After the Higgs report, the Smith report and the government’s examination of the accounting and auditing profession, Department of Trade and Industry inspectors have come up with a new set of recommendations following an investigaton that looked at the audit carried out by PricewaterhouseCoopers at TransTec.
So scathing were the criticisms of PwC’s work that the inspectors felt the need to offer a recommendation that could, if implemented, forever change the relationship between auditors and shareholders.
Buried on 284 of the 390-page report is the proposal that auditors should include in their main report for shareholders any accounting matters they feel would be better understood with the help of an explanation from an auditor.
If the recommendation is implemented it could mean an end to the dry and brief audit opinion currently included in annual reports, and emphatically re-establish the fact that an auditor’s primary responsibility is to shareholders – not executive board members.
No longer would auditors be able to get away with just reporting what their responsibilities are and conclud-ing that the accounts ‘represent a true and fair view’ and were properly prepared according to the Companies Act 1985.
Auditors may be compelled to explain just where they may have clashed with the company directors and how the issues were resolved.
If that was done during an agm it could result in fireworks if significant institutional shareholders used it as ammunition for grilling company directors.
Indeed, the inspectors conclude: ‘An oral report at the agm … would encourage open, informed discussion and would focus the minds of the audit committee and auditors on the significance of the issues.’
In many ways, those words for auditors are a bit of a bombshell. Surprisingly, a quick survey of big and mid-tier firms demonstrated that few had seen or contemplated the implications of such a change.
Those that have are quick to recognise that it would have major implications for auditors.
Firstly, if acted upon, it would put auditors in a much more powerful position over company executives. Institutional shareholders have recently demonstrated a proclivity for becoming more intimately involved in the affairs of companies.
The investment fund Fidelity showed a real determination during negotiations on the merger of Carlton and Granada to make sure it got the man it wanted in the chairman’s seat. Imagine what investment funds might do if the auditors were providing the ammunition?
Secondly, the inspectors’ proposal has raised real concern in connec-tion with the potential liabilities faced by auditors.
Indeed, the ICAEW believes that if the recommendation were to go ahead the government would first have to settle the question of how to reduce the scale of the liabilities hanging over auditors.
‘The ICAEW would like to see auditors able expand the extent of their reporting, for example, in relation to the operating and financial review,’ says David Illingworth, president of the ICAEW. ‘However the current regime of auditor liability effectively discourages new developments, and we believe that recent recommendations need to be part of a cohesive package of reporting reforms that also address auditor liability.’
Expect then to see the institute and possibly the other professional bodies launch into a vigorous campaign should the government start taking the inspectors report seriously.
However, before we get to that stage, it has to be asked whether the DTI will act on the report in some way? That remains to be seen.
But it’s worth bearing in mind that the DTI has only just finalised changes to the combined code on corporate governance, which went into effect on 1 November.
It seems unlikely that the department would want to embark on yet another round of soul-searching debates on audit.
- It should be best practice for the chairman of the audit committee, along with the auditors to report important issues to shareholders;
- penalties for misleading auditors should be increased and directors should be made personally liable;
- the operating and financial review (OFR) should explain why management think their business is well positioned for the future;
- the OFR should be reviewed by the auditors for consistency with their understanding of the business;
- institutional shareholders should meet with the company chairman and the chairman of the audit committee to discuss their work; and
- auditors should recognise that ‘auditing may be a confrontational business and they need to be prepared to stand up to management’.
- Source: DTI inspectors report on TransTec.
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