Michael Izza, the chief executive of the Institute of Chartered Accountants in England and Wales (ICAEW)

Michael Izza, the chief executive of the Institute of Chartered Accountants in England and Wales (ICAEW), has been candid about the future of auditing amid the Carillion fallout, saying the profession needs to “be prepared to think and act differently.”

Features | From Pivot Magazine

Coming through crisis

It’s in everyone’s interest that auditing works. How do we fix it?

A Facebook IconFacebook A Twitter IconTwitter A Linkedin IconLinkedin An Email IconEmail

In January, Carillion plc, a massive U.K. construction company, collapsed after multiple profit warnings sent its stock tanking. It was Britain’s biggest corporate failure in years, and because the firm had hundreds of government contracts to build and manage homes for the military, and provide services to schools, hospitals and prisons, it sent shock waves through the economy.

Critics were soon questioning the role of auditors. In May, a U.K. parliamentary committee report accused Carillion of deceiving lenders and investors, and criticized its auditors for a lack of oversight. The Financial Reporting Council, the regulator of the audit sector in the U.K., has come under fire in recent years for failing to take timely action in connection with high-profile corporate collapses, and for being “too cosy” with the audit profession.

Michael Izza, the chief executive of the Institute of Chartered Accountants in England and Wales (ICAEW), has been candid about the future of auditing amid the fallout, saying the profession needs to “be prepared to think and act differently.” He spoke to Bryan Borzykowski from Pivot in July.

You called the parliamentary committee report into the collapse of Carillion a watershed moment,” adding: “It should be seen as a wake-up call for business leaders, for regulators and for auditors.” Strong statements. Tell us more about your thinking.
MI: Carillion was not the first high-profile corporate failure, nor will it be the last, and it is important to remember that it was a management failure first and foremost. But it turned the spotlight on the auditors—as is only right and proper—and the parliamentary committee report concluded that they had fallen short of the high standards expected of them.

This is a watershed moment because the profession is recognizing that the status quo is no longer an option. For too long now there has been an acceptance that there is an “expectation gap” between what audit is technically required to do and what society has come to expect—and there is much truth in that. But now the profession has seen firsthand that politicians, regulators and wider society expect something more from auditors than just expressing a pass/fail opinion on financial statements. If the profession is not meeting the demands of society, then that is our problem, not theirs, because without the trust and confidence of wider society, we cannot deliver. Every day there are thousands of good audits that do exactly what they are meant to, but if trust in audit as a whole is undermined, then those audits suffer. So when I said this was a wake-up call, what I meant was we need to change. We need to explore how we can regain that trust. If we cannot, then I genuinely fear we will not have an audit profession in 20 years’ time.

What can Canada learn from what is happening in the U.K.?
MI:I think the main aspect for everyone globally to take away from this is trust. Audit—and the whole accounting profession—can only operate if it commands the trust and confidence of society as a whole. I think Carillion made it clear that everyone is a stakeholder in this process. By comparison, concern about financial services, for example, can seem distant from everyday life. But when people see hospitals not being built, roads delayed, and large-scale job losses, not to mention the prospect of school dinners not being served, military personnel going unhoused, and pensions failing to be paid, it brings it home quite starkly that audit is in the public interest, not just there to serve investors.

Has Carillion tarnished the reputation of auditors in both the U.K. and abroad? If yes, how can that be reversed?
MI: Unfortunately, I believe that it has. The best way, in my view, for the profession to start to rebuild trust is to demonstrate both value and relevance. This will mean showing how audit can deliver confidence in business, and always displaying the very highest professional, technical and ethical standards. But I think it will also mean exploring how we can update what is essentially a 19th-century process for a 21st-century economy. How can auditors add more value? Are there other areas where assurance can be used? I believe there are. I think we will find a number of areas where the expertise and experience that auditors have can be applied to ensuring more trust in business as a whole.

What, specifically, are the expectation gaps in the U.K.? Do you think the same sentiments are being or will be felt elsewhere? 
MI: We have been talking about the expectation gap for a long time—the phrase first appeared in the 1870s! ICAEW has defined the expectation gap as being “the difference between what the public and other financial statement users perceive auditors’ responsibilities to be and what auditors believe their responsibilities entail,” and there are a number of areas where this might be an issue, the most common three being fraud, going concern and internal controls.

But I think there is a wider issue here, and that is a more general feeling that auditors are not being held to account, that they are only ever responsible to the people that pay their bills. This is not the case. Professional accountants came into being as a way to protect society against corporate misbehaviour.

It is this more general expectation gap that needs to be addressed. This is not about dry technical details in long statements; it is about trust and confidence. I am optimistic about audit, and I believe that there is plenty that can be done to restore that trust, but we need to start now.

How do you get started? Who is leading the drive for change?
MI: I hope that we are. The Audit Quality Forum, a group made up by ICAEW, the FRC [the Financial Reporting Council] and the government’s BEIS [Business, Energy and Industrial Strategy] department, is convening an independent review of the future of audit. This will look at the scope of the audit; what does society require, and how can we meet those needs? What will we have to do to restore trust? How can we use our expertise to demonstrate the value and relevance of audit today?

