Committed to reform

IF THE LORDS were under any illusions about the level of interest in, and the divergent opinions on, the future of audit then that at least became clearer during its inquiry into the audit market.

That may be the only thing about the audit market that’s clear. On top of the hours of evidence heard, the Lords received another 57 pages of supplementary evidence following the end of face-to-face sessions.

It’s not all a mess though – some threads have appeared. For example, the term “audit committee” appears 33 times across the 57 pages.

So what role could the committees play in the governance of the audit profession in the future? Is there consensus among experts and stakeholders, or further disagreement?

Ernst & Young believes the role of the audit committee could be strengthened through issuing a report to investors providing greater transparency into discussions with management and the auditor on key financial statement risks and critical judgments and estimates.

And the firm wants more: “Strong active corporate governance including improved disclosures in company annual reports of an audit committee’s policy.” Increased exposure to the workings of audit committees could prove a catalyst to engage the investor community more closely with the governance of business.

But that could create a situation where audit committees feel more comfort from sticking with Big Four auditors, warns the ICAEW.

Increasing competition at the top end of the audit market is considered by some as an important step in improving the image of the profession; although the Big Four argue they already adhere to the highest quality.

Others are more interested in radical reform of the audit appointment process, with audit committees at the heart of that change. Former professor of accounting Brenda Porter suggests the audit appointment process is flawed.

The board appoints auditors on behalf of shareholders. But in a disagreement with the auditor, the directors under company law have a fiduciary duty to represent the company’s best interests.

Because of this they cannot represent the shareholders’ interests in relation to backing the auditor’s position.

One option would be to have an independent body appoint non-director members on to audit committees, who would be there wholly to serve shareholders.

Rotating auditors or pressuring them to be more ­sceptical will fail, Porter argues. The issue is not of quality, but of fundamental conflicts of interest within the audit model. Porter does appreciate the difficulty in her suggestion, in that the legal status of audit committees would change.

Auditors’ external communication must be improved to raise the awareness of what auditors undertake and the value they provide, according to PwC chairman and senior partner Ian Powell, echoing Ernst & Young.

The statutory audit report is “formulaic”, said Powell, leaving auditors with no opportunity to describe how they have undertaken their work.

Powell admits that changing its form could be time-consuming and possibly cloud its purpose, so a better option might be to add more content into the audit committee’s report, “where there is greater discretion over content”.

Discussion about the future role of the audit committee in greater governance was also vigorous at the ICAS/Grant Thornton event on the future of assurance last week.

More frequent discussions between non-executives and investors will increase good governance, particularly as it is an area that has been underserved in terms of their collaboration.

Audit committees should increase the transparency around the audit tender process, said Hermes Equity Ownership director, Paul Lee. More disclosure and discussion about the audit process was also required, he added.

RBS audit committee member Brendan Nelson said there was no evidence that
the longevity of the audit relationship with a business produced a lack of scepticism, nor was auditors’ quality a problem.

Instead, the ability for investors to gain a view of a company’s performance and the risks taken to make business decisions through annual reports was difficult in the current format.

Mandatory rotation of auditors will not solve this issue of transparency of information, a point Nelson agrees with Brenda Porter. But he disagrees with her over the independence of non-executives on the same issue.

Rotation would undermine non-executives making an independent decision about the best course of action. “This is a vote of no-confidence in their governance – it’s in the interests of non-execs to look after shareholders,” said Nelson.

Any change to the audit committee’s role through statute will take time – as would be the case for auditors. Instead, in the short term at least, it is more likely that efforts to engage investors, regulators and auditors – plus audit committees – in the financial services sector will filter down through the rest of UK PLC.

More will be known on that following today’s EU conference on auditing and financial reporting, and when the Lords report back on their findings.

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