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Chapter 2

Concerns with the quality of auditing

Auditing standards

2.1        Auditing standards in Australia are governed by the Corporations Act 2001. Audits must be conducted in accordance with legally enforceable auditing standards that were introduced for financial reporting periods from 1 July 2006 following the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004.

2.2        Australia's financial reporting system is established by Part 12 of the Australian Securities and Investments Commission Act 2001 (the ASIC Act). One of the main objects of section 224 of the ASIC Act is to develop auditing and assurance standards that:

• provide Australian auditors with relevant and comprehensive guidance in forming an opinion about, and reporting on, whether financial reports comply with the requirements of the Corporations Act; and
• require the preparation of auditors’ reports that are reliable and readily understandable by the users of the financial reports to which they relate.[1]

2.3        Two of the key bodies in Australia's financial reporting system are the Auditing and Assurance Standards Board (AUASB) and the Financial Reporting Council (FRC). The AUASB, established by section 227 of the ASIC Act,[2] is responsible for developing auditing standards in Australia.[3]

2.4        The FRC, established by section 225 of the Australian Securities Commission Act 1989, was re-established in 2001 by Part 12 of the ASIC Act.[4] The FRC has responsibility for overseeing the financial reporting framework, and its role is to:

• provide broad oversight of the processes for setting accounting standards and auditing standards in Australia;
• advise the Minister on these matters; and
• determine the AUASB's broad strategic direction.[5]

2.5        The passage of the Corporations Legislation Amendment (Audit Enhancement) Act 2012 (Audit Enhancement Act) on 27 June 2012 repealed the requirement for the FRC to monitor auditor independence, and added responsibilities in the area of audit quality. The FRC is now required to give 'strategic policy advice and reports, to the Minister and professional accounting bodies, in relation to the quality of audits conducted by Australian auditors'.[6]

2.6        In developing Australian Auditing Standards (ASAs), the FRC has directed AUASB to use the International Auditing and Assurance Standards Board (IAASB) International Standards on Auditing, and to make any necessary amendments such that the ASAs are 'legally enforceable under the requirements of the Corporations Act 2001'.[7]

2.7        The current ASAs that were issued in October 2009 'conform with the equivalent International Standards on Auditing (ISAs)' and are 'operative for financial reporting periods that commenced on or after 1 January 2010'.[8] The 2011–12 financial year was also the 'second full year of adoption of the ASAs in Clarity format',[9] intended to be clear, comprehensive, and easier to understand and apply.

2.8        Auditor independence is a fundamental principle of the external auditing system.[10] The AUASB has developed a set of requirements to which independent auditors are required to adhere, including ethical requirements, professional scepticism and judgement, and obtaining sufficient appropriate evidence:

Ethical Requirements Relating to an Audit of a Financial Report

14. The auditor shall comply with relevant ethical requirements, including those pertaining to independence, relating to a financial report audit engagement.

Professional Scepticism

15. The auditor shall plan and perform an audit with professional scepticism recognising that circumstances may exist that cause the financial report to be materially misstated.

Professional Judgement

16. The auditor shall exercise professional judgement in planning and performing an audit of a financial report.

Sufficient Appropriate Audit Evidence and Audit Risk

17. To obtain reasonable assurance, the auditor shall obtain sufficient appropriate audit evidence to reduce audit risk to an acceptably low level and thereby enable the auditor to draw reasonable conclusions on which to base the auditor’s opinion.[11]

Recent changes to the audit supervision framework

2.9        In March 2010, Treasury released the consultation paper Audit Quality in Australia: A Strategic Review. The paper found that Australia's 'audit regulation framework is robust and stable' and 'in line with international best practice'.

2.10      Although Treasury agreed with the findings of the United Kingdom Financial Reporting Council (UKFRC) on the drivers of audit quality,[12] Treasury emphasised two crucial and unique attributes applicable to Australia:

• Australia’s audit regulation framework; and
• the audit review processes, and in particular, ASIC’s audit inspection program.

In particular, Treasury noted that the Australian Securities and Investments Commission (ASIC) is a statutory body under federal legislation and that accounting and auditing standards and auditor independence are all legally enforceable under the Corporations Act.[13] These two factors contributed significantly to the robustness of the audit regulation framework.

