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The Audit and Corporate Governance in the United Kingdom (UK)

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The Audit and Corporate Governance in the United Kingdom (UK)

Corporate governance and audit are essential functions that attract investors to a country.
The audit of the companies' annual financial statements is among the cornerstones of corporate
governance. Corporate governance is the set of policies and regulations that controls and directs
the operation of a company. Therefore, auditing, which establishes the financial status of a
company through specific procedures, significantly contributes to corporate governance. In the
United Kingdom, the audit of companies has been associated with increased corporate failure in
the nation leading to the deterioration of the corporate governance reputation. Auditors have
been publishing positive annual reports for companies, but the same companies collapse, which
has caused the public to lack trust in the audit profession in the nation. This paper critically
analyzes the UK's audit profession in relation to comments by a student on the matter of
increasing corporate failure in the nation.

The Current Status of the United Kingdom (UK) Auditing Profession

The United Kingdom (UK) has been experiencing an increased rate of corporate failure
in the last decade. The Insolvency Service released data that showed that in the last quarter of
2019, more than 17,196 companies had filed for insolvency (Parliament.UK, 2019). This was a
6.8% increase from the 2018 insolvencies and the highest number of underlying insolvencies
since 2013 (Parliament.UK, 2019). Among the biggest corporate collapse in the UK was the
Carillion collapse in January 2018 (Parliament.UK, 2019). The Carillion failure caused
significant economic degradation in the UK and worldwide since the company was operating
both in the UK and across other nations globally. By the end of 2019, other major corporate
failures were the BHS, Thomas Cook, British Steel, Wirecard, Petisserie Valerie, and a British
travel firm (Parliament.UK, 2019). One common thing among all companies that collapsed is
that all their financial audits showed that their financial health was good and the company could
sufficiently fund its operations. However, after the collapse, the companies indicated that their
financial statements had been cooked to hide crucial financial information. For example,
Carillion Company indicated that £1.9 billion cash was not in their account, while Petisserie
Valerie's books overestimated £94 million (Parliament.UK, 2019). The increasing collapse of
these companies causes more people to lose their jobs, others to lose their pensions, and the
government to lose revenue generated through taxes on these companies and their employees.
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The collapse of BHS led to the loss of more than 11,000 jobs, while Carillion had more than
20,000 employees losing their employees (Parliament.UK, 2019). Such occurrences mean that
the UK Auditing process and regulation are not as dependable and reliable as they should be.
When the auditing process is not properly executed and fails to detect malpractices in the
company's accounts, the consequences are severe not only to shareholders but also to
stakeholders such as pensioners, employees, suppliers, and customers who have vested their
interest in viability and success of the company (ICAEW, 2021).

On the contrary, most companies have been collapsing. At the same time, their financial
statements in audit reports show good financial health, including liabilities, assets, and losses or
profits, but still collapse (Neate & Davies, 2020). This has caused the public to distrust the
financial auditing profession because regardless of how well they show a company is doing
financially, they are not sure whether the reports are true or fabricated. The lack of trust in the
auditing profession has led to 83% of the UK population believing that the current auditing and
accounting system in the UK is incompetent. The regulations are weak because they motivate
directors and auditors to fabricate financial information with thousands of false entries to display
companies as profitable and successful to the public (Neate & Davies, 2020). In 2020, two years
after the collapse of high-profile corporates, the UK leadership has done nothing to mitigate the
increasing corporate failure, reputation degradation, and loss of public trust (Neate & Davies,
2020). The government's failure to learn from the corporate failure deepened the lack of trust and
damaged the reputation of the government auditing and accounting systems (Neate & Davies,
2020).

