Audit quality under pressure as firms cut costs

Audit quality could be the latest casualty of the downturn as accounting firms cut costs in some of the toughest market conditions seen in ten years, regulators warn.

The Financial Reporting Council (FRC) wants accounting firms to maintain high audit standards despite near unprecedented pressure on profit margins.

Paul George, head of the FRC’s Professional Oversight Board, is concerned that a general downturn in audit work might see firms concentrate on their bottom line at the expense of audit quality.

Markets rely on auditors to provide assurance and comfort about company performance and data. It’s feared cost cuts could promote a culture where their own business growth is more important than audit quality.

“Any prolonged reduction in investment in audit, be it recruitment, training or investment in systems or any behavioral changes to a realignment of personal objectives will have a long-term impact on audit quality,” he said.

“[The FRC] has an important function as a counter balance in the equilibrium between commercial pressure and audit quality.”

The board has found no drop in audit quality, but noted one case where audit man hours were cut and another where staff rewards were altered to reward business growth at the expense of audit quality.

This year industry giant PricewaterhouseCoopers changed its bonus criteria to emphasise business growth, which jumped from 25% to 40% as a proportion of its KPIs. Meanwhile, audit quality portion dropped from 25% to 20%.

The FRC’s audit inspection unit, which investigated the issue, said the underlying message represented “a potential risk to audit quality”.

It noted however the change was small in terms of total remuneration “and was not intended to undermine the importance of audit quality”.

The inspection unit also found that in one case PwC staff were told to reduce audit hours by 5%.

In its 2009 transparency report, PwC said bonuses are arrived at against individually tailored balanced scorecard of objectives, including member’s responsibilities, performance and overall profitability.

Richard Sexton, head of assurance at PwC, said he would noever compromise audit quality on cost grounds. “Quality is a must have and it is just part of the job… Quality is what drives our reputation and if we let quality drop then our reputation drops and we may as well not be in the business,” he said.

The unit also inspected PwC’s big four rival KPMG and found audit quality was not significantly represented in performance assessment.

“We concluded from our review… that the achievement of audit quality objectives does not have as significant an impact on partners’ overall performance assessment as their achievements in other roles,” the report found.

According to a KPMG report, the firm rewards its staff based on service,
professionalism, knowledge, accountability, business focus, problem solving, relationship building, staff development, drive, resilience and “making an impact”.

KPMG, along with the rest of the industry, is under considerable pressure since the recession. In August, Ernst & Young’s head of assurance John Flaherty said retendering “driven on the grounds of price” was at its highest level in 10 years.

George said he was conscious of commercial pressures and said he had noted actions taken to maintain margins.

“While we have not identified that any individual action has had a direct adverse impact on audit quality, we are highlighting the risk,” he said.

IN OUR VIEW

Who do auditors service – investors or themselves? The answer to this question will colour your view on close to every emotive audit issue, not least of all this one. The Big Four and their mid-tier cousins are suffering. Revenue is down. Competition is stiff. Something needs to give. Audit quality,we are repeatedly told, is sacred. Now,many will see just how sacred it really is.