2.11      While Treasury found that the overall legislative framework did not require 'fundamental reform',[14] it did identify some areas for policy reform. The Audit Enhancement Act made a number of amendments aimed at improving audit quality. The measures include:

• auditor partner rotation: the existing requirement that, for audits of listed companies, the audit partner must be rotated every five years was retained but listed companies are now able to extend the period by up to two years subject to auditor independence and audit quality safeguards;
• annual transparency reports: audit firms that conduct 10 or more audits of large entities are now required to publish an annual transparency report;
• audit deficiency reports: ASIC is now able to publish a report on the auditing deficiencies identified in an individual audit firm if the firm has not taken appropriate action to remedy the deficiencies within six months; and
• communication by ASIC: ASIC is now able to communicate directly with an audit client in relation to significant matters, such as the conduct of an audit by an audit firm (the confidentiality requirements of the ASIC Act previously prevented this).[15]

Audits of self-managed superannuation funds

2.12      The Superannuation Laws Amendment (Capital Gains Tax Relief and Other Efficiency Measures) Act 2012 introduced a requirement for auditors of self-managed superannuation funds (SMSF) to register with ASIC to conduct SMSF audits from 1 July 2013.[16]

2.13      As at 15 March 2013, ASIC's online registration system for SMSF auditors had received about 2000 applications, of which ASIC had registered about 400. ASIC expects about 6000 applications to be made.[17]

2.14      Mr Greg Tanzer, ASIC Commissioner, stressed that the registration system raises standards by administering a competency exam designed to test critical judgement in relation to superannuation requirements and tax compliance. He noted that 'some exemptions' from the test would be granted to 'existing auditors with substantial experience'.[18]

ASIC's concerns with auditing quality

2.15      In his opening statement at the public hearing on 3 December 2012, ASIC Chairman Mr Greg Medcraft raised concerns about the quality of auditing in Australia.[19] These concerns foreshadowed the findings contained in the ASIC audit inspection report which was due for release on 4 December 2012.[20]

2.16      The ASIC audit inspection report for 2011–12 found that:

...in 18% of the 602 key audit areas that we reviewed across 117 audit files over firms of all sizes, auditors did not obtain sufficient appropriate audit evidence, exercise sufficient scepticism, or otherwise comply with auditing standards in a significant audit area.[21]

2.17      At the December hearing, Mr Medcraft expressed his disappointment with the results and noted that they represented a further decline in auditing standards from those that ASIC had previously reported on:

...last year I indicated that a level of 15 per cent was already far too high in terms of having problems where it really was inadequate evidence to support an audit opinion. I think clearly we expect as a country that that number should be substantially less than 10 per cent and, in terms of audit quality, significantly less. These results, I find, being a former auditor and chartered accountant, very disappointing and frustrating. I consider what we are seeing now as [a] second strike for the audit sector and it is clearly one I think the profession should consider itself on notice: it needs to lift its game.[22]

2.18      In the report, ASIC identified three areas of deficiency that required improvement:

• the sufficiency and appropriateness of audit evidence obtained by the auditor;
• the level of professional scepticism exercised by auditors; and
• the extent of reliance that can be placed on the work of other auditors and experts.[23]

2.19      At the December hearing, Mr Medcraft identified a lack of professional scepticism as the key failing:

...clearly, it is a lack of scepticism ... You are there as an auditor and you are meant to be sceptical about seeing what is presented to you.[24]

2.20      The ASIC oversight hearings in March 2013 provided the committee with an opportunity to explore these issues further with some of the bodies involved in the auditing process, including the AUASB, the FRC, the Institute of Chartered Accountants Australia (ICAA), CPA Australia, Treasury, and ASIC.

