Rise of digital disruption in the auditing process

Friday, 18 October 2019 00:00 -     - {{hitsCtrl.values.hits}}

 


 “Andrew is purchased as a household robot programmed to perform menial tasks. The Martin family quickly learns that they don’t have an ordinary robot as Andrew begins to experience emotions and creative thoughts. In a story that spans two centuries, Andrew learns the intricacies of humanity, life  and love”

 

Director Chris Columbus invented this technology-driven movie called ‘Bicentennial Man’ in 1999. 

For filmmakers and storytellers alike, the future has always been a fountain of creative possibilities and endings, a way to grapple with our fears of the unknown by portraying them as fictions. Perhaps, one could go so far to say that futuristic stories are test run simulations of what our world could be. 

Nearly, 20 years later, today we are experiencing the reality hidden in this scientific fiction through Artificial Intelligence (Robots) and ‘The Fourth Industrial Revolution’ is fast approaching with a significant revolution in digital technology.

The emergence of digital technologies, from cloud computing to mobile to analytics, is fundamentally transforming the way organisations, both public and private sector operate. Financial management, including accounting, cash management, treasury, and banking, is in the middle of a digital transformation. 

Professional accountants in practice (‘auditors’) are part of that connected world. This is changing the ways in which they communicate and collaborate with those in the businesses they work with and for, and shaping new working patterns, methodologies and processes. In fact, this is a complete transformation of the external audit function starting from the primary objective of the audit and scope of the audit.

The primary objective of the audit is to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error. In meeting this objective, the auditor performs various audit procedures on a test basis (sample test) considering the level of risks on financial statement areas.

Tomorrow’s technology will completely change the objective and scope of the audit where complete verification of transactions, balances, processes will be in place with the support of the technology. This will enable auditor to express 100% assurance (rather reasonable assurance) by performing 100% verification of balances.

This will bring us to raise three critical concerns:

1. What are the key technology changes affect to financial reporting and auditing process? 

2. What challenges will external auditor be faced with digital disruption? 

3. What changes will be taken place in the auditing process and what opportunities are in place? 

 

 

Discussion of the problem

 

Talking about automation, digital disruption is in the top of the agenda and many business leaders are researching and taking initiatives to adapt for fast developing new technology. On the other hand, many others are still struggling to understand digital disruption and its impact to their own economy or business. This disruption is coming in many forms and also really challenging to the auditors and their current auditing process.

This article seeks to understand if auditors in Sri Lanka sufficiently aware of the digital disruption and its impact to them and also analyses the challenges and opportunities of digital disruption for auditing process.

 

 

Methodology

 

As digital disruption has not been properly researched in Sri Lanka and still an emerging discussion point in our context, the following modes were used to analyse the subject matter.

  • Research and study of various global survey reports and discussion reports;
  • Listening to various global discussion forums, interviews;
  • Discussion with local auditors/audit practitioners (limited).

 

Findings and discussion

 

The fourth industrial revolution is occurring which is enabling businesses to operate in significantly different ways enabling technologies include artificial intelligence, internetworked physical devices, cyber physical systems, nanotechnology, and biotechnology.

What are the key technology changes affect to financial reporting and auditing process?

Amongst the all those technology trends and developments, there are four specific new technologies that can be leveraged to significantly improve and modernise financial reporting and auditing process.  Those technologies will be transition into the mainstream over the coming years.  Those four technologies are:

1. Robotic Process Automation (RPA);

2. Knowledge-based systems and other application of artificial intelligence; 

3. Blockchain-based distributed ledgers.

4. Data analytics

 

 

Robotic Process Automation (RPA) 

 

RPA is often mistakenly thought of as a form of AI but the ‘robots’ are software routines that are more like very sophisticated Excel spreadsheet macros than genuine AI. RPA is a software that can be easily programmed or instructed by end users to perform high-volume, repeatable, rules-based tasks in today’s world where multiple loosely integrated systems are commonplace.

RPA has enormous implications for the audit and is already bringing huge benefits. In the analogue world where accounting was done with manual tools like physical ledgers, the auditor would validate processes and transactions using statistically valid sampling or similar techniques. Using RPA, auditor can analyse 100% of certain datasets through various audit lenses. This means that auditor can quickly identify the outliers that need further examination. 