However, in 2021, the government launched a consultation on wide-ranging reforms

essential to regaining trust, rebuilding reputation, and modernizing the nation's audit and
corporate governance regimes (Kwarteng & Callanan, 2021). This was after the government
noticed it was losing its position as a global destination for foreign investors. The reforms are
intended to enhance corporate governance and increase regulatory power over auditors, audit
committees, and directors (Kwarteng & Callanan, 2021). Also, the reforms will enhance fraud
prevention and detection measures and introduce internal control assurance and reporting
(Kwarteng & Callanan, 2021). Although these reforms will be fully effective by 2024 and they
are undergoing scrutiny by professionals and comparison with regulation from nations with good
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auditing system history, it is an indication that the government is no longer turning a blind eye to
the matter (Kwarteng & Callanan, 2021). The government is now actively working towards
eliminating corporate failure and gaining back its reputation and trust from the public. Therefore,
the future is promising if the reforms are well-structured and implemented effectively.

Corporate Governance Issues

Corporate governance in the UK has always been viewed as one of the most effective
models that have significantly contributed to attracting international investors regardless of the
industry they are interested in. Corporate governance refers to the policies, rules, standards, and
qualities that a company's operation is directed and controlled (Financial Reporting Council,
2016). The system oversees the company's procedures, practices, and policies, and the board of
directors usually handles it. The shareholder's responsibility in corporate governance is to
appoint directors and auditors who can satisfy their corporate goals (Financial Reporting
Council, 2016). Since the directors are appointed by the shareholder and can be fired if they do
not fulfill the needs of shareholders, when the company's financial position is unstable, they will
tend to forge information to make their clients' shareholders happy, hoping to recover in the next
financial year. However, the corporate governance system in the UK is comprised of legislative
laws, market guidelines, and codes of practices which necessitates its efficient operation
(Financial Reporting Council, 2016). The Companies Act sets the default, mandatory
regulations, and legal standards derived from the common law, Disclosure and Transparency
Rules, and Listing Rules established by the Financial Conduct Authority (FCA) (Financier
Worldwide, 2022). The UK Corporate Governance Code is the most essential code of practice
and undergoes regular updating by the Financial Reporting Council (FRC). The code operation
principle is the "comply or explain" (Financier Worldwide, 2022).

Comply or Explain Approach

The FCA Listing Rules require all listed companies to follow comply or explain approach
(Financial Reporting Council, 2022). However, a company may choose whether or not to comply
with all its provisions or explain its non-compliance. The approach increases flexibility,
acknowledging that not all companies can be accommodated by a single governance regime
(Financial Reporting Council, 2022). The approach relies on shareholders' engagement to seek
further explanations for non-compliance. When the company shareholders are not content with
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the explanation of the directors, they have the right to remove and appoint other directors
(Financial Reporting Council, 2022). The approach requires company directors to report to the
shareholders instead of the authorities or regulators. Hence the adequacy of corporate
governance is established by those who elected the board of directors. This is a better way to
allow investors to scrutinise their investments or make good decisions before investing in a given
company, especially when the company has explained non-compliance. However, the directors
may be tempted to collude with the auditors or the shareholders to ensure the information given
to the public displays good corporate governance and can attract more investors to their
company.

The Role of Internal and External Auditors in a Company Auditing

External and internal audits are complementary duties under the assurance framework of
a company, and both are vital for effective corporate governance. However, these two functions
are distinct in terms of responsibilities, value, expertise, and who they should report to. The
external audit is a statutory function where the auditor is appointed in accordance with the
specification of the Compliance Act (ACCA, 2021). The Companies Act guides their
obligations, rights, and duties. The key role of the external auditors is to sufficiently work on the
company's financial statements and establish an independent opinion that shows whether the
statements show an accurate and fair view of the company's financial health (ACCA, 2021). The
opinion is shared with the shareholders, in the case of private and public companies, they report
to the legislation (ACCA, 2021). External auditors' reporting format follows the auditing
standards, and their reports are visible to the public domain through annual financial statements,
which are essential in filling the registrar of the company's forms (ACCA, 2021).