2.21      In his opening comment, Mr Jim Murphy, Executive Director of the Markets Group at Treasury, stated that from Treasury's perspective, the need for an increase in standards had not been conclusively determined:

In terms of policy it is an open question as to the standard of audit quality in Australia...I think ASIC is very cognisant of that view and their program of checking on audit quality is very important. That said, there are international issues abroad where questions about audit quality are being asked...I think we have to keep a very close watch on how audit quality is happening in Australia and whether there is really a need for an uplift in the standards.[25]

2.22      The committee asked the industry bodies for their comments on the ASIC findings. There was agreement between the ICAA, CPA Australia, the AUASB and the FRC that professional scepticism and critical judgement are crucial in the audit process.[26]

2.23      Ms Liz Stamford, Head of Audit Policy at the ICAA, pointed out that in their 2012 survey of 1700 partners, managers, newly qualified accountants and graduates, 97 per cent 'rated professional scepticism as one of the top three most important skills in their role'.[27]

2.24      Mr Amir Ghandar, Policy Adviser on Audit and Assurance for CPA Australia, explained that professional scepticism is relevant to the entire audit process and includes applying critical judgement to risks, asset valuation and asset existence:

It is an attitude. It is a question in mind. You could say, if I could use a vulgar analogy, there is an art and a science in auditing, and professional scepticism is something that falls squarely within the art of auditing. It is the approach and that manifests itself in decisions that auditors make and in the behaviours based on those decisions, including things like identifying where there is a conflict between something they have seen in evidence and what is actually presented in the financial statements. It includes suspending judgement until there is enough evidence available to make a decision or a conclusion in a particular matter. When it comes to obtaining audit evidence as to the existence of assets that are stated on the balance sheet, auditors under the audit standards apply a risk based approach to determine what level of risk is involved in the existence of those assets. In fact, that assets exist is an auditing term. They then perform procedures based on that assessment of risk that allow the auditor to obtain reasonable assurance as to the existence of the asset.[28]

2.25      The committee draws attention to the role of auditors in the collapse of Trio Capital. In its report into the collapse, the committee expressed concern that auditors' approval of financial statements does not necessarily mean that the actual assets underlying the financial statements exist. Further, an auditor's assessment of a compliance plan and the work of the compliance committee as 'effective' essentially only means that they exist. The committee noted then, as now, that in the case of Trio, the requirement for the auditors to demonstrate 'professional scepticism' about the information given to them was insufficient to prevent the loss of investors' funds.[29]

2.26      Ms Lynette Wood, Chair of the FRC, stated that in the wake of the new requirements regarding FRC responsibility for audit quality under the Audit Enhancement Act, the FRC had 'established an Audit Quality Committee in late 2012'.[30] The committee includes members from the FRC, AUASB, APRA, ASIC, the Australian Institute of Company Directors, CPA Australia, ICAA, and the G100, a group of Australia's senior finance executives.[31] The FRC was 'very concerned' about the ASIC findings and they have been a topic of discussion among stakeholders on the Audit Quality Committee.[32] The FRC also pointed out that it now tests for professional scepticism when it interviews candidates for AUASB board positions.[33]

2.27      Ms Merran Kelsall, Chair and Chief Executive Officer of the AUASB,  noted that the AUASB auditing standards 'adopt and conform with the full suite of international standards on auditing' issued by the IAASB.[34] She pointed out that her role as a standard setter did not qualify her to express a view on the accuracy of the ASIC findings.[35] However, she did observe that there has been a significant raising of the bar in terms of auditing standards since the end of 2011, and that rather than conveying a sense of despair, it was important to clearly articulate to auditing firms those areas that ASIC has identified for improvement.[36]

2.28      The ICAA also remarked on the 'significant changes to the actual standards, the expectations of the work and the documentation of that work' that have eventuated as a result of the new standards, and that this may have influenced the ASIC findings to some extent.[37]

2.29      Both the ICAA and CPA Australia stated that they took the ASIC feedback 'very seriously'.[38] In a letter to the committee, CPA Australia Chief Executive Alex Malley stated that CPA Australia 'considers audit quality of paramount importance and is absolutely committed to constant improvement'.[39]

2.30      Both the ICAA and CPA Australia stated that the ASIC inspection report provided valuable feedback for the profession. Ms Stamford and Mr Ghandar both emphasised that their organisations actively incorporate the ASIC insights and focus areas into their training programs, professional reviews, communications, events and guidance. ICAA now has a focus on behavioural training and is emphasising to its members the role of coaching and mentoring in demonstrating to junior staff the application of professional scepticism.[40] Similarly, CPA Australia is:

...active in promoting the focus areas and building the focus areas into training, our professional program, quality review and other key audit quality infrastructure. We, in fact, host podcasts with representatives from ASIC about the focus areas on our website.[41]

