Jun 01 2020
Auditors have been under extreme scrutiny over the past few years following a number of scandals and collapses of high-profile businesses. The latest Audit Quality Inspection results revealed that 33% of audits were below standard, while the number of insolvencies and business failures continues to rise. Not only have firms collapsed, but audit firms are now suffering reputational damage, letting down shareholders and the public interest. Poor performance has led to a number of reviews, notably the March 2019 Kingman review and the December 2019 Brydon Review, to improve quality and restore trust. This article examines the issues auditing firms are facing and how IBISWorld, as a trusted market research provider, can offer solutions.
Falling audit quality
- Commercial awareness and upskilling: a lack of reliable sources to quickly gather information and use as a benchmark against the company can lower the quality of audit.
- Failure to challenge: an auditor may lack the sufficient knowledge of a company’s business model or the impacts of its external environment, which leads to failure to challenge the firm’s assumptions and increases the scope for a scandal or even the collapse of a company.
- Low fee model: business model relies on volume. With time constraints, auditing becomes a box-ticking exercise rather than a thorough investigation. Furthermore, audit practices generate approximately 20% of revenue for the Big Four and are less profitable than services such as consultancy, which diminishes the value and importance placed on audits.
How IBISWorld helps
Solution 1: Commercial awareness
No company, and consequently no industry, operates in isolation. The industry is a company’s all-encompassing ‘environment’ and it is imperative that auditors understand this environment to be successful.
Even at the planning stage, auditors must be knowledgeable of a client’s key competitors, the trends within the largest buying markets and the performance of the products and services to accurately assess and flag the short- and long-term operational risks.
Our Industry Risk Rating Reports assess the structural, growth and sensitivity risks a client may face for the next 15-18 months, while our Industry Reports delve a little further into each of these drivers.
Our products cut research time, enable auditors of all experience to gain an immediate understanding of a client’s business, and help educate and build credibility and quality among the profession.
Solution 2: Professional scepticism
Industry information equips examiners with an arsenal of credible data and analysis to gain a deeper understanding of a business; an understanding that is a pre-condition to professional scepticism. With greater industry insight, auditors can benchmark performance, challenge clients with confidence, ask questions that may otherwise go unheard and apply a greater level of scepticism to ensure material misstatements are detected.
Consider the following:
An auditor is asked to examine the financial statements for a firm that operates in the Dairy Cattle Raising industry.
The client has reported revenue growth of 5% over the five years through 2020-21, primarily driven by milk for liquid consumption (increase in volume) and rising prices (value), and an operating margin of 7.7%.
However, the IBISWorld current performance section tells you the industry revenue has declined at a compound annual rate of 0.2% over the five-year period. The Products & Services section suggests liquid milk consumption per capita has fallen due to growing migration trends. Meanwhile, the Key External Driver, the farmgate price of milk, has fallen following the removal of the EU milk production quotas, and the Cost Structure Benchmark Section highlights that industry profit has declined over the five-year period, averaging 1.2% of revenue.
Such vast deviations between a client’s reported financials and the industry average warrant questioning. IBISWorld not only provides insight into a firm’s operating environment, but also offers a series of pre-written iExpert questions to help challenge client assumptions. An auditor needs specific industry information and data to conduct a credible audit and to ultimately execute professional scepticism.
Solution 3: Value-added services
Auditors are also experiencing unprecedented attrition from clients who want more value for their money. It is imperative to move away from simply checking boxes to offering more in-depth analysis and actionable insight. IBISWorld not only helps you ask questions and appropriately apply professional standards, but also equips you with knowledge to provide a more personal service and move away from price-based competition.
Consider the following:
A company in the Breakfast Cereals & Cereal-Based Foods Production industry is debating diversifying into non-dairy milk production. There are specific data points that can be shared, such as the growth rates, key success factors and barriers to entry, that might help make a difficult decision easier.
For instance, over the five years through 2020-21, the Non-Dairy Milk Production industry’s revenue is expected to grow at a compound annual rate of 19.3%, and rise at a compound annual rate of 12.8% over the five years through 2025-26, driven by changing lifestyles and diets, suggesting great growth potential.
After establishing demand, it is crucial to understand what makes the business successful. This can be identified under the Key Success Factors sub-section, which lists specific qualities that fruitful businesses operating in the industry possess.
The auditor needs to determine if the client has the appropriate resources and if they can compete. This can be identified under the industry’s supply chain network and barriers to entry. In this case, the client shares a similar operating environment and supply chain to the Non-Dairy Milk Production industry and there are therefore minimal barriers to entry: the client already has access to inputs (milled grains), a factory with all the necessary processing equipment, the health and safety certification and an established distribution network.
Having established the client has ability and assets to diversify, they need to determine how to compete, be it on price, or by entering the market with a niche product. This information can be found in the Basis of Competition sub-section.
The auditor may also turn to the IBISWorld Risk Rating Report, and taking this information into account and weighing all other cost factors, decide the diversification venture is viable.
This kind of information is vital for better and faster business decisions. To move away from box ticking and pricing pressures, auditors must provide insights on how to improve those numbers. A more personalised service garners credibility in the eyes of the client and retention.