On the other hand, internal auditors can be the company’s employees or auditors
outsourced by the company board (ICAS, 2019). The audit charter sets out the internal audit's
rights, duties, and obligations (ICAS, 2019). Their key role is to provide internal audits and offer
an annual internal opinion on the company's state. They report to the board of directors through
the audit committee (ICAS, 2019). Internal auditors do not have a prescribed reporting format,
and their reports are not publicly visible. Therefore, one of the main reasons for having both
internal and external audits in a company is the different purposes of the audits. However, while
it is mandatory for all listed companies to perform an external audit, there exists no legal
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requirement for an internal audit in the UK (ICAS, 2019). Even though a company does not need
internal audits, companies need to perform internal audits. This is because internal audits can be
frequently conducted to detect fraud, errors, and actions that can deteriorate the company's
reputation. They are conducted according to the company's demand to establish how it complies
with legislative requirements and to help make decisions that will improve company production.
External audits are performed annually, and if there were errors, frauds, or non-compliances,
actions would have caused detrimental effects on the company’s financial position and increased
future risks of collapsing. Therefore, a company utilises internal audits for progressive
monitoring of company performance and prevention of risks, and external audits are hired for
compliance with the legislation and to confirm the work of the internal auditors.

External and internal audits should have a constructive relationship with regular
communication and information sharing. Though, it is critical to maintain independence and
objectivity in every function through clear boundaries. The external auditors may enquire about
information and clarification from internal auditors but should not use their work. The
International Standard on Auditing (ISA) was amended in 2013 in the "Using the Work of
Internal Auditors" section (CIIA, 2020). Although the ISA established circumstances that
external auditors might use an internal auditors’ work, in the UK, the FRC disallows external
auditors from getting direct assistance from using internal auditors (CIIA, 2020). Therefore,
external auditors should not rely on internal auditors' reports. Hence, if a company collapses even
when the most recent external audit shows a good financial position, the external auditors are
responsible for answering questions about the authenticity of their report. As stated above, the
two assurance frameworks should independently provide their opinion reports. Their work is to
detect misstatements, malpractices, or false entries independently. The board of directors will
question the internal auditors

Key Regulations in the UK Audit Profession

In the wake of increasing high-profile corporate failure in the UK, the government
realised that the previous regulations controlling and monitoring the audit and corporate
governance were becoming ineffective and required modification. The modification in the form
of reforms, "Restoring trust in audit and corporate governance," is intended to solve some of the
vital loopholes causing corporate failure in the UK (BEIS, 2021). The key concerns addressed by
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the reforms are holding directors into account, establishing clear fraud detection and prevention
policies, and empowering the shareholders. The Audit, Reporting, and Governance Authority
(ARGA) will enforce the regulations, which will replace the FRC (BEIS, 2021). The ARGA is a
statutory body that will promote and protect investors' and public interests.

Directors Accountability

The ARGA will have the authority to impose sanctions on directors who violate their
obligations with regard to corporate reporting and audit. This enforcement authority will apply to
all directors of Public Interest Entities (PIEs) and, in exceptional circumstances, to directors of
their subsidiaries (BEIS, 2021). The enforcement regulations will be essential in preventing
directors from working with auditors to present financial audits which only favour their interest
but rather the true depiction of the financial status of a company (BEIS, 2021). The strict policies
on the accountability of the directors will also be essential in detecting and preventing fraudulent
activities in audit processes. Fraudulent activities and directors' ability to work with the auditors
to falsify financial statements and report in their favour.

To ensure directors are accountable for their duties and there is no collusion with
auditors, policies against company directors are enforced in the UK. The ARGA will be
permitted to investigate and sanction breaches relating to corporate audits. The statutory policy
will ensure that directors demonstrate compliance with all policies.

Audit and Assurance Policy

The regulations on the audit and assurance policy are critical in controlling the quality of
work conducted by the directors and auditors. The statutory policy requires that after every three
years, listed companies will be required to issue an audit and assurance policy which ARGA will
use in assessing the company's approach to validating the information in the reports provided for
shareholders beyond the annual financial statements and audit reports (BEIS, 2021). The audit
and assurance policy will establish how companies are ensuring policy and adhering to all
regulations regarding the auditing process and corporate governance (BEIS, 2021). ARGA will
use the policy to ensure that all the companies are efficiently following regulations and the
auditing process is working according to the policy. Therefore, fraudulent activities or the
probability of auditors colluding with the directors will be eliminated. It is also essential to
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ensure that auditors perform their duties effectively. When the ARGA detects malpractices in the
auditing process, the involved party is supposed to face the legislative law.