2.31      There was, however, criticism of ASIC's conclusion about the overall level of audit quality, and also the way that ASIC had publicised those findings. CPA Australia took issue with the conclusions drawn by ASIC based on the methodology that ASIC used to conduct its audit inspection review. Mr Malley stated that the risk-based sample used by ASIC was unrepresentative of the total population and therefore unsuitable as the basis for drawing generalised conclusions. Mr Malley also criticised the approach taken by ASIC in its dealings with the profession:

...ASIC has persistently demonstrated a propensity to make statements in a range of public forums that are sensationalised and driven by a media grab mentality rather than seeking constructive outcomes and working collaboratively with the profession.[42]

2.32      These sentiments and the potential for public confusion were reiterated by Mr Ghandar at the public hearing:

As an auditor, I am very aware of the importance of the nature of a sample, and the types of conclusions that can be drawn from it, including how the sample was selected and whether it is representative of the underlying population. The ASIC audit inspection program is not a representative sample of audits in Australia, hence CPA Australia questions the persistent statements on audit quality in Australia from ASIC's communications that have been widely reported in the media.

The mantra of one in six audits being deficient, of frustration, of disappointment and failure are just not backed up by the science and logic you would expect, given the ramifications of such statements. A risk-based sample is, in fact, intended to select audit files that are more likely to contain issues. Further, the basis of reporting, sample selection and the inspection work may vary from one period to the next, also putting ASIC's statement of a decline in audit quality under question. This is tough language. A reasonable person would conclude that this is for public consumption, not for the profession. It is tough talk giving an impression of action, of activity by the regulator. We are concerned that this could be confusing to the community...In our view, it is of utmost importance to the public interest to provide confidence and clarity to the community. It is clear that the impact of ASIC's language around its most recent inspection report is unhelpful to the objective of the program—to promote high-quality financial statement audits—as it distracts from the real value of the program: identifying focus areas and fostering a constructive dialogue with the profession.[43]

2.33      While recognising that '[m]any audit matters are matters of judgement', ASIC has expressed confidence in the processes that they undertake for their audit inspection program and noted that their findings appear to be in line with other reviews of audit quality, both within Australia and globally:

...we are confident in our processes. Our senior executive reviews all the reviews to ensure consistency before they go out. We have a staff member at the moment who is a secondee from the Canadian regulator. In particular instances he has provided feedback that how we see the issues would be consistent with how the Canadian regulator would see the issues. In addition to that, the trend that we are seeing is consistent with a number of other trends, which include the ICAA's audit quality report, various international regulators' reviews of audit quality. It is also consistent, as I understand it, with the firm's own internal quality reviews.[44]

Committee view

2.34      The committee is reassured, at least to some degree, that there is a commitment to improving the audit process among the key stakeholders. However, it draws attention to high profile cases, such as Trio Capital and Banksia Securities, where auditors failed to undertake an adequate inspection of financial statements. To the committee's mind, there remains a need for ASIC to continue to carefully scrutinise the quality of auditing in Australia and the framework and standards within which the audit profession operates. 

Structure of the auditing industry

2.35      The structure of the audit industry is of particular interest given that four large audit firms dominate the global and Australian audit market: PricewaterhouseCoopers, Deloitte, Ernst & Young, and KPMG. This has raised concerns both internationally and within Australia about the extent of competition within the audit market and its potential impacts on audit quality.

2.36      In February 2013, the United Kingdom (UK) Competition Commission issued the provisional findings of its market investigation into the supply of statutory audit services to large companies in the UK. It concluded that competition in the audit market 'is restricted by factors which inhibit companies from switching auditors and by the tendency for auditors to focus on satisfying management rather than shareholder needs'.[45]

2.37      Ms Laura Carstensen, chair of the UK Audit Investigation Group, found that existing safeguards, such as audit committees, appeared insufficient to prevent misaligned auditor incentives or to facilitate a dynamic and independent auditing market:

Shareholders play very little role in appointing auditors compared to executive management—and despite the presence of audit committees and other safeguards—audit firms naturally focus more on meeting management interests. The result is a rather static market in which too often audits don’t fulfil their intended purpose and thus fail to meet the needs of shareholders.

