Have auditors learned more from the 2008 financial crash than economists? The high priests of the dismal science refuse to recognise that the world has changed, though their discreditied theories continue to collapse about their ears. Any serious penetration of the causes of collapse are not in the university syllabus, which now reads more like a mathematics branch-line.
One recent Nobel Prize-winning economist has dismissed the Federal Reserve’s money-creating frenzy of $85 billion per month as “a kind of nothing activity, a neutral event; the trillions of asset purchases on one side of the Fed’s balance sheet, and the trillions of government debt on the other, basically cancel out. It’s no big deal.” Fortunately, there isn’t a Nobel Prize for auditing brilliance: so no need to seek out examples of crassness on a comparable scale.
In its efforts to sound a wake-up call for the profession, the Competition Commission (CC) has delivered its final report on audit firm competitiveness. It has reluctantly reduced the frequency, from every 5 to every 10 years, of its requirement for companies to put their audit contracts out to tender, reflecting its acknowledgement that the considerable cost and disruption involved could wipe out any benefit produced by the change.
The FRC’s Audit Quality Review (AQR) teams are required to review the audit engagements of each of the top 350 companies every five years, and loan agreements carrying “Big-4 only” clauses are to be outlawed.
But having a change imposed by law, even every 10 years, is pointless in cases when it is not warranted at all – indeed when the interests of shareholders may best be served by retaining the incumbent auditors. Surely those most directly affected are the most reliable judges? And will teams carrying out mandatory AQRs, themselves costly and inherently disruptive, possess skills capable of adding value?
Competition not the point
The CC’s questionable involvement arose in the wake of the 2008 banking crisis, when auditors’ laxity in passing the accounts of bankrupt banks, followed by taxpayer bailouts, was perceived to stem from a lack of competition. Yet the number of audit fiascos was far greater 30 years ago, when the “Big-8” competed with each other far more ferociously than anything you’ll find now. Audit failure had nothing to do with competition or lack of it. We need to look elsewhere.
For example, if the accounting framework is based on dubious mark-to-market valuation models and permissive, untested acceptance of management’s rose-tinted assessment of foreseeable losses, auditors will always get suckered into believing that compliance with standards is the same thing as true and fair.
A flawed accounting model will always generate its auditing shadow, making it doubly difficult to withstand management pressure to see things in a more favourable light. Will greater competition bring in the methodology of rigour that should be second nature, even to a trainee? Hardly.
A new report by PwC shows that in the four years from 2008 to 2012 the “non-performing loans” of European banks doubled in amount to almost 1.2 trillion Euros.
When a borrower’s interest and principal repayments dry up indefinitely, that’s non-performing loan – and only a non-performing auditor will allow it, year after year, to remain on the bank’s balance sheet, at full value. A pretence that merely prolongs the agony. And competition is not the problem.