Audit Reform: A talent tightrope

AS the long sighs of relief fade that reform is finally done, many on the larger audit side of the accounting profession are starting to worry about where that reform will leave us over the longer term.

There is general agreement that mandatory tendering will enhance competition (albeit some concerns about the number of competitors) and most acknowledge that competition is a good thing and likely to act for the benefit of audit quality, which moves further to centre stage in the audit selection process.

However, there are dangers of unintended consequences for auditors and audit firms in what appears to be a satisfactory outcome to years of negotiation and jostling among market participants.

The lifeblood of any accounting firm is its people and, in particular, its brightest young people – the partners of the future and the young partners of today. Many (but not all) of the brightest and best want to deal with the larger clients; those with the highest profiles and the complex challenges they can throw up. Well, they used to, but may not be so keen in future.

The very fact that quality is going to be to the fore in auditor selection may act as a deterrent to them. Audit Committees will naturally want to know about individual partners’ internal and external review scores – one of the few objective areas where they can benchmark quality. Can a partner with a poor result in recent years (irrespective of circumstances) be a credible member of a pitch team? Possibly not.

Given the necessary imperative of revenues in the economics of accounting firms, the activity of auditing Public Interest Entities starts to look a little like a high risk activity. The regulator’s push for unsatisfactory results to have a clear financial penalty won’t help, although the damage to self-esteem is likely to be of greater consequence to the individual than any loss of income.

In particular, the incentive to be auditor of higher risk businesses becomes increasingly difficult to identify. Would any firm want to endanger the future of any of its best people on a client who likes to push the envelope? No, but these are exactly where the best people should be deployed.

With the increased complexity inherent in accounting and in auditing over recent years, firms are already concerned that their young people are becoming narrower in scope of expertise and might lack the “bandwidth” their predecessors had. The restrictions on non-audit services are likely to exacerbate this.

While the new ethical standards do understandably give independence a more robust regime, they will reinforce that the auditor becomes only an auditor and that the broader professional outlook that could be expected of an audit partner is consigned to history. That may be the intention, but it will result in arguably less interesting, and less interested, audit leaders in future.

Millennials will be the audit partners of the future. Much has been said about their demand for balance, for variety and for development, none of which would appear to sit well with this new world. But it isn’t unremitting gloom. Outside statutory audit the demand for assurance services more broadly has risen and might be expected to accelerate more. Auditors will want to make sure their skills are appreciated as new markets unfold, so that the variety and challenge they seek can at least partially be met in new arenas.

The economics of accounting firms have been referred to briefly. While it is early days, the usual outcome of increased competition is lower price. Although the former Competition Commission found audit to be as profitable as other services, most audit partners would believe it if they were told that audit was a less financially rewarding activity than tax or consulting (and many claim to be told that on a regular basis).

Any long term fall in relative profitability threatens the fabric of audit firms. Large profit share differentials between service lines make for unhappy partnerships, particularly where market share is high and consulting partners, for example, feel their practice is constrained by “untouchable” audit clients. Many of us recall the Andersen Consulting/Arthur Andersen spats and subsequent split with distaste.

While everyone clearly values audit quality highly we just need to be careful that we don’t let dry measures of it deter talent. We need to guard against its commoditisation and the threat to a unitary profession.

James Roberts is senior audit partner at BDO 

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