It is clear that there is significant dissatisfaction amongst some institutional investors with the relevance and extent of reporting in audited financial reports. This needs to change so that external audit becomes a more genuinely independent and challenging exercise where auditors are less like corporate advisors and more like examining inspectors.[46]

2.38      The consideration of mandatory audit firm rotation (covered in the next section) is one of the possible remedies that the UK Competition Commission is considering in the wake of these findings.[47]

2.39      Given developments overseas, changes in the structure of the Australian audit market are of interest. CPA Australia provided the committee with the preliminary results of a study into competition in the ASX-listed company audit market.[48]

2.40      The significance of the changes in the audit market between 2000 and 2011 depends on the measure chosen. The size of the market captured by the big four audit firms has decreased markedly in terms of the volume of financial audits, but there has been only a very slight reduction in market dominance by the big four in terms of the share of audit fees:

• market share by number of ASX listed company financial statement audits of the largest audit firms decreased from 63 per cent to 44 per cent; and
• market share by audit fees of the largest audit firms decreased from 91 per cent to 87 per cent.[49]

2.41      The gains in market share have accrued to the large medium- and medium-sized audit firms. The market share of small audit firms is very small and decreased marginally over the study period.[50]

2.42      The study attributed the 'lesser decrease in market share by audit fees compared to number of ASX listed company financial statement audits' to the following factors:

• the larger audit firms are focusing on larger company financial statement audits, while small and medium audit firms have focused on medium and smaller listed company financial statement audits, and taken on many of the newly listed company financial statement audits over the period of analysis;
• the impact of an increase in the scale of [the] largest listed companies due to global and national acquisition/merger activity and growth; and
• significant step up in scale of listed entities at the top tier of the market (S&P/ASX 200) as compared to the scale of medium and smaller sized listed companies.[51]

2.43      The headline conclusion from the CPA Australia and the Accounting and Finance Association of Australia and New Zealand (AFAANZ) study is that their findings 'indicate a competitive and complex market' for audit services.[52]

Mandatory rotation of audit firms

2.44      ASIC noted that the issue of mandatory auditor rotation was being discussed within the European Union and recommended that it should be considered in Australia with a view to ensuring that Australia remained mindful of what was occurring in overseas jurisdictions.[53]

2.45      Mr John Price, ASIC Commissioner, laid forth some of the key arguments for and against audit firm rotation. Arguments for audit firm rotation include:

• concerns about auditor objectivity given that fees are paid by the audited entity;
• concerns about audit quality, including professional scepticism;
• concerns about independence issues between auditor and client; and
• bringing a fresh mind to the audit and challenging long-standing accounting treatments.

Arguments against audit firm rotation include:

• the loss of a long-standing client might result in reduced remuneration and loss of standing for the audit firm;
• additional costs to the client in a new auditor coming up to speed;
• lack of familiarity might cause the new auditor to miss things that an auditor more familiar with the business would spot;
• the cost to a client firm of the audit tendering process;
• a long-term relationship with the audited entity's management actually facilitates a good relationship, discussion and understanding of the business; and
• the fact that audit partner rotation in Australia may deal to some extent with the issue of a new set of eyes coming in.[54]

2.46      Mr Medcraft expressed the view that, given the seriousness of the audit quality results, a 10-year rotation would mitigate some of the up-front costs and 'is probably not unreasonable to consider'.[55]

2.47      Mr Ghandar agreed that all options to improve audit quality should be considered, but noted that the evidence on the mandatory rotation of audit firms was 'very mixed' and the benefits were uncertain. By contrast, Mr Ghandar said that research on the system of audit partner rotation was positive:

In Australia we already have a regime of partner rotation which has been shown to provide clear benefits in terms of independence through independent research.[56]

Auditing quality in rural and regional Australia

2.48      Auditing quality in rural and regional Australia was identified as an area of concern by the committee. Ms Stamford said that senior experienced practitioners go to regional areas with the ICAA quality review program, and also attend regional conferences. Ms Kelsall added that in 2005 the AUASB identified a lack of awareness and understanding in small firms about the legally enforceable standards introduced. Since that time, the accounting bodies and larger firms have devoted significant resources to this issue, 'which is why there is such a robust engagement program now with smaller and regional firms'.[57]

2.49      In response to questions about a difference in audit quality between cities and the regions, Mr Ghandar did not accept that there was necessarily better audit quality in the cities. His view is that the audit profession faces similar challenges to other professions in attracting professionals to work in a regional setting:

