Auditors: love on the rocks

Tougher rules on governance and auditor liability are placing increasing strain on the auditor/client relationship and auditors are worried that this could have a negative impact on the quality of audits.

Link: Internal auditors can cut Sarbox costs

Big Four audit fees in the US doubled in 2004 because of the compliance requirements of Sarbanes-Oxley 404 as auditors have had to take more time to ensure compliance with the new rules and protect themselves from liability law suits.

But as auditors have become more cautious, their relationships with clients have grown colder, creating a confrontational atmosphere between auditor and business.

Adecco’s recent experience showed how super-attentive auditors could produce a £65m compliance bill. Recent research found that up to a third of CFOs felt their relationship with auditors had deteriorated over the last year-and-a-half.

Kingston Smith’s refusal to resign its audit of listed cash shell Boustead, despite the company’s insistence that it do so, indicates that auditors and clients in the UK specifically are also feeling the strain.

Steve Maslin, head of assurance services at Grant Thornton, says the hostile relationship between auditors and businesses is more prevalent in the US because of Sarbanes-Oxley, but acknowledged that in the UK auditor rapport with some companies was also under strain. ‘In the UK some relationships have not been affected, but there are cases where relationships have deteriorated because of the regulatory environment,’ he says.

Michael Hughes, chairman of KPMG’s UK audit arm, says regulations have effected the auditor/client dynamic because of the gap between the two parties.

‘The increased significance of the audit committee has diluted the relationship between the auditor and the client. Finance used to be a two-way debate, but now a third party is involved, the closeness is watered down,’ Hughes says.

According to Hughes the change to IFRS has also played its part.

‘IFRS has pulled out an established accounting system from the roots and changed policies. There is less scope for accountants to make judgements so their relationships with CFOs are going to change,’ Hughes said.

The limits placed on non-audit services had further served to detach auditors from clients.

Research by PIRC found that in 2004 the sums paid by companies to their auditors for non-audit services was on a downward trend.

PIRC said that in 2004 the average FTSE 100 company was now spending £1.5m on non-audit services for every £1m spent on audit fees. This was down on £2.2m spent in 2003.

Hughes says this has had an impact on the relations between auditors and clients.’Financial directors used to be able to use auditors for several non-audit functions, but that can’t be done anymore and has distanced the two from each other,’ he says.

Martyn Jones, national audit technical partner at Deloitte, however, stresses that close relations do not mean that auditors are compromised.

‘A good relationship does not mean that there is complacency on the part of the auditor,’ Jones says.

‘Familiarity with a client must never reach the point where it compromises objectivity, but an open professional relationship creates the best environment for conducting an audit,’ Jones adds.

Glyn Barker, UK head of assurance, agrees: ‘The client and auditor should have a close working relationship based on trust and respect, but with a clear understanding of appropriate rules and regulations to ensure independence is maintained at all times.’

In a ‘trying regulatory environment’, Jones adds, companies are ‘on the defensive’, which makes it more difficult to establish a ‘healthy relationship based on openness’.

Maslin says a frosty association makes it much harder to conduct an audit effectively.

‘In a healthy relationship, companies are willing to help and bring any matters of concern to the auditor’s attention. In confrontational situations, however, when an auditor asks questions it gets nothing back but evasive answers and awkward body language,’ Maslin says.

Jones, however, fears that changes to legislation in the UK could see relations decline to an even greater degree than before.

‘Amendments to the Companies Act, to put it in line with US legislation, are on the cards. A tighter regulatory regime could have an effect on relationships in the future,’ Jones says.

He adds that the cost-benefit ratio needs to be carefully considered when tightening regulations – from a financial and non-financial viewpoint.

‘Stricter standards mean extra hours spent on an audit and auditor fatigue, not to mention the impact on relationships between auditors and clients. Regulators and shareholders need to be sure that the costs of tighter regulations match the benefits,’ Jones says.

Related reading