspicion and forensic skills. One of the key principles is that their work must be designed to inform good decision making.
I have proposed a reform programme for auditors, directors and shareholders to achieve the core purpose of enhancing confidence in business. This includes obligations to endeavour to find fraud, to ensure that dividends are paid properly, and to extend the concept of auditing beyond the financial statements to other parts of directors’ reporting.
Key performance indicators that influence executive pay are an obvious example. In this era of climate change anxiety, tomorrow’s auditors, not necessarily accountants, should be able to give assurances about what directors are saying about environmental performance too.
A central recommendation is that directors report on the resilience of their company. Too often we have seen corporate failures where it appears that one day a company is a
‘Too often we have seen corporate failures where one day a company is a going concern and the next it is bankrupt’
going concern and tomorrow it is bankrupt.
Reporting on resilience in the short, medium and long term, and obtaining appropriate independent assurance from auditors that this reporting is based on proper processes, will lead to enhanced stakeholder confidence.
Auditors should not be inhibited from sharing their judgments but rather be encouraged to share, with greater granularity, their reasoning. They should also be obliged to pay attention to risk signals external to the company when conducting their audits.
It is simply not enough to fall back on rules. A poem quoted in the Thirties ended:
“According to our figures the enterprise is wrecked
But subject to these comments the balance sheet’s correct.”
Correct is not good enough: users of accounts need more information.