Where is the audit profession going?
On Sept. 11, 1844, a boat entered New York Harbor carrying three Bavarian immigrant brothers. They arrived with nothing except a pair of shiny new shoes each. After working for a short time as cotton traders in Alabama, they set up a bank in New York City — a financial institution that grew to be one of the largest and most prestigious in the world. The bank survived two world wars and the Great Depression.
This heroic and inspirational story that reflects so well on the opportunity that presented itself to three young immigrant men who fled their home country, Germany, to make better lives for themselves in the United States, came to a crashing climax 10 years ago when the collapse of Lehman Brothers (for that was the bank’s name) triggered a systemic global financial crisis from which the world is still recovering today. Lehman Brothers is now synonymous with financial catastrophe.
How could such an icon of hope, aspiration and opportunity in one generation become the poster child of greed, corporate failure and inequality in another?
How appropriate it is that this story is being dramatized on the stage of London’s Royal National Theatre on the evening of the launch of my new book, “The Auditor: Quo Vadis,” which I have co-authored with Linda de Beer. And how appropriate that the story is being told from the pen of a Florentine playwright, because our own story traverses Italy where, in 1494, Luca Pacioli created the system of double-entry bookkeeping which is the foundation of modern-day accounting practice.
In many ways, the history of Lehman Brothers follows the arc of our book, which seeks to tell the story of the audit profession, a profession created to provide confidence in the quality of financial transactions and processes, to instill trust in business, attract investment, and help to create the foundations for long-term economic success. The audit firm “cousin” of Lehman Brothers might very well be Arthur Andersen, which fell in the aftermath of the Enron scandal in 2002-03.
And the Lehmans’ story is important because it reveals a noble purpose that today could be forgotten, and which goes to the heart of business, value creation and our capital markets. That same noble purpose can be found in the origins of accounting, audit, and the creation of the modern accountancy profession, which flourished from the mid-19th century onward. It is worth remembering too that accountancy has always been a public interest profession.
The accountancy profession, and the role of audit, have responded to an increasing pace of change in our society, economy and capital markets. The global economy is changing at an accelerating pace, with new technology challenging traditional business models and an increasing concentration of economic power and wealth in the hands of very large corporations.
Alongside this, the nature of value has evolved into a more multidimensional concept, including intangibles, societal and environmental factors, as well as the traditional financial resources. And the audit firms themselves have been the subject of consolidation, meaning that in most markets globally, 80 percent of the audits are conducted by the Big Four.
This evolution — to the economy, the nature of value and the profession itself — has brought with it changed expectations, and our book explains how the audit profession, regulators and others should make changes now to meet those expectations.
The risk to the profession is nothing less than extinction, largely due to the unlimited liability regime and concentration in the audit market. This is a matter of public interest because a failure of one firm could lead to a significant loss of confidence and, therefore, value in the capital markets.
Take one example. Since the mid-1980s the behavior of our capital markets has started to change, with the introduction of socially responsible investment that takes social and environmental impacts into consideration.
ESG (environmental, social and governance) reporting, the formation of the Global Reporting Initiative, integrated reporting, and the introduction of corporate governance codes served to reveal an information gap that financial data alone could not fill.
Today we are witnessing the rise of the intangible economy, resources that are not recognized on the traditional balance sheet. Multifaceted reporting, providing a broader set of information on which investors can make decisions, is the new norm in many economies.
The above analysis does not seek to deny the tremendous change undertaken both by audit firms themselves and within the regulatory environment in which they operate. The audit profession and the regulatory landscape have changed significantly in recent years, driven both by the megatrend of globalization and individual and systemic corporate crises.
Professor Judge Mervyn King is chairman of the International Integrated Reporting Council, and a senior counsel and former judge of the Supreme Court of South Africa. His new book, co-authored with Linda de Beer, is “The Auditor: Quo Vadis?”
Standards have become internationalized and the role of audit quality in the financial reporting chain has become heightened.
There is a greater focus on audit quality and independence both by regulators and the audit firms themselves.
One of the most encouraging signs is the expansion of services offered by audit firms, responding to growing market need. In most surveys of CEOS and CFOS, cybersecurity comes at the top or close to the top of concerns faced by business leaders in today’s context.
Similarly, there is heightened regulatory interest and support for mandating sustainability reporting and integrated reporting. Firms are increasingly providing assurance services in these areas, requiring the development of multidisciplinary teams to ensure the firms have access to the right suite of specialist skills.
The megatrends the world is facing, including climate change, the fourth industrial revolution, globalization and artificial intelligence, demand a modern audit profession capable of attracting the skilled professionals to provide the assurance services needed by 21st century businesses.
The risks and opportunities facing the global economy 20 years from today will require a profession that is flexible, agile and responsive to remain relevant and avoid the risk of extinction. In our book we pose other solutions too, including a limitation to the auditor liability regime, regulatory monitoring of the mandatory audit firm rotation rules to assess their effectiveness, and the introduction of an audit judgment rule.
“Change is the only constant in life,” said the Greek philosopher Heraclitus. It is a mantra that must be heard and acted upon to secure a global audit profession for the future in the public interest. AT
This is the first installment of a new series of guest columns on “The Future of the Audit,” where experts in the field will share their thoughts on the many changes coming to this traditional service.