Auditors: where is the love?

Why do auditors get such a bad press? The old joke about walking backwards
into the future has given way to new, more serious attacks.

Anthony Hilton, City columnist in the London Evening Standard,
hammered the profession recently for its apparent inability to spot ­ over a
period of several years and over a sequence of several deals ­ the alleged
‘systematic looting’ of Hollinger by the newspaper tycoon Lord Black.

Back in January, Guy Jubb, corporate governance chief of Standard Life,
ridiculed the usefulness and quality of modern audit reports, describing them as
being ‘riddled with get-out-of-jail-free provisions’.

Last November, John Tiner, chief executive of the Financial Services
Authority, told auditors bluntly to ‘focus on their core service of delivering a
quality audit that adds credibility to financial statements’.

The profession doesn’t even have the defence of being short of money for
investing in quality improvement.

Thanks to the demands of Sarbanes-Oxley in the USA, fees and profits on both
sides of the Atlantic are higher than they’ve been for years. And audit still
accounts for more than half the income of the largest firms.

Yet long before audit became compulsory, Edwin Waterhouse, 19th century
founder of the Big Four accounting firm that bears his name, had all the clients
he could cope with ­ and no fee resistance. Why? Because his passion was not for
consistency or compliance at all, simply a passionate desire to help his clients
see the true costs of what they did.

Since then, the profession has got into the habit of being more concerned
about supply-side issues of efficiency and speed than about demand-side issues
of quality, and more nervous about litigation than about adding value. No
wonder, in terms of the quality of service they offer, that audit firms are
widely perceived to be undistinguished and virtually indistinguishable.

The chief executive of a London investment company put it baldly: ‘I’ve dealt
with about 20 of the top accounting firms, and they range from the adequate to
the awful.’

Win them over

Despite this bleak backdrop, experience in the field makes me believe that
auditors can win back the respect and affection of their clients. The first step
on the long march is relatively simple. It amounts to a radical rethink of
audit’s most visible product: the traditional report that goes to clients in the
wake of an audit.

At present, almost all such documents make a series of points, each of which
is broken into three sections: the one usually headed Observation, Weakness or
Problem, identifying some technical misdemeanour or financial inefficiency, a
section entitled Significance or Risk, defining the scale of the problem and one
called Recommendation or Action, which sets out what the auditor thinks the
client should do about the problem. There’s then usually a fourth section,
initially left blank for the client’s response.

In the audit reports I’ve seen over the last 20 years, two patterns are
almost universal: the longest of the three sections is the one headed Problem,
Weakness, or Observation. The fewest words, by a long margin, appear in the
Significance or Risk section. The points are clustered by function, division or
region. But there is no clear basis for the order of points within any one
cluster. Both patterns matter because neither addresses the client’s needs.

Clients will not take action on any point merely because it infringes some
accounting standard. They’ll take action only if the cost of a problem is larger
than the cost of its solution. If the solution costs more than the problem,
they’ll live with it ­ and, from a commercial point of view, they’d be right to
do so.

And if, as is usually the case, the auditor has avoided any attempt to
quantify either cost, the client will put ‘Noted’ in the client-response section
­ which is a polite way of saying nothing will happen. The audit team feel
ignored and frustrated; and the same point turns up in the following year’s
report, thereby infuriating the client.

By this analysis, the fix is obvious. Put the weight of effort and the bulk
of the words into the part that explores the implications, effects and
significance of each problem. And aim to work towards a money figure, however
approximate, near the end of the paragraph ­ where it will be easily comparable
with, the cost of your suggested solution.

Approached in this way, each point can also avoid using judgmental words such
as ‘poor… inadequate… weak’, which can be guaranteed to offend the executive
whose department is being criticised.

The second pattern ­ the absence of any clear basis for ordering points
within the report ­ irritates clients because it obliges them to read through
all the points, on the off-chance that an important one is buried near the back.

Be explicit

Reworking each point into an explicitly commercial form in the way described
above offers a straightforward way out of the difficulty. Simply open the report
by explaining how the points have been clustered (by function, region or
business unit).

Then add a sentence along the lines of: ‘Within each
function/region/division, the points have been ranked in order of their
financial significance to your company, with the most important first.’

Any executive browsing the report can then decide how large a point needs to
be to merit his or her attention, and stop reading when the value of the points
drops below that level ­ in the confident knowledge that all subsequent points
will be smaller still. The result: time saved and a happier client.

One other benefit flows from this approach. It becomes possible to add up the
differences in cost between each problem and its solution on all the points in
the report, and present the total in a covering letter, along the lines of: ‘Our
report identifies points x,y and z, which we think deserve the attention of the
Board. If you act on all of them, our analysis suggests that you will add
upwards of £X00,000 to next year’s bottom line.’

Clients presented with such a total invariably compare it with the audit fee
­ and feel, as a result, that the audit has added real value.

Does this approach work? Unquestionably. Every audit team I’ve persuaded to
experiment along these lines has found that clients love it. In some cases,
clients have been so pleased that they’ve recommended the firm, unprompted, to
potential new clients.

Over the years, I’ve also been asked from time to time to rethink and redraft
real audit reports, going back through the working papers with the audit team to
derive realistic figures to support each point. And the sum total of points
which have been left unacted-upon or merely ‘Noted’ in all those reports?
Precisely zero.

Tony Scott is a director of business communications
specialist Oliver Scott Consulting www.oliverscottconsulting.com