 

 

Knowledge-based systems and other application of artificial intelligence 

 

Knowledge-based systems are considered to be a major branch of artificial intelligence. They are capable of making decisions based on the knowledge residing in them and can understand the context of the data that is being processed.

Knowledge-based systems broadly consist of an interface engine and knowledge base. The interface engine acts as the search engine, and the knowledge base acts as the knowledge repository. 

Learning is an essential component of knowledge-based systems and simulation of learning helps in the betterment of the systems. Knowledge based systems can be broadly classified as case-based systems, intelligent tutoring systems, expert systems, hypertext manipulation systems and databases with intelligent user interface.

 

 

Blockchain-based distributed ledgers

 

Blockchain is an open, distributed ledger that can efficiently record transactions between two parties in a verifiable, permanent way. Blockchain is the technology at the heart of Bitcoin and other cryptocurrencies. Without blockchain, cryptocurrencies would not exist in their modern form.

The blockchain embeds contracts and transactions in digital code. This digital code and the record of these transactions are stored in a transparent, shared database. This database is decentralised, which means it is held by people (“nodes”) all over the world. This decentralised system protects the blockchain from tampering, deletion, and revision.

Using the blockchain, everything we do has a digital record. That means every process, transaction, task, and payment has a digital record. Each record can also be traced back to an individual. It has a signature that can be identified, validated, stored, and shared.

Ultimately, this allows organisations or individuals to conduct business in a more efficient way. With blockchain, we have a tamper proof, verifiable, and permanent way to record transactions between two parties.

 

 

Data analytics

 

Analytical tools have long been applied to the data derived from accounting and operational systems. Some auditors/audit firms are already using data analytics as part of their transactions testing, gradually moving away from traditional sampling techniques. Data analytics allow auditors to use 100% of a population’s transactions when performing their tests. 

Data analytics enables auditors to improve the risk assessment process, substantive procedures and tests of controls. It often involves very simple routines, but it also involves complex models that produce high-quality projections. Auditors using such models need to understand them, and to exercise significant judgement in determining when and how they should be used.

 

 

What challenges will external auditor be faced with digital disruption?

 

Based on the recent surveys and views expressed by key executives in the business industries including auditors, it is certain that practicing/auditing firms will undergo major technological change in the next three to five years. This could be a complete transformation to digital environment where current audit process will be changed significantly.

Would this mean that the external auditor will disappear in the digital world? At least not in the immediate future, but like many of the disruptive transformation taking shape around us with everything going digital, external audits cannot stand insulated.

Among emerging technological disruptions, Bitcoin, blockchain, artificial intelligence and RPA have been presented as major threats to current auditing and financial reporting process. 

The blockchain has its foundations in the distributed ledger concept and cryptology that promises transparency, immutability, security, auditability and is very available. Simply, it is like a copy of a digital ledger automatically maintained and synchronised with every party in a transaction chain that captures every transaction across all the parties as well as modifications.

When it comes to external audit, investor looks in to auditors as trusted third parties for their opinion to assure that the financial statements are true and fair. The auditor achieves this objective by performing audit procedures as per the requirements of auditing standards.

However, in a mature blockchain and an artificial intelligence driven world, together with RPA, investor could in real time have a true and fair view of financial statements that are inherently trustworthy. This would eliminate the need for external audits in its current form, including all the associated audit procedures surrounding examination of records, assessing compliance with accounting principles, accuracy of accounting estimates, etc.

What changes will be taken place in the auditing process and what opportunities are in place?

When companies fail, confidence takes a knock and stakeholders question whether the audit is fit for purpose. To address these concerns, stakeholders are calling for an audit which gives more meaningful insight beyond the historic ‘pass/fail’ provided within the auditor’s report. By embracing emerging technology, auditors can address this.

In the audit profession automation is making audits faster, smarter and reducing the risk of error.

