Industry torn over audit sector criticism

The Institute for Public Policy Research (IPPR)’s claims that audit regulation is a “wild west” have been met with disapproval, with a leading industry body arguing that the issue is much broader.

The think tank published the claims in in a research paper last month. It argues that the audit sector is “failing society” and is the root cause for the flaws in the financial reporting system.

“Audit regulation really is a wild west at the moment – the purpose of it is incredibly narrow,” says Carsten Jung, senior economist at the IPPR.

“Running such a critical industry on such a thin regulatory layer is very risky. We need to bring audit into the 21st century.”

Jung also outlines some of the issues cited in the IPPR’s report, including detecting material fraud and detecting financial misstatements. But ‘aggressive accounting practices’, he argues, is perhaps the most prevalent.

“Often auditors just tick off something as long as it’s justifiable within the rules,” he says.

“They use assumptions or techniques that could be problematic, even if they’re within the rules. What we want them to do is really give a view on it.”

Jung points out that this approach is enabling “boom and bust” cycles in corporate Britain – where businesses present artificially inflated depictions of their finances and eventually lead to collapses.

Such practices were largely to blame for the scandals surrounding construction firm Carillion and café chain Patisserie Valerie in recent years. In both cases, financial reporting malpractices were the driving factors.

However, reaction from industry watchdog Accountancy Europe has contrasted the IPPR’s views, with the body arguing that a more holistic approach to bolstering financial reporting is needed.

“With all the outreach we did, we did not come to the conclusion that this is just one sector,” says Hilde Blomme, deputy CEO at Accountancy Europe.

“There isn’t necessarily one big reason – it’s a number of factors that play together. We believe that more can be done by auditors, but we also believe that other parties have a role to play in helping improve the system.”

These views are reflected in a paper published by Accountancy Europe in February earlier this year. The paper identifies the key flaws within the financial reporting ecosystem as a whole, citing audit as just one factor.

For instance, its proposals include paying specific attention to senior management fraud, requiring companies to implement a fraud risk management system, and mandating an audit committee in all public interest entities.

“There is a risk that just focusing on corporate governance leads to lack of reform on the audit side. The issues with audit have been clear for at least three decades and nothing’s been done, so we need to be careful,” Jung argues.

The two sides have also tussled over UK government’s recent audit consultation, with Jung arguing that its approach is “vague” in some areas.

The Department for Business, Energy and Industrial Strategy (BEIS) unveiled the proposals in March earlier this year. Broadly, they comprise plans to improve the audit market, restore confidence in the sector, and bolster director accountability.

“The government whitepaper does tackle the issue of narrow purpose, but it’s quite vague on it,” says Jung.

“It’s not clear enough. The government should be more comprehensive and specific on this purpose.”

But the views of Accountancy Europe seem to contrast this once again, with Blomme praising the UK government’s rounded approach to reforming the sector.

“There are a number of proposals [in the consultation] that seem to be in line with what we have. Maybe the most striking is this more holistic focus on how this system can improve as a whole.”