Q. It’s being said that the quality of the audit process has not changed recently, despite the fallout from the financial crisis. What are your views on this?
Over the last decade, I think our focus on audit quality – our emphasis on objectivity, independence and professional skepticism – has improved significantly. However, the financial crisis did teach us that a quality financial statement audit cannot be expected to address a flawed business model or less-than-robust risk management processes. For example, many companies had a “velocity business model,” with their business model and compensation schemes grounded in originating or acquiring assets, restructuring them for distribution, often in complex structures and derivatives, and getting them off the balance sheet as quickly as possible while retaining nominal amounts of residual risks.
While financial markets were receptive to these structuring and distribution activities, everything was fine. But the moment the market lost confidence, access to capital disappeared and it all came crashing down. Before the crisis, people generally assumed resilience of funding sources. Now people understand that this is not always the case and not all assets or structures are created equal.
Q. How can you quantify the commercial value of the audit – both to the company being audited and to the wider capital market?
A company’s view is generally that if it’s audited by a Big 4 firm it’s going to get a quality audit, and there is value in that from investors’ and other stakeholders’ perspective. Having said that, we also add value by delivering insight and perspective across a wide array of financial, regulatory, operational and technology topics.
Q. How can audit quality be ensured in an environment where delivery costs are rising but prices falling?
Our statutory mandate as auditors is grounded in having confidence in the quality of what we do. Declining profit margins cannot come at the sake of the quality of the product. That puts the onus on us to better demonstrate the value of the audit and to argue for and obtain a fair fee for the quality work we do. On the operational side, we need to explore and capitalize on opportunities to improve audit quality and drive efficiencies in how we execute an audit.
Q. What would auditors do differently if unconstrained by regulation and able to deliver solely what the capital markets want?
Currently an audit opinion is given on past financial information. I’d like to get to the point where we have a continuous audit process and provide assurance on information on a contemporaneous or real-time basis. Say a company issues a press release or a financial data supplement containing information outside of normal financial statement information but entirely related to the financial performance of its products, business functions or geographical locations, should you attach an audit opinion to that? I think you can and should. Isn’t that the type of real-time information that investors want? I also think there is an opportunity to expand the nature and use of the audit and assurance product. For example, in industries like health care or financial services, there are new and evolving financial, demographic or salient business disclosures that the external auditor can and should be associated with.
Q. Of all the parties that have an interest in an audit, which do you think feels most short-changed by the value it provides, and why? Are their concerns justified, and how can they be addressed?
The biggest issue we face is a lack of understanding of what we do as auditors and how to interpret our audit opinion. Far too many people look on the audit as an insurance policy – a “guarantee” against all things of a financial, risk, management or regulatory nature that may befall a company. We have an opportunity to better communicate what exactly we do in an audit and what our opinion really means. There may be an opportunity to describe more prominently matters that warranted a substantial amount of audit attention, including significant estimates and judgments made in the preparation of financial statements that are subject to interpretation and the work we performed in relation to them.
In the current model we do report on these items to the audit committee and management, but there may be an opportunity to better communicate those matters to external stakeholders. The regulators in the US are looking at this topic and I am interested to see how this debate will take shape.
Jim Liddy is Vice-Chair of Audit in the US. He is responsible for creating and executing the strategic vision for the US Audit practice, and leads a team of over 800 Audit partners and more than 7,000 Audit professionals. In addition, Jim serves as the Regional Head of Audit, Americas and Chair of the Americas Audit Steering Committee. Jim has spent more than 30 years serving KPMG clients and has held various leadership roles throughout his career. Prior to his current role, Jim served as the National Managing Partner, Audit for KPMG and the National Line of Business Leader for KPMG's Financial Services practice.