Corporate Reporting Supervision

Instead of the ARGA seeking court orders to direct changes to company accounts and
reports like the FRC, the authority will be permitted to review the whole corporate reporting
process and direct any necessary changes (Dentons, 2022). This policy will ensure that the
auditors' and directors' malpractices in annual financial reporting are detected and prevented.
Since the whole audit process is monitored and supervised by ARGA, the auditors will always
approach directors as clients and perform their duties following the required rules to avoid
sanctions and degradation of their reputation.

Oversight Audit Committee and Shareholder Engagement

In addition to the existing policies on audit committees overseeing the audit and reporting
process, the government intends to set minim requirements that all audit committees should be
based on when appointing auditors (Dentons, 2022). The policy also creates provisions that
inspire shareholder engagement in the audit process.

Recommendations for Improving Audit and Corporate Governance in the UK

There is a great need to prevent further corporate failure in the UK. The increased
corporate collapsing in the region is associated with the loopholes in audit and corporate
governance regulations, where auditors and directors have been colluding to falsify information
in the financial reporting to display companies as profitable and worthy to invest yet, the
companies are on the verge of collapsing. Although there have been reforms suggested to
improve the audit and governance regulation in the UK, some essential improvements should be
adopted to improve the audit and governance process.

More power to FRC instead of Creating a New Authority

The plan to establish ARGA to replace FRC statutory duties may take longer, but ARGA
is the epicenter of the reforms (Dentons, 2022). Instead of establishing a new statutory body, the
government may give the proposed powers of ARGA to FRC. This will allow easy and faster
implementations of the suggested reforms in the nations. Also, FRC has experienced staff in
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audit and corporate governance, and therefore, it will be easy for them to enforce the new
policies with more power handed to them.

Analysis of Root Cause of Corporate Collapsing and Factors Affecting Quality of Audits

In collaboration with ARGA, the audit firms should undertake critical analysis to
establish the underlying root cause of the corporate failure or poor-quality audit (Hawes, Hoyle
& Sykes, 2022). When the company collapses, the ARGA and audit firms should explain in
detail, and establish what caused the company (Hawes, Hoyle & Sykes, 2022). This is to help in
the development of new policies which will prevent further corporate or audit failure based on
the identified causes.

Regular Revision of the Audit and Corporate Governance Policies

The world economics and business environment are changing, so corporate governance
strategies are changing (Hawes, Hoyle & Sykes, 2022). This means that audit procedures and
government regulations must be regularly revised to match modern requirements. New audit
threats or collusion strategies may be undetectable with the old procedures. Therefore, revising
the regulation and implementing modern strategies is essential.

In conclusion, the UK has been experiencing an increased rate of high-profile corporate

collapsing, which has been detrimental to the nation's economy. As the companies continued to
fail in the market, while the most recently published audit reports showed the companies were in
healthy financial status, investors, shareholders, stakeholders, and the general public doubted the
UK's audit and corporate governance system. Corporate governance in the UK has been viewed
as one of the most effective models that have significantly contributed to attracting international
investors regardless of the industry they are interested in. The UK Corporate Governance Code
under the Companies Act is an essential code of practice and operates under the principle of
"comply or explain." The Companies Act, in conjunction with other audit regulatory bodies, has
established the distinct roles of internal and external auditors. Although there is no legal
requirement for internal auditors, companies utilise them to continuously monitor company
progress and growth. In general, the audit profession is governed by key regulations that ensure
directors, shareholders, auditors, stakeholders, and regulatory authorities are effectively working
towards better corporate governance and preventing corporate failure. Some essential policies
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that ensure strict regulation and compliance by companies include directors' accountability, audit
assurance, and reporting supervision policies. As the UK strives to ensure corporate failure is
eliminated and its reputation as the best destination for investors is regained, the nation can
ensure that root causes for inadequate auditing and corporate failures are identified and policies
to control them established. Also, the nation can ensure a regular revision of the audit and
corporate governance policies. If the recommendations are implemented, the future of audit and
corporate governance in the UK will be promising, and the nation will regain its reputation and
the trust of the public.
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References

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