In the past, to audit the millions of entries on the purchase ledger of a large company, an auditor would start by choosing a statistically valid sample (let’s say that is 50). For each of those 50 transactions, they would have to check whether that purchase was properly authorised, whether the cash actually went out of the bank account (so that’s 50 copies of bank statements to find), and check that whatever was bought actually arrived so they would also be looking for 50 different goods received notes. That would have been two weeks’ work, minimum, to examine a tiny slice of the transactions on the ledger.

The new technology and data analysis tools allow us to move away from a sample testing approach to an evaluation of an entire population of transactions. Those technology driven tools can check the characteristics of millions of entries in an instant, immediately flagging any exceptions. It then lets us visualise the data in lots of different ways by supplier, by transaction date, by amount for example, increasing the chance that the auditor will spot unusual items or trends. All of that takes a fraction of the time spent previously much more assurance, much less human effort. 

The use of drones in the audit is also bringing efficiencies. Drones can be used in physical verification of assets to save auditors having to physically travel to locations. But this is only the beginning. Drones can be applied to a number of industries, such as mining. Open-cast mines can cover several square kilometres, and auditors may need to assess the physical state of the mines. In a similar fashion to how they check stock counts, drones can be used to quickly map the area, make reports, monitor work progress and so on. And all without having to travel into the mine, saving time and avoiding safety hazards.

Furthermore, Artificial Intelligence (AI) is already being used to make the audit process better. AI can be used to spot patterns and anomalies in large bodies of structured data. Any problems identified are recognised and remembered by the machine, which then ‘learns’ from its experiences and applies the learning to the next set of data. 

Another critical aspect of auditing is responding to fraud risks. Auditors have limited, clearly defined responsibilities for detecting fraud. Yet public reaction to high profile corporate fraud shows that expectations of auditors extend beyond this. There can be huge disappointment in the minds of the general public, whenever there is any kind of fraudulent activity where were the auditors?

With new methods of data analysis, we can ask a machine to look out for accounting fraud, beginning by showing it large data sets where fraud had been committed and therefore helping it learn what patterns to spot. However, just as AI is constantly evolving, so are the methods used to commit fraud.  We must ensure that the technology we use does not fall behind.

Natural language generation and processing is another tool of opportunity in digital auditing process which enhanced the corporate reporting. A machine could take general ledgers, sub-ledgers and other accounting records to write a summary that gives a balanced view of a company’s performance. Right now, auditors need to consider whether narrative reporting is “fair, balanced and understandable”, but perhaps in the future we will embrace the neutral commentary produced by an unbiased machine. A machine can scan a 100-page contract in seconds, looking for words and phrases that might indicate a difficult revenue recognition decision, for example, in the past, an auditor with a very quick reading speed would have taken at least 4 hours to complete the same exercise.

 

 

Conclusions

 

The auditors will not be replaced by the technology, but it will be used to enhance the auditing process.  If machines can do jobs faster, and better, let’s use them. Let’s allow them to carry out the time consuming, lower judgement, repeatable elements of the audit, the data extraction and analysis of financial information which used to take weeks, recognising that the machines will deliver a higher quality and quicker analysis of high volumes of data. 

The auditor can then bring his or her creativity and experience to interpreting the data, presenting deeper insight to businesses and their key stakeholders. And of course, taking advantage of machine learning, these new insights can be fed back to the machine, meaning that the machine-led analysis will be even stronger next time. It sounds straightforward but we must not oversimplify. Audit is more than analysing and validating the financials. It is also about being embedded within a company, understanding the culture, drawing on experience and instinct to identify areas of concern. 

We still need people in the audit because we need judgement, intuition, constructive dialogue and courage. As long as our machine friends are unable to replicate these, auditors will be needed. 

Digital disruption could not replace the element of professional judgement!

In conclusion, it is impossible to predict the future with any degree of certainty. By keeping informed about technologies as they evolve, considering new technologies as they emerge, and then assessing their implications for finance professionals and those they serve and support, auditors can be prepared to minimise the burdens and maximise the benefits. In this way the auditor can exploit technology and potentially change the scope of what it means to be an auditor.

 

(The writer is Associate Director – Audit and Assurance of BDO Partners.)

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