...there is, of course, a challenge in attracting registered company auditors to regional settings, as there is in many different fields. We see the same thing with doctors, lawyers, teachers and just about any field. I think it is fantastic to draw attention to that and, CPA Australia certainly does everything that we can to promote the attractiveness of the profession to those working in a regional setting, and also provide those with all the resources that we can—whether those are conferences, training or a direct interface with them.[58]

Dealing with areas of greatest risk in an audit

2.50      The committee questioned industry bodies about the areas that might cause the greatest risk in terms of auditing. Areas of concern included:

• determining the depreciation periods for assets;
• judgements as to whether particular expenditure can be regarded as capital investment and therefore not expensed;[59]
• complex valuations, particularly in difficult markets or where there is little market at all because no transactions have taken place; and
• group audits of global entities across multiple jurisdictions.[60]

2.51      Ms Stamford observed that the new Clarity standards require an auditor to focus on the area of greatest risk at the outset and therefore to design the audit process around that risk.[61]

Potential conflicts of interest

2.52      The committee also wanted to understand what industry procedures are in place to deal with the conflicts that may arise between auditors and client firms when an auditing firm may have other lucrative contracts with the client firm.

2.53      The ICAA identified a range of elements to deal with inherent conflicts such as training; coaching; the application of the relevant standards, including 'a team planning meeting at the beginning where the objectives of the audit are discussed, the risks are discussed, the risks of fraud are discussed'; review by a more senior person; and prioritisation of scepticism. Ms Stamford noted that retention of the client is not part of what the audit firm is trying to achieve.[62]

Proposals for audit-only firms

2.54      ASIC noted that there is discussion in Europe about restricting the non-audit services that audit firms can provide to clients. Mr Price laid out some of the arguments for and against such provisions, and also noted that the United States of America (USA) already has certain provisions in this area:

What you are really talking about there is the provision of non-audit services to audit clients. There are some restrictions already in Australia in terms of how that can be dealt with—although they are on a principles basis. There has been some discussion in overseas jurisdictions, particularly Europe, about prohibiting audit firms from providing non-audit services to their audit clients—so things like tax services, bookkeeping, valuations, actuarial services, and legal services. Arguments for that sort of approach include that it enhances actual and perceived objectivity of auditors, I think. Independent specialists could be sought to provide those other services. It could provide greater certainty as to what non-audit services are and are not acceptable, if you have a hard line of what is allowed and what is not allowed. As far as international jurisdictions go, it is important to note that the US already takes a more prescriptive type approach to prohibited non-audit services by audit firms. As with everything there are arguments against as well. On the other side there are possible efficiencies in firm specialists providing non-audit services, and greater effectiveness when you have all of that in-house. Specialist areas might also end up having to reduce resources if effectively they are carved out of audit firms, so you might not get the same quality of those non-audit specialist services. Also, there might be less attractiveness in going to work for some of the larger firms if you have either got to be on the audit side or on the non-audit side. They are some of the arguments for and against.

...We are analysing the merits for and against. It is very important for us to understand what is happening in overseas jurisdictions. The consultation processes that are underway in some of these jurisdictions are very significant, both in the EU and the UK, and they are largely able to be translated to the Australian environment. It is simply recognising that Australia, as with all things in business, operates in a globalised environment and where we do have rules that are materially out of line with those environments there is a risk that it either diminishes confidence in Australia as a place to make investments, and that increases our cost of capital, or alternatively it increases the cost of doing business in Australia if someone is also doing business overseas because you are meeting two different requirements.[63]

2.55      CPA Australia expressed concern about the notion of audit-only firms. Mr Malley disputed the idea that conditions in the USA and Europe correspond to Australia.[64] Mr Ghandar pointed out that restrictions exist to prevent an audit firm providing conflicting audit and non-audit services to a client. He drew a distinction between those restrictions and the idea of preventing an audit firm providing non-audit services to a different client:

