These impressions of the Brydon Report were written by Professor Chris Humphrey to stimulate big picture thinking and encourage a holistic approach. We share Chris' concern that a "traditional" reading of the report might yield the creating of linear lists or cherry picking. The new landscape can shape a public arena on which the profession should play a key role.
It has been fascinating to watch how the press and various interested parties have commented on the Brydon Report. Some comments have been bland in the extreme, with a good number amounting to little more than cut and paste versions of the executive summary of the Report. Others have clearly zoomed in on their pet interest, with the Financial Times, for example, initially leading its coverage on capital maintenance (chapter 17 of the Report) before revising its reporting to focus more on the general nature of the proposed ‘sweeping’ reforms.
The varying reactions to the Report compelled me to attempt to lay out a suggested way of reading the Brydon Report to enable its depth and significance to be best appreciated. In what follows, I focus on 12 fundamental principles or standpoints contained within the report, providing an analytical template that will hopefully assist in the positioning, understanding and enactment of the Report’s 64 separate recommendations.
Sir Donald Brydon states that he was startled to discover the continuing relevance of the 1992 McFarlane Report and its identified list of anxieties about the role, scope and societal purposefulness of audit (p. 17). Put simply, the McFarlane Report did not have the impact it should have had – and, as Sir Donald goes on to note, the comments he has received on the role of audit some 27 years later have been accompanied by a ‘very considerable level of irritation’ at the lack of substantive progress.
There are various times in the Report where Sir Donald recognises the complexity of the (‘challenging’) situation confronting the audit function and associated professional, business, regulatory and societal interests and desires. He recommends the importance of taking a holistic approach that gives due respect to the complexity of the environment within which audit sits (p. 16). He stresses the importance of not viewing audit in isolation of the context in which it operates, particularly in terms of the interactions between and differing responsibilities of key actors/institutional players (p. 18) and how differing actions and behaviour on their respective parts could permit better and more effective audit and improve trust (in corporate business) in its entirety (p. 19).
In terms of integration, he also emphasises the importance of coordinating across the various policy recommendations to have come out of the Kingman and CMA Reviews to avoid both duplication and speculation. He does not want company Boards to be over-encumbered with competing corporate governance priorities (p. 16), nor to damage UK competitiveness by proposals that do not add value but add unnecessary cost burdens or are likely to deter capital raising (p. 18). He does, though, want to respond in a way that makes audit better and more effective, addresses calls for audit to be ‘refocused to serve a wide public interest’ (p. 18) and for the recommendations to be capable of universal (international) application (p. 18).
Such contemplation of cost-benefit considerations should not be taken to imply that the Brydon Report is intent on just marginal or incremental change. Sir Donald makes it very clear that he finds all the talk of (differing forms of) the expectations gap to be a ‘distraction’: ‘Either audit is helping to reinforce deserved confidence in business or it is not. What is required is better audit delivered by professionals in a more understandable framework’ (p. 21). He stresses that more is needed in terms of reforming the statutory audit than a literal following of the law (and doing audit ‘properly’), stating very directly that ‘the improvement of audit should go further’ than this by making ‘audit a more informative process and product’ (p. 21).
The core foundation on which the Brydon Report builds its analysis and recommendations is its rethought and redefined concept of audit which states that the “purpose of 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” (p. 22).
There are numerous important elements to this restated purpose of audit. First, and most fundamentally, audit is represented conceptually as something more than the statutory audit of financial statements. Sir Donald is critical of the tendency to view ‘audit’ as being synonymous with this latter, more narrowly defined function, especially when the expectations of audit have clearly (for many years – as evidenced by the expectations gap) been linked to wider concerns. This tendency leads him to argue that ‘today’s audit is a relatively arcane activity, operating within very precise rules, where the output of the auditor, even if precisely correct, cannot satisfactorily fulfil the desire of stakeholders to understand the resilience of the entity whose financial statements are subject to this audit’ (pp. 26-27).
To move audit beyond the ‘arcane’ (p. 26), Sir Donald stresses that audit has to ‘provide information that is useful to present and potential investors, lenders, creditors and other users in making rational investment, credit and other decisions and assessments about the company’ (p. 24). With regard to audit serving a wider public interest, and moving it closer to an informative function and away from a predominant compliance orientation, Sir Donald also recommends that ‘auditors should be free to include original information materially useful to a wide range of users, in their audit report and at the AGM, and not be confined to commenting on that which has already been stated by directors’ (p. 24). This reporting obligation should extend to information that is not included in the company’s annual report but used, for example, by the company in investor presentations.
In promoting a broader purpose for audit, conceptually, a critical element is the term or notion of ‘deserved confidence’. Here it is vital to note, first, that the level of confidence being pursued through the audit is not just confidence in the accuracy of the financial statements but the establishment and maintenance of ‘deserved confidence in a company, in its directors and in the information for which they have responsibility to report, including the financial statements’ (p. 22). Secondly, it is important to recognise that the concept of ‘deserved confidence’ relates both to the responsibilities of company directors and the responsibilities of auditors.
