The “flawless” audit exists in the mind alone. Regulators such as the Financial Reporting Council (FRC) are therefore having to deal with the many that, in varying degrees, are flawed. However, the FRC’s practice of allowing so many years to pass before reporting their findings and punishing the culprits undoubtedly weakens its authority and blunts its effectiveness.
Since companies’ financial statements are published annually the time taken to audit those statements must, by definition, be less than a year. Yet consider the FRC’s latest finding – on Deloitte’s audit of the software company Autonomy Corporation. Can it seriously be claimed that justice has been served – despite the imposition of a £15 million fine on the firm (plus costs of over £5 million) and a total of £750,000 on two responsible partners – when the disgraceful audit work to which the finding relates took place more than a decade earlier?
Why such a delay?
If the audits in question themselves took, say, 10 months to complete, why did it need 10 years to establish how damnably ineffective they were?
“…but things have changed” – forget it!
This absurd (but typical) lapse of time simply invites public scorn for the process and allows the firm to declare, deferentially, that “things have changed” and that “our current methods wouldn’t allow it to happen again now” – which, if you think about it, is complete rubbish: the same firms were saying the same thing at precisely the same time that they were last found guilty of atrocious auditing!
No doubt the tribunal had to wade through a huge amount of complex paperwork; and it is always necessary to observe the due process of natural justice and to allow ongoing legal proceedings to be concluded. But the value of any finding depreciates with the passing of time. Whatever the reasons, the entire regulatory process is brought into disrepute when findings have become academic – details having been forgotten and players moved on or gone home.
It’s that word again!
The search for better auditing is littered with suggestions for enhancing auditors’ independence – a condition that’s frustratingly hard to define but is most recognisable when absent!
In principle, auditors should not be permitted to undertake any lucrative non-audit advisory work because the lure of additional fees would compromise their single-minded audit focus. Even the need to audit a client’s implementation of your own advice would present a threat to objectivity.
Threats to objectivity
But the FRC’s recently published “agreement” with Big-4 firms lists the “audit-related services” that will be permitted. These include reviews of interim accounts, reports to regulators, even work on financial controls, and proposes a cap on the fees for this work at 70% of average audit fees.
Its “overarching principle” for determining whether each prospective engagement meets the revised ethical standards is almost unintelligible. It is rambling, convoluted and, ultimately, subjective, amounting to little more than a ready-made guide for loophole-seekers! Just in case you think I’m exaggerating: “The firm and each covered person is free from conditions and relationships which would make it probable that an objective, reasonable and informed third party would conclude the independence of the firm or any covered person is compromised.”
Unsurprisingly, critics of this damp squib have not been slow to voice their dismay. Even the Institute of Chartered Accountants’ CEO, Michael Izza, believes “it will do little to improve quality or choice in the market”. The view of Tim Bush, head of corporate governance at shareholder support group “Pensions & Investment Research Consultants”, is more scathing: “It’s not only voluntary, but parts of it are weak to the point of being harmful. No wonder the Big-4 signed up to it” – criticisms echoed throughout the academic sector.
….the corrosive power of self-interest
By now it is blatantly clear that all the regulatory reviews and recommendations firms sign up to are incapable of disentangling the web of cross-relationships between audit firms, the financial services behemoths that own them, and the clients that pay them. So far, every contrived attempt to achieve audit independence has fallen victim to the corrosive power of self-interest.
Preserving the integrity of financial statements of public companies is critical for investors, creditors and employees in a free market economy and their audits are far too important to be assigned to private sector firms. Only a national body (a “Public Company Audit Office”) would be sufficiently independent to adopt the rigorous, disinterested and uncommercial stance now needed to prevent the profession from continuing to confuse compliance with meaningful reporting.
An audit levy on all public companies
A PCAO would be free to subcontract audit work to any firm with requisite expertise and credentials – but the crucial point is that the PCAO would issue audit reports in its own name. It would agree fees with subcontractor firms for settlement by PCAO on completion of satisfactory work, and an “audit levy” on all plcs would pay for the service.
Interposing such a powerful intermediary, with a mandate for maintaining high standards of public company audit practice, would shield firms from the ordure and ignominy that now dogs them. They should welcome the lifting of this burden.