By Rachel Waterhouse, CEO, Australian Shareholders’ Association

Audit independence is often treated as a technical issue. It is not.

For shareholders, audit independence goes to the heart of trust and transparency. Investors rely on audited accounts to make decisions. They need confidence that the numbers, and the accounting assumptions and policies underpinning them, have been tested independently, objectively and with professional judgement.

Recent scrutiny of KPMG Australia should matter to shareholders because it raises broader questions about trust in audit firms and the safeguards around independence, confidentiality, conflicts and professional conduct. Coming so soon after the PwC tax leaks scandal, it is reasonable for investors to ask whether governance, confidentiality, conflict management and professional conduct across the audit profession are being tested with the rigour shareholders should expect.

At the Australian Shareholders’ Association, we believe audit independence is central to investor confidence. ASIC Commissioner Kate O’Rourke has put the issue clearly: “Auditor independence is fundamental to trust in Australia’s financial reporting system. Auditors must avoid situations where their objectivity is compromised or could reasonably be seen to be compromised.”

Audit independence should not sit quietly at the back of an annual report.

Why trust in audit matters

There are two issues shareholders should keep in view.

The first is confidence in the audit firm itself. Companies rely on shareholders trusting that the external auditor is independent, objective and held to high professional and ethical standards. Where an audit firm faces serious questions about its governance, confidentiality, internal reporting processes or ethical culture, that confidence can be weakened. Once trust is weakened, the value of the external audit process is diminished.

The second is board accountability. Shareholders do not manage the audit relationship day to day. That responsibility sits with the board and the audit and risk committee. Boards must be able to explain how they assess independence, manage conflicts, review performance and decide why the auditor remains appropriate.

Audit firms must earn trust. Boards must test and explain that trust. Shareholders should not assume either.

The board’s role

Audit depends on credibility. The audit opinion carries weight because shareholders are entitled to expect the auditor to be independent, objective and held to high standards at all times.

When an auditor appointment, reappointment or change comes before shareholders, it should be treated as a genuine governance issue, not a routine resolution. The Notice of Meeting should clearly explain the reasons for any change in external auditor and the basis on which the auditor has been selected.

Australia does not currently require mandatory audit firm rotation for listed entities in the same way as the United Kingdom and European Union regimes for public interest entities, where maximum tenure and tendering requirements apply. While an individual may not play a significant role in the audit of a listed entity for more than five out of seven successive financial years under the Corporations Act, the audit firm itself may continue as auditor for many years if the board considers this appropriate.

Mandatory firm rotation is not without critics. It can in some instances increase costs and reduce company-specific knowledge. However, long auditor tenure can create familiarity risks and weaken the perception of independence, particularly where consulting services are provided by the same firm. At a minimum, boards should explain why retaining a long-serving audit firm remains in shareholders’ best interests and how they have tested the market through periodic competitive tendering.

Even where no auditor resolution appears on the AGM agenda, shareholders are not powerless. They vote on directors, including audit committee chairs when they stand for election or re-election. They can ask questions at AGMs and challenge boards on audit tenure, tender processes, former audit firm relationships and conflict management.

Former audit partners serving on listed company boards also deserve closer attention. There should not be a blanket rule against this. Many bring expertise in financial reporting, assurance, risk and governance. But expertise does not remove the need for distance, disclosure and judgement.

Where a director has a current or former relationship with the company’s external audit firm, shareholders need more than a generic independence statement. They are entitled to understand how the board assessed that relationship, what safeguards were used, and whether the director was excluded from decisions involving an actual or perceived conflict.

What shareholders should ask

Shareholders are not able or expected to inspect audit files or second-guess accounting standards. Their role is to hold boards accountable for the quality of audit oversight.

That means looking beyond the name of the audit firm. Shareholders should consider how long the firm has served, whether the audit has been competitively tendered, what non-audit services were provided, what the audit committee says about independence, and whether disclosed relationships raise reasonable questions about conflicts.

They should also read the auditor’s report in the annual report, particularly any qualification, emphasis of matter or Key Audit Matters. These sections can highlight areas of significant judgement, complexity or risk, and help shareholders understand what the auditor focused on.

Useful questions for AGMs include:

• When was the external audit last competitively tendered, and why does the board consider the current firm to remain the best choice?
• What non-audit services were provided by the auditor during the year, what was the value of those services as a percentage of audit fees, and what factors did the board consider in determining that auditor independence was not compromised?
• Where a director has a former relationship with the audit firm, what specific safeguards or recusals apply?
• Given the publicly reported regulatory, governance or conduct issues affecting the company’s external audit firm, what additional assurance has the Audit and Risk Committee sought about audit quality, independence, confidentiality of information and the integrity of the engagement team?
• What criteria does the board use to assess the external auditor’s continuing appointment, including audit quality, independence, tenure, non-audit services, sector expertise and engagement team performance?
• How does the Audit and Risk Committee assess the quality, depth and challenge of the external audit, particularly in relation to significant accounting judgements and Key Audit Matters?
• Were any Key Audit Matters, significant judgements or areas of audit focus raised by the auditor that are not fully addressed in the company’s annual report disclosures?

These are not technical questions for technical purposes. They go to whether the board is exercising proper oversight on behalf of shareholders.

Confidence must be earned

The answer is not cynicism about the audit profession. High-quality audit is important to shareholders, companies and the broader economy.

But trust in audit depends on more than reputation. It depends on transparency, strong governance and a willingness by audit firms and boards to confront conflicts before they become matters of public concern.

KPMG Australia has acknowledged that its treatment of a whistleblower and its investigation into the allegations fell short of expectations. Coming after the PwC tax leaks scandal, the wider point for shareholders is that listed company boards also need to show how they test audit quality, independence and confidence in the external auditor.

For shareholders, the message is clear: read the disclosures, question the assumptions, and use voting opportunities where there are concerns. The questions shareholders ask, and the votes they cast, send a signal to both boards and auditors about the standards they expect.