OCTOBER 2019 – EMILE WOOLF
PROPER AUDITS – STILL TOO DISTANT
While recently rummaging through some old papers I spotted the transcript of a lecture I gave in 2003 called “How can audits be made effective?” I was intrigued, but not surprised, to note that the subject matter of that lecture nearly 17 years ago has hardly dated at all – conflicts of interest; independence; responsibility for fraud detection; law reform; proportional liability; you name it! And we appear to be no nearer a consensus on how to resolve these issues.
If anything, the problems have intensified. The Big-4 grip on the large company audit market is tighter than ever and brooks no practical rival. This is hardly surprising, given that the size of FTSE companies has grown exponentially and their structure is more complex than ever. Indeed, one wonders whether even the most intense scrutiny by the most sceptical of audit firms could ever yield a sufficiently meaningful level of assurance.
Too big to audit?
If we have reached a point where such companies are simply too big to audit, the entire approach would have to be rethought. A single tersely worded opinion on “truth and fairness” of financial statements will not suffice, and the audit scope would have to be widened to embrace the corporate culture itself from the inside.
audit process even less manageable
Some would object that such a change would make the audit process even less manageable than at present – but we should remind ourselves that the financial statements are simply a product of processes devised by management to effect truthful reporting. If the culture of that management – including the quality and integrity of the controls it has put in place – were to be the main subject of the audit, investors would be provided with a more meaningful, and less time-sensitive, portrait of performance than today’s conventional framework.
There are, of course, many other avenues to more effective auditing that are still under review, such as the development of conglomerates – clusters of medium-sized audit firms that have combined to create practices of a size and reach capable of handling audits of FTSE-350 companies. This move is already underway, but major questions remain on capability and fit.
audits as high-risk loss leaders
A more practical obstacle, of course, is the imbalance between risk and reward. Any firm prepared to tackle the audit of a huge company has little to play for and much to lose. And this is the real reason why Big-4 firms are so insistent on retaining their highly profitable consultancy teams, while they view audits as high-risk loss leaders.
There are other commentators who believe that public company audits are so important to investors, creditors and employees that they should never have been accessible to private sector firms. Their suggestion is that only public sector auditors, possibly licensees under the auspices of the Audit Commission or equivalent, would be sufficiently independent to adopt a wholly disinterested (albeit it uncommercial) stance.
While these and other suggestions, including those emanating from the Kingman Report and that of the Competition & Markets Authority, are in the mix, spokespersons from the big firms remain solidly opposed to any split between their audit and consultancy divisions. Indeed the chief of EY’s international network has stated his belief that the quality of his firm’s audits depends on EY remaining a multidisciplinary firm.
You can’t audit your own firm’s work
Clearly, he has a point: both audit and non-audit divisions of the firm must keep themselves up-to-date with all the relevant legislation and knowledge. But – and this is the important point – the firm’s non-audit consultancy personnel should never be permitted to submit technical advice or recommendations to clients of the audit division, because that would mean the latter having to audit the effect of implementing that advice. You can just imagine it: “Whoever told you that there are disclosure exemptions for related, but non-jurisdictional, group entities? That’s rubbish!…..Oh Dear! It was our own chaps in legal services!”
faint risk of cover-up
You can see, I’m sure, that there may be just a faint risk of a cover-up, somewhere along the line!
My own view is that nothing significant will change until a sense of personal responsibility, and the legal accountability that must accompany it, returns to provide the requisite level of assurance that investors are entitled to.
Until then the profession will continue to confuse compliance with reporting truth. Under the cloak of compliance it will report on climate policies, gender policies, whistle blowing policies and the firm’s ethical priorities. Important though these issues are, investors require something totally different.
[EMILE WOOLF 22-9-19]