THE RUN-UP TO AUDIT IN THE 2030s

Sometime in the 2030s, if not earlier, most
of the functions involved in a financial audit will be automated and the team
size will drop by half. Automation, AI and machine learning will do a majority
of accounting work and it is only logical that this will have an impact on
audits. The accountants and auditors aren’t going to die soon; we will need
them to orchestrate the maelstrom of change.

SEVEN things are discernible in the run-up
to the 2030s and those in the attest function will have to see how to stay
afloat.

TREND 1: THE RISE OF
AUTOMATION

Ever since the Industrial Revolution kicked
off more than 175 years ago, the human fascination for technology has
multiplied. Companies have automated a lot of their manufacturing and service
processes. Over the years, these have affected the staid old professions of
accounting and audit, too. From 13 columnar sheets to an AI-driven data
analysis pack, we have come a long way.

Let us not associate technology only with
large publicly-listed companies. In fact, it is the smaller entities that are
far more nimble. MSMEs, which are characterised by a high degree of
centralisation in decision-making and deficiency in internal controls, too, embrace
technology as they step onto the growth highway. Auditors, too, must keep pace
with the times and embrace new audit technologies. Since these tools and audit
laboratories can be expensive, small and medium firms will use cloud-based
tools on pay-per-use model.

IPA (Intelligent Process Automation), which
is the next upgrade from RPA (Robotic Process Automation), has come to stay as
an advanced data extraction tool, with its inbuilt artificial intelligence
module helping in decision-making. Such changes compel us to evaluate our
competency levels. Are auditors prepared to do it in the areas they specialise
in: audit, accounting, consultancy, tax and compliance? The ICAI has stepped in
to help in this direction. Recently, it released Version 2.0 of the Digital
Competency Maturity Model for Professional Accounting Firms (DCMM), which helps
accounting firms make these self-assessments. DCMM provides implementation
guidance on how far one should move ahead. However, being competent and mature
enough to handle digitalisation is just the beginning. There is a long way to
travel on the road to execution.

The winners will emerge from among those who
assess themselves, make the necessary shift and go the full distance on
technology.

TREND 2: WE WILL HAVE TO DEFINE AUDIT QUALITY

Judging audit quality is both subjective and
challenging. It is beyond compliance with standards and processes, adherence to
legislation and zero defects. Today, we are unable to define ‘quality.’ We go
back to an oft-quoted statement on photography: ‘I don’t know what’s good
quality photography, but I know it when I see one.’ We have taken a similar
stand on what constitutes audit quality. This stand must stand (pun
intended).

In the next two years, we must have a
generally accepted definition of Audit Quality. By the way, the ICAI has
initiated steps to establish a framework for an Audit Quality and Audit Quality
Maturity Model. Apart from the auditors, the clients, too, must take cognisance
of this development. If that happens, it will add cheer to the auditors’
efforts and minimise the audit-expectation gap.

Thankfully,
audit reporting has slowly moved from template-based reporting to a more
‘entity-specific’ reporting. The SA-706 ‘Emphasis of Matter and Other Matters’
and SA-701 ‘Key Audit Matters’ have been the key differentiators. These have
helped improve the quality of audit and enhanced the relevance of audit opinion
to users. CARO 2020, which is exhaustive and looks onerous, is also a step
toward reducing the expectation gap.

It’s crucial to define the expectation gap
and identify the reasons for it. ‘Expectation gap’ is the difference in
perception between ‘what the public thinks auditors do’ and ‘what the
public wants auditors to do.’ This gap hasn’t narrowed with time and
there are three reasons for this.

First, Knowledge Gap: What auditors do is different from what the public thinks they are
doing and this is called Knowledge Gap. Professional bodies communicate with
audit firms by making available updated information on changes in regulations
and the need for change. Audit firms, in turn, interact with clients and sound
them out on these changes. But, somewhere down the line, the message the public
receives is feeble and not forceful because there is a perceived absence of
wide-reaching platforms.

Second, Performance Gap: What auditors are supposed to do
differs from what they actually do and this is known as Performance Gap. Let us
underscore one aspect. ICAI, as a standard setter, has been continuously
responsive by updating standards on accounting, audit and ethics and by providing
implementation guidance. The action on lax and inefficient auditors is not as
fast as some would have wished it to be and so the public perception is one of
laxity.

