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A broader purpose and more challenging culture are essential for the audit system to serve society and business better, says IPPR

A complete culture change within the UK’s audit industry is needed to ensure that other crucial reforms fully restore public trust in the system, according to a report published today.

Without a new approach that encourages challenge to clients and speaking up within the audit firms themselves, there is a real risk that past mistakes will be repeated, the report by the IPPR think tank says. Culture change within the industry, including the dominant ‘big four’ audit firms, should not be treated as an afterthought but should be rigorously prioritised, defined, put into effect and tracked.

The IPPR paper, Remaking Audit, the second in a series of three, comes as the government is considering reforms to the industry, proposed in its recent white paper. IPPR argues that auditors should be set a renewed public purpose of becoming a trusted referee of business so that audit is far more than a ‘tick-box exercise’.

That means stablishing confidence in audit firms’ ability to detect and warn of fraud, financial misstatements and problematic accounting practices, and to live up to the same standards in audit-related consulting activity. This is crucial if the industry is to be trusted with a broadened role, also advocated by IPPR: to report on the quality of business governance, environmental risk reporting, and data and cyber governance.

With this in mind the report calls for a series of key changes across the industry including:

Cleanly separate the audit and consultancy arms of audit firms, to end potential conflicts of interest.
Establish a new audit regulator, the Audit, Reporting and Governance agency (ARGA), with a larger staff and better resourced than the current Financial Reporting Council. This should set a regulatory framework for delivering a strong ethical culture in audit firms, similar to that in place for financial services.
Establish an ethical standard not just for auditors but also for consultancy services, to ensure their practices are aligned with the public interest.
Overhaul accounting rules to ensure businesses cannot pay out more than they actually earn to shareholders (a common practice), and are less able to make rosy forecasts of profits.
Overhaul the ethical culture in audit firms, with the regulator regularly assessing the progress firms are making towards implementing it.

On internal culture, it calls for measures to develop an atmosphere of purpose, challenge and excellence with steps such as:

Reform partner compensation so that it rewards audit quality rather than adjacent commercial aims.
Celebrate courage and promote auditors who challenge clients, whether or not this results in immediate financial reward for the audit firm.
Train to improve decision-making, raising awareness of ‘grey areas’ and ‘slippery slopes’ that could ultimately lead to audit failure.
Build institutional memory by openly discussing cases of audit failure, in the same way that NASA analyses the causes of the 1986 Challenger spacecraft explosion as part of its induction process for new employees.
Reduce pressure on and encourage ‘speak up’ by junior auditors - they are often the first to encounter difficult issues during audit projects but time pressure creates a strong incentive not to report an irregularity.
Conduct regular reviews of culture in audit firms, learning from the similar practice in financial services, with partners held responsible for the culture within their teams.

Carsten Jung, IPPR senior economist and lead author, said:

“Auditors need to define and articulate a purpose beyond profit, and put it into action - otherwise they will breed cynicism in their workforce. They should see their role as doing the detective work on businesses that society needs to ensure that they are run responsibly, with the wider public interest in mind.

“Career incentives within the audit industry are too reliant on giving good news rather than flagging potentially bad news early on. Audit firms need to be given a clear public purpose of comprehensively challenging businesses where challenge is needed. To achieve this, it’s vital to put culture change at the heart of the revamp of the audit industry.”

Shreya Nanda, IPPR economist and co-author of the first report in this series, said:

"Audit firms should openly discuss past cases of audit failure, and routinely analyse their root causes with new joiners. To this day, NASA analyses the root causes of the explosion of the Challenger spacecraft as part of the induction for new staff. To prevent another Carillion, audit firms should learn from NASA, and do just the same.

“We need to bring the audit industry into the 21st century by stepping up regulatory oversight and ensuring that, among other much-needed change, the failings of its internal culture are also addressed.”

NOTES TO EDITORS

The IPPR paper, Remaking Audit: A plan for culture change and regulatory reform by Carsten Jung and Marco Meyer, will be published at 0001 on Friday May 28. It will be available for download at: http://www.ippr.org/research/publications/remaking-audit
Co-author Dr Marco Meyer is junior research group lead and Freigeist Fellow at the University of Hamburg’s Department of Philosophy
A previous IPPR paper examined the profound weaknesses of the current audit system. The Truth Tellers: Why we need profound audit reform now, by Carsten Jung and Shreya Nanda, was published in April and is at http://www.ippr.org/research/publications/the-truth-tellers

A third paper in this series will review in detail the reforms proposed by the recent government white paper, and will be published later this year.
IPPR is the UK’s pre-eminent progressive think tank. With more than 40 staff in offices in London, Manchester, Newcastle and Edinburgh, IPPR is Britain’s only national think tank with a truly national presence. www.ippr.org