While the Brydon Report does state the information contained in financial statements will remain core to the redefined audit (p. 27), it is evident that the audit of financial statements in itself cannot be expected any longer to be the sole basis on which confidence is established in the company. Or, put another way, that it would in some circumstances result in a misplaced level of confidence in the company if such ‘confidence’ was based solely on the reported view emanating from the financial statements’ audit. Deserved confidence comes from both the company and its auditors doing more than at present.
The recommendations in the Brydon Report regarding different additional forms of reporting (in addition to its financial statements) by the company and its directors all emanate from this standpoint or principle. This includes reporting on the company’s resilience, its internal controls, dividend policy and approach to capital maintenance, its major risks, its audit and assurance policy and providing a public interest statement. ‘Deserved confidence’ derives from this information and the assurance as to its veracity provided by the auditor.
By going back to basic conceptual issues and building from there, the net effect of the approach taken in the Brydon Report is one of delineating the core framework through which to demonstrate the resilience of public interest entities and from which deserved confidence can be established. Its core spirit is to move beyond basic myths and assumptions, arguments and counter-arguments about what is currently being served and/or delivered by audit and what reliance can be taken from audit. Instead, it establishes a position or approach through which the emphasis is on demonstrating the company’s resilience and how it is serving the public interest rather than presuming that this is happening (and seeking to counter by force of voice those who argue that this is not happening). In essence, the approach is to cut through such ‘noise’ and establish a sounder empirical demonstration of the company’s resilience and public impact – in short, to assure and inform in ways that get to the core of what is required to create ‘deserved confidence’. It is a report that frames what we need to know about public interest entities, what ‘they’ need to tell ‘us’. Companies must stop assuming public interest but demonstrate it; we must stop hoping that audited financial statements mean resilience but ensure that we are shown what resilience means; don’t presume, but assess, assure and inform.
There is a strong undercurrent in the Brydon Report centred around thinking differently. Much of the prior analysis has focused on the Report’s commitment to thinking differently about the purpose of audit, the nature of corporate action and of reporting on such action. Underlying this is a commitment to fixing systems, a desire to get away from a compliance mentality and allowing rules and checklists to define what is good or what is better. There is an underlying spirit of ensuring that companies function better and that auditors conduct better ‘audits’ that ‘inform’ and do not just check compliance (p. 34; p. 40). You can detect at times a sense of frustration that such basic and spirited thinking has got so buried, if not lost: ‘One transatlantic call illustrated the quagmire that is audit well when I was asked what I meant by “better”!’ (p. 21).
There are various connections made in the Report to debates around the future of capitalism and of saving capitalism, of reconstructing corporate responsibility and the rights and obligations regarding stakeholders beyond the company’s shareholders. There are vivid links here with the type of campaigns and initiatives by outlets and bodies such as the Financial Times, the US Business Roundtable and the British Academy regarding the pursuit of ‘better’ business and a clear recognition of the greater scope for audit to serve the interests of other stakeholders (p. 45). However, in framing various recommendations, the Brydon Report does stress that it has chosen to leave the power of decision making regarding the scale of audit applied to particular companies in the hands of its shareholders (p. 50). In this regard, Sir Donald speaks very openly of wanting to avoid the ‘trap’ of over-auditing or an over-reliance on audit – to the extent that audit comes to be ‘used as an excuse for less rigorous decision making and information sharing’. He wants those primarily responsible (i.e. directors) not to rely on the auditors to correct errors that they could and should have addressed. He also does not want a ‘checking culture to pervade all of business’ (p. 50). As such, while the Report delineates a new, extended audit purpose and stresses both the importance of audit in developing confidence and trust in business and the damaging consequences of an inadequate or ineffective audit (p. 45), it also emphasises that ultimately the responsibility for (and causes of) business failure lie with the directors (p. 45) and expects better of them.
The Brydon Report seeks to avoid ‘an everything must be audited culture’ (p. 50) by highlighting the importance of getting information right first time – with a ‘do it right first time culture avoiding the necessity to employ layers of checking’ (p. 50). In essence, the balance being drawn is such that the development of audit is seen as both vital and necessary but is not something to be done in isolation – establishing ‘deserved confidence’ is a joint venture comprising both better auditing and getting businesses to behave better in the first place.
In developing the purpose of audit, the Brydon Report reframes the relationship between audit and assurance (pp. 26-29), essentially incorporating assurance within the broader concept of audit (of which the financial statement audit is just one form or element of audit). Attaching this greater scope or significance to the function of audit (and its multiple component parts), in turn, lends strength to the need for ‘auditors to be professionals in their own right’ (p. 30) rather than just being part of another profession (currently most prominently associated with the accounting profession). The Report talks of the need, given its principal objective of stimulating better audit, for ‘much greater clarity about what an auditor is and to whom he or she owes a professional duty’ (p. 30) and sees this as being established through the creation of a new corporate auditing profession, with ARGA being tasked as acting as the ‘midwife’ (p. 31) to bring it to fruition.