Third, Evolution Gap: What the public wants the auditors to do and what the auditors are
supposed to do, is called Evolution Gap. Society is unmindful of what the
auditors are supposed to do. True, regulatory changes are taking place at
breakneck speed. New legislations, new standards or revisions in the existing
ones have been coming in at a rapid pace. The auditors are also not lagging in
compliance with the amended laws. Despite this, the public expects audits to
evolve in a way so as to prevent the failure of the audited-client. We in the
profession must look at this expectation gap and narrow it down.

The winners will emerge from among those who
can bridge the performance gap fully and the other two gaps as much as they
can.

TREND 3: SEPARATE GRAMMAR FOR A SEPARATE CLASS OF
COMPANIES

Standards are the grammar of both accounting
and auditing. There will be a different set of financial reporting guidelines
for ‘Less Complex Entities’ (LCEs). The auditing standards now apply to all
audits irrespective of their nature, size and structure. This practice is
leading auditors to focus on ‘compliance’ and not on ‘judgement.’ In the years
ahead, we will most likely have a different set of standards for auditing. Such
a package would make documentation and risk assessment disclosures easy.
Judgement will be back in auditing.

Limited internal controls and management
override characterise several MSME audits. These are demanding situations that
affect efficient audit performance. Worse still, these situations come with low
remuneration. If an auditor assumes that the examination of an SME client
carries lower engagement risk compared to that of a large entity, the auditor
is mistaken. SMEs most often scale at a high growth rate and do not have robust
internal control systems and other governance oversights to manage the pace of
growth. It is nobody’s case that work should be done only to the extent of fees
received. But if truth be told, that’s an overriding reality in at least some.
We will see audit firms agree upon and insist on a minimum fee commensurate
with the nature and size of the engagement.

Winning firms will be those that realise the
engagement risk in every engagement – small, medium, or large – and who either
cover it or seek a price for it.

TREND 4: FRAUD IS AUDITOR’S OBLIGATION

‘Fraud’ will be the biggest challenge in the
future. An auditor of financial statements has a fraud detection
responsibility, especially if it leads to a material misstatement in the
financial statements. Remember, SA-240 lays the primary responsibility for
preventing fraud at the door of the management. But the auditor is responsible
for providing reasonable assurance. The truth is that there are certain
limitations in audit and even if the audit is planned appropriately, some
material misstatements may remain undetected. If we want to be in the attest
function, we must learn to live with this reality.

Look at the challenges. Under the Companies
Act, 2013 the auditor has to report the fraud to the Central Government. But it
does not require the auditor to carry out a roving investigation to detect
fraud. A reading of the Auditing Standards and the Companies Act, 2013 throw up
a couple of aspects. First, an audit engagement requires the auditor to express
a ‘true and fair’ view on the financial statements. But such a commitment does
not envisage that all frauds would be detected. Second, a fraud not being
exposed does not mean that the auditor has not carried out his engagement
correctly.

When no fraud is reported or comes to light,
we don’t compliment the auditor for a job well done. But at the faintest hint of
scandal, the stakeholders descend on the auditor like a tonne of bricks and
bombard him with a barrage of questions. We in the audit profession must never
lose sight of this reality.

While auditing, an auditor maintains the
mindset that fraud is always possible. When the auditor is a fraud examiner, he
begins his / her assignment with the belief that someone is committing fraud
and affirms that belief unless the evidence shows no signs of fraudulent
activity. In a regular audit, we must be alert towards the perpetrators and the
impact on the defrauded organisation. The best practices would include:

(i)    Implementing audit procedures that throw up
warning signals.

(ii)   Recognising that submission of financial
results is merely the end-result of an audit process that runs through the
year, during which the integrity of auditing should be unquestionable.

(iii) No member of the audit team can entertain the
view that detecting fraud is not an auditor’s job. If this were the case, then
compliance with auditing standards on fraud detection may become a rote
exercise.

(iv) Being alert to factors that may create
incentives or pressures for management to commit fraud and might permit
opportunities to do so.

(v)   Recognising that improper revenue recognition
is a fraud risk in particular where estimates and judgement involved is high.

(vi) Evaluating transactions and events in which
management override has been applied over internal control matters, causing a
dent on reliability.

(vii) If the audit process determines that evidence
of fraud may exist, the auditor should consider the organisation’s position and
report it to appropriate authorities.

Often, there have been concerns about the
independence of auditors. These arose in the context of the appointment
methodology, a significant part of the audit market space being occupied by a
few firms, the high cost of audit of Public Interest Entities (PIE) and the
increasing complexity of business operations. Besides, one can perceive changes
in personal value systems because of the increased materialism that the world
has chosen.