There are already quite stringent requirements that were put in place last decade, and did exist before that but were strengthened significantly last decade in the aftermath of Enron et cetera. Those prevent auditors from providing consulting or conflicting services to clients whose financial statements they are auditing. It is a completely different matter to extend that to auditors or audit firms being able to provide consulting services anywhere. In an environment where business is becoming more and more complex and these other areas are so much more important, it seems to me that you would want to be bringing more expertise within the audit firm so that that is on tap in those complex audits, rather than trying to create a sort of siloed audit-only firm.[65]

ASIC efforts to improve audit quality

2.56      ASIC indicated to the committee that it is keen to be proactive in improving audit quality in Australia. Mr Price outlined five key areas that ASIC is targeting, including:

• meeting with the six largest audit firms in Australia to help them prepare an internal action plan to improve audit quality;
• working with other audit oversight regulators and security regulators internationally on strategies to improve audit firm quality;
• suggesting improvements to auditing standards both in Australia and internationally to provide better guidance to auditors;
• speaking to audit committee chairs within companies and encouraging them to ask audit firms about whether there were any ASIC findings in respect of the audit performed for their company; and
• taking enforcement action where required.[66]

Industry suggestions to improve audit quality

2.57      CPA Australia drew attention to other initiatives that may have the potential to improve audit quality as well as 'the information that investors are receiving', such as integrated reporting and auditor commentary:

[I]integrated reporting ... seeks to provide a more holistic view into company business models and risks, therefore allowing investors and their advisers to anticipate more readily what may happen in the future. There is also auditor commentary and improving auditor reporting. While they are a challenge to work through, those initiatives have the possibility of setting up an environment where auditors would compete on the clarity and the usefulness of the information they are providing in the audit report.[67]

Committee view

2.58      The committee acknowledges the recognition by the accounting and auditing professions of the importance of professional scepticism. However, based on the findings of ASIC, there appears to be a gap between an articulated acknowledgement of the importance of professional scepticism and its consistent application to the auditing process. The committee is pleased that the professional bodies are promoting behavioural change, but it remains concerned that a clear strategy has not been articulated if the efforts by the various bodies do not lead to measurable improvements in audit quality.

2.59      The committee shares ASIC's concern about audit quality in Australia and is pleased that ASIC has a policy of constructive engagement with the audit firms and professional bodies. The committee looks forward to an update from ASIC on how it has worked with the large audit firms on their action plans to improve audit quality and whether there has been constructive engagement with all the relevant firms.

2.60      The committee notes that professional bodies such as CPA Australia and the ICAA acknowledge the need to maintain and extend their programs of professional support in regional and rural areas and commends them for their efforts. The committee looks forward to hearing from ASIC about their discussions with the largest audit firms on the issue of ongoing professional relationships and mentoring between large city audit firms and small regional audit firms.

2.61      The committee is concerned about the standard of training in the auditing industry and that university courses and professional training do not appear to be instilling in auditors a sufficient degree of critical judgement. The committee notes ASIC's comments on graduate qualities, and is interested to learn from ASIC what progress they have made in facilitating an improvement in the level of scepticism among graduates.

2.62      The committee is keen to know more about the approaches that ASIC has made to audit committee chairs within client firms.

2.63      The committee would like further clarification of the extent to which conditions in the USA and Europe translate to the Australian context, particularly with regard to discussions about audit-only provisions for audit firms and mandatory audit firm rotation. The committee believes that all options should be considered, and that ASIC needs to be both mindful of international developments and differences between the Australian economy and other jurisdictions.

2.64      The committee notes that CPA Australia and AFAANZ conclude that the Australian audit market is competitive. However, the committee remains concerned about the structure of the audit industry despite the gains in market share made by large medium- and medium-sized firms. The committee notes that the big four audit firms continue to dominate the market in terms of their command of audit fees, suggesting that mid-tier firms may face barriers in competing in the top end of the listed market.

2.65      The committee is concerned about the relationships between auditors and client firms, in particular the inherent conflict involved in blowing the whistle on financial matters if it might jeopardise other lucrative contracts that an auditor has with a client firm.

2.66      The committee notes that CPA Australia drew attention to other initiatives that may have the potential to improve audit quality and investor information. The committee is keen to gain ASIC's perspectives on proposals such as integrated reporting and auditor commentary.

2.67      The committee acknowledges the evidence provided by industry and professional bodies about what an audit actually encompasses, but it remains concerned about the gap that exists between what the public expects and what the public gets with regard to an audit.

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