While there are some indications in the Report of a willingness to contemplate changes to the auditors’ liability regime (e.g., p. 23; pp. 100-102), the predominant emphasis is on the importance of focusing on the responsibilities of auditors and consolidating their position as a primary force in building ‘deserved trust’ in audited corporations. This applies particularly to the stated importance of establishing a new audit profession and ensuring that it is working to appropriate principles and meets its public interest responsibilities (p. 23). The Report highlights that there is currently little clarity and transparency over the profitability of existing financial statement audits (pp. 100-101). The word ‘impossible’ is only used four times in the Report but appears twice in two pages in stressing that any rational debate over audit liability is not possible without transparency on the profitability of audit.
It is important that the Brydon Report’s conceptual repositioning of audit is fully understood. What audits and auditors can do should be contemplated from the pursuit of ‘deserved confidence’ and not from what has or has not been achieved in the name, and more restricted form, of financial audit and the perspective of audit firms and professional institutes that have typically provided, and regulated/supervised, such a service. Essentially, the assessment task is one that should be undertaken from the perspective of a new profession. Do not just listen to the views of the ‘old’ (financial statement) audit profession, but also contemplate what those who will comprise or have the chance to comprise the new broader and more diverse profession have to say.
The Brydon Report is divided into 29 different chapters and this can encourage segmentation, even though, as argued here, the Report’s recommendations connect closely to and build on the fundamental foundation of a repurposed audit. If one’s concern about the current functioning of audit are covered in a specific chapter, it is possible to read what the Report has to say in such a chapter and then dismiss it in overall terms on the basis that its recommendations do not meet what was required to address the limitations of the financial statement audit. But such behaviour misses the point that the Brydon Report is framed around a broader conception of audit and its recommendations have been made and must be judged in relation to this broader conception – not the perceived failings as identified by past ‘pet’ topics and hobby horses. A fundamental repositioning of audit is being proposed rather than further tweaking of the financial statement audit that has struggled for too long to meet societal expectations of ‘audit’.
The Brydon Report is about securing better audit and better companies, not looking for new ways to sanction poor performing companies and poor auditors. It is about boosting the functional competence of audit, not cataloguing the inadequate performance of financial statement auditors. It is about establishing a framework that inspires better auditing, rather than focusing only on what still needs fixing in financial statement auditing or asserting that the financial statement audit is better than you have thought it was. It is about thinking in bigger picture terms about audit.
So rather than viewing individual chapters in isolation, seek to connect them through the lens of contemplating what is ‘deserved confidence’ and how it is formed and sustained by businesses, their board of directors and their auditors.
It could be said that a strong auditing profession should not have needed something such as the Brydon Report – it should have been able to sort things out for themselves and the people who depend on audit. But, as the Brydon Report has indicated, the strength of the profession is open to doubt, even though financial statement audit services may well be generating a substantial financial surplus for the firms that provide them. It is an intriguing comparison in that, formally, the Report finds that there is no separate ‘auditing’ profession and that for an activity centred on transparency, we do not know enough about its overall financial standing.
The challenge for ‘auditing professionals’ is to think conceptually, to go back to first principles and to avoid viewing their world and their scope for action through the lens of asking ‘what does the standard say?’.
Many years ago, an audit firm provided the dictionary definition of the verb ‘to think’ on the front cover of a book explaining its audit methodology. The Brydon Report is certainly one that will make many people think hard about the audit function and the nature of the auditing profession. But not in a random or speculative way. The beauty of an independent review is the freedom to develop and express ideas but the fundamental value of any such review is the framework that it provides for the pursuit of change.
There is a very clear philosophy in the Brydon Report, which is about getting the most from audit, whether it relates to those training and educating auditors, those working as auditors, the public interest entities being audited or those relying on the work of auditors. This philosophy is underpinned by a central vision – of better auditing, better decision making and better, more resilient businesses (including audit firms) working visibly in the public interest. Critically, what distinguishes the Brydon Report is the way it constructs the case for change by going back to and reformulating the basic purpose of audit and the nature of audit professionalism and developing its recommendations from there. There has been much said in the past that the Kingman, CMA and Brydon Reviews have been undertaken in the wrong order. The approach taken by the Brydon Report should facilitate the connectivity across the other reviews and promote a coordinated approach to reform and development across different key stakeholders and professional, regulatory and educational institutions.
I would strongly encourage people to read the Brydon Report from cover to cover. But above all, to embrace its spirit and appreciate how its proposed reforms build from this spirit. It is certainly a challenging report but what a positive challenge. Hopefully, with this report, a better future for auditing is now within our grasp. As a society, we should not waste this opportunity. This is a moment to lead, to set agendas, to apply principles that really do secure substantive change in practice and the practice environment.
In profiling the Report on the day of its release (on BBC Radio 4), Sir Donald stated that his review had been charged with determining how to improve the quality and effectiveness of audit which involves (looking at) the entire system around audit. In response to a question that his report had essentially ‘torn up the rule book’, he went on to say that its recommendations had “created a new landscape I hope for audit which will be very clear”. It is a vision that ‘deserves’ our ‘confidence’.
Chris Humphrey is challenging the profession to try a different conceptual thinking about audit and to rethink its role in creating a better society.Read more
Highlights from the first ‘Time to Think’ session that we hosted for young professionals on 12 March at ICAEWRead more
We hosted a symposium for audit firms to explore areas where we should be collaborating betterRead more