There is also
the increasing awareness that the line between profession and business is
thinning. For a pure Chinese wall to be built, audit firms must focus only on
certifications and assurance. Everything else should be under a different
entity that maintains an arm’s length distance. Mere departmentalisation won’t
do in this regard.

The earlier firms understand these technical
niceties and make the necessary adjustments, the faster they will step onto the
growth track.

TREND 5: CODE OF ETHICS

Professional independence should be felt,
experienced and be visible, however tough that may be. This is the hallmark of
any profession and this is what will bring in public trust. As with the profession
of medicine, ours is the profession of trust and so our work must be executed
without a hint of interdependence.

The new version of the Code of Ethics,
effective 1^st July, 2020, is a significantly large document. By
imposing restrictions in particular for PIE, on taxation services to audit
clients, by introducing assessments for ‘threat to independence’ and specifying
reporting obligations for non-compliance with laws and regulations (NOCLAR),
the document shows that its heart is in the right place. For it to succeed, we
need to follow it both in letter and in spirit. Many a time, we do see
instances of bending of the law without breaking it. Some of the provisions,
especially relating to networks, might appear onerous but if we have to pass
the test of public scrutiny on independence, we must follow them. Independence
is the foundation for trust in an Audit Opinion and it is worth walking the
extra mile to protect the respect for and enhance the stature of the audit
profession. As the profession evolves more fully, we will see a lot more
changes to the Code to keep it current and modern, not archaic and ancient.

The firms that traverse the distance from
being good to great will practice both value and ethics in thought, deed and
action.

TREND 6: GLOBAL TRENDS WILL AFFECT INDIA

Two reports merit attention: the Brydon
Report and the three-year strategic plan of the International Forum of
Independent Audit Regulators (IFIAR).

At the instance of the Department for
Business, Energy & Industrial Strategy, UK (BEIS), Sir Donald Brydon
undertook an in-depth review of audit quality and effectiveness. In December,
2019 his report was placed in the public domain. It contains path-breaking
suggestions, calling for extensive reforms for accomplishing improved audit
quality.

Here are some of its suggestions that give
you a heads-up of what you can experience in the coming years.

(a) Redefine the purpose of audit: The purpose of an audit is to help establish and maintain the
deserved level of confidence in a company, its directors and the information
they report, including the financial statements.

(b) Introduce the concept of suspicion: Auditors exercise professional judgement and appropriate scepticism
and suspicion throughout their work. Auditors must act in the public interest
and should consider the interest of all users and not just the shareholders.

(c) Enhance
the informative nature of the audit report: Auditors need to create continuity between
successive audit reports, provide greater transparency over differing
estimations, perhaps disclosing graduated findings, and call out
inconsistencies in the information made public.

The second is the set of initiatives taken
by the International Forum of Independent Audit Regulators (IFIAR). In its
three-year strategic plan, IFIAR is focusing on achieving ‘significantly
improved audit quality on a global basis’. It has revisited the role of Audit
Committees (AC) in different jurisdictions and is actively reviewing whether
ACs should select the external auditor, determine their fees and assess audit
performance. A set of Audit Quality Indicators for evaluating external auditors
is also under evolution.

The audit firms that are 2030-ready will
keep a constant vigil on the global best practices and developments and
internalise them to the extent possible.

TREND 7: ANYWHERE, ANYTIME, ANYONE

This was waiting to happen. The
infrastructure was in place and the competence was there; it only needed a push
and societal acceptance. Covid-19 gave us just that. Even as audits have gone
beyond the paper-and-pen phase and with global audits already being done from
remote locations, the next jump will be carrying out reviews from anywhere you
may be: office, home or cafeteria. As the world steps into a new order of
freelancing as opposed to full-time employment, as travel becomes increasingly
cumbersome, as Generation Z steps into the workplace, audits from anywhere and
anytime will become the norm. Footfalls in clients’ places will drop just as
footfalls in audit offices dropped during the last 20 years.

With AI, RPA,
Blockchain, big data and machine learning, the world of accounting is changing.
People will not log data; machines will. Already, many accounting applications
today can put the smartest of analysts to shame with the speed of execution and
dexterity of operations. Neither accounting nor auditing is so quickly going to
disappear. As long as there is cricket, there will be scorekeepers and umpires.
Accounting is about scorekeeping and auditing is about umpiring. What’s
changing is how frequently we want to see the scores, in what mediums we want
to see them and how many of the documents can be digitalised. The firms that
will lose out are the ones that are not seeing the gathering storm and not
preparing for it: the Kodaks of the world. Have an influential culture,
modernise and use emerging technology and you will win.