Columnists are spoilt for choice – I could have covered the European Central Bank’s quantitative easing programme (more accurately, “counterfeit”); the Greek anti-austerity surge (“reneging on your debts”); unshackling the Swiss franc (“reality check”) – and I could have thrown in the fact that the examination syllabus for becoming a chartered accountant excludes the word “economics”, totally! But there are pressing professional matters this time.
An appeal tribunal has overturned most of the Financial Reporting Council’s earlier disciplinary findings against Deloitte, in the long-running saga of MG Rover. Even the ICAEW’s own Guide to Professional Ethics also came in for censure as “vague and unhelpful”, and its guidance on the need to have regard for the “public interest” could not alone form the basis of any misconduct charge. These serious findings are bound to raise wider concerns about the reliance that may safely be placed on Institute “guidance”.
The appeal also held that the original tribunal had unfairly criticised Deloitte’s fees as “excessive” without calling expert witnesses, and this “unjustified criticism” may have influenced the tribunal’s other findings.
Last year the FRC decreed that audit reports should disclose information on audit scope and materiality, and they are now growing longer and longer. KPMG’s audit report on the 2013 group accounts of Rolls Royce runs to over 5,000 words, covers six full pages and includes findings on eight areas of risk.
there is no parallel for such lavish scrutiny resulting in such miniscule output
I remember when Professor Lee Seidler of New York University wrote an intriguing paper on the length of audit reports. He showed that the audits of Arthur Andersen’s largest clients occupied, on average, 94 man-years of audit work, while the average length of resulting reports was 142 words. He concluded: “In the entire realm of investigative reporting there is no parallel for such lavish scrutiny resulting in such miniscule output.”
In those days, however, readers knew where they stood. A qualified audit opinion stood out like a sore thumb and, by and large, that was what most users were interested in. Now you would be hard pressed to find it among the verbiage that clutters reports with information of questionable worth.
The materiality factor
Take the vogue for disclosing a “materiality” threshold. Its mathematical integrity expressed as a single figure is easily misunderstood, even by auditors. The auditors of BSkyB disclose in their 2014 report that the materiality used was £50 million. Could this not invite a suggestion that auditors are letting themselves off the hook for misstatements of income or profit, however caused, below that “huge” number? Could auditors use such widespread disclosures as a defence in litigation, as happened 85 years ago in the landmark case of the Royal Mail Steam Packet Company?
That company had incurred trading losses for years, but undisclosed transfers from past reserves masqueraded as current trading profits. The prosecution alleged that shareholders would be deceived into believing that the company was trading profitably, and criminal charges followed against the Chairman and auditor.
Sir Patrick Hastings, defending Mr Morland, the auditor, called Lord Plender as his main expert on secret reserve accounting. Plender declared that it was “routine for firms of the very highest repute to use secret reserves in calculating profit without declaring it”. Sir Patrick then argued that questionable accounting was in fact wholly immaterial: “If my client was guilty of a criminal offence there is not a single accountant in the City of London who is not in the same position.”
all accountants were doing the same thing
Mr Morland’s successful defence was therefore based on the extraordinary observation that all accountants were doing exactly the same thing!
The new reports are littered with their own brand of anodyne terminology, typically including: “balanced judgments”; “consistent with standards”; “no significant errors”; “estimates mildly optimistic”; “appropriate disclosure”. When you have read enough of this stuff it begins to sound trite. Yet the FRC will always insist on more and more, while auditors plead that all is well because everyone is doing it.
Last year, in the US alone, forty companies with reported losses under standard accounting rules issued public share offerings that disclosed profits – after adjusting for “non-recurring” addbacks! And there was no lack of narrative.
Inflated audit reports may make the big firms feel safer, but regulators surely miss the point. They should rather focus on the quality of auditing.
And one more thing: are the efforts of the big firms really worth $50 billion in audit fees each year?