In Canada, we have multiple layers of compliance and oversight; audit committees, auditors, management, standard setters and regulators work together, and it’s fair to say the overwhelming majority of audits are done to the highest standard. In your opinion, how important is this kind of collaboration?
MI:I think it is vital that there is constant dialogue between audit committees, auditors, regulators and management if we are to safeguard and improve audit quality. ICAEW has done a lot of work on this, and we have seen enhanced dialogue between auditors and audit committees—especially in financial services in response to the financial crisis. But it needs to go beyond this.

One thing that is absolutely critical is that we avoid unintended consequences when seeking to remedy the challenges faced by the audit profession. For example, when the European Commission’s Statutory Audit Directive came in in 2016, it included a number of measures rightly aimed at enhancing competition and choice. But just two years later the number of audit firms registered for Public Interest Entity audit work has dropped from 51 to 32, a fall of around 40 per cent. This is far from ideal. Regulators, who are tasked with being the stewards of audit quality, will need to strike the right balance between a proportionate level of regulation and one that dissuades smaller firms from taking on larger audit work. ICAEW is constantly working on guidance and thought leadership that helps guide best practice and raise standards. The good news is that everyone has exactly the same objective in this area—making sure that audit work is of the highest quality.

Change is rapid in today’s business landscape. You believe there should be a greater use of technology in the audit sector. In what way?
MI: Technology is already changing the way that we do audit. For example, in terms of something like inventory, there was a time when you had to send someone to physically count things, whether that was cars, say, in the automotive industry, or to clamber all over a warehouse. Now, you can use drones. They are faster and have more capability. But the use of technology, especially Big Data and artificial intelligence in the form of machine learning, has the potential to change things even more. When I started as an auditor everything was conducted through sampling. Now we have the capability to audit 100 per cent of a company’s transactions, and cognitive technology can process vast amounts of data faster and more precisely than any human. Obviously this has a beneficial effect on accuracy and speed, and potentially on cost. But where it really has the capability to change things is on what the audit of the future can offer. Because such technology focuses on pattern recognition, it has the potential to point out where processes or controls can be improved. And it will be able to identify outliers and exceptional events, meaning there might be a potential to spot, say, fraud.

Technology is only going to be more commonly used in audit, and the profession should prepare for that. That means that the auditor of the future needs to be comfortable with technology. That doesn’t necessarily mean everyone will need to be able to code, but it does mean they need to be up to date with technical capabilities and happy in the new technology environment if they are to remain relevant to business.

Beyond what you’ve already mentioned, where do you see the accounting profession over the next five to 10 years? What other changes do you anticipate? What needs to change?
MI: As I say, I think one of the main changes will be the impact of technology on the profession. Robotic Process Automation and artificial intelligence are going to revolutionize the way we do business. I expect we will see a lot of compliance work being automated, and artificial intelligence increasingly being used to spot patterns in Big Data, and in decision-making environments.

But this does not mean there will be a reduced demand for the profession—in fact I believe quite the opposite. I think we will see professional accountants moving up the value chain to more strategic roles. This will have an inevitable effect on the skills and aptitudes needed to become a professional accountant. I suspect we will need to engage more with technology, but I also believe we will need to focus on instilling the softer skills—strategy, communication and leadership, for example.

It’s worth noting that the rise of technology will not just change the way we do accounting. It will also change the things we are accounting for. Take artificial intelligence, for example. We know that AI cannot display bias, as it is a computational algorithm. Yet evidence from the United States shows us examples of very explicit bias in AI software—which can only have come at the data input stage.

So I believe we will see a demand for assurance on the processes and controls around data. And then there are broader questions. How do you audit a robot? How do you tax a robot?

What strengths does the profession bring to the table to help businesses successfully navigate change?
MI: The core values of professional accountants, whether they are based in the U.K., Canada or elsewhere, have always been trust and integrity. We train people to be able to bring the highest levels of professional and technical expertise, alongside the highest ethical standards. The specific areas and skills of accountancy may change depending on technology and markets, but the essential qualities—integrity and professional skepticism—never will. For example, some aspects of the modern office—tablet computers, say, or smartphones—would seem bizarre to our Victorian forebears. But I believe they would still recognize the core of what we do straight away.

What gets measured gets done

With audit quality being such an important issue, CPA Canada, the Canadian Public Accountability Board and the Institute of Corporate Directors have created the Audit Committee Guide to Audit Quality Indicators, a comprehensive guide to assist companies in reviewing and evaluating factors of audit quality.

Audit quality indicators (AQIs) can offer insights and facilitate collaboration among auditors, management and the audit committee. These indicators also provide more in-depth information to assist stakeholders in assessing and achieving sustained audit quality. Indicators can include, for example, the expertise of an audit team, the timing of audit execution and the level of communication.

Stefan Mihailovich, principal of corporate oversight and governance at CPA Canada, highlights the fact that there is no “one-size-fits-all” answer to the issue of audit quality. “It’s vital for the audit committee to have an open dialogue with both the management team and the external auditor,” he says. “All parties involved need to understand what ‘audit quality’ means to the organization, and how they think it can be best achieved.”

While the guide is geared toward audit committee members, it is also recommended reading for management and audit teams. It can be found at cpacanada.ca/AQIguide