Where is the au­dit pro­fes­sion go­ing?

Accounting Today - - Assurance - By Mervyn King

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?”

Au­dit

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.

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