PracticeAuditA financial manifesto – Restore the faith

A financial manifesto - Restore the faith

Accountancy is under the spotlight like never before. But headlines aside, technological developments and globalisation mean the profession must consider where its future lies. Our ten-point agenda for change lays a foundation for that future. Former Treasury mandarin Sir Peter Kemp (see biography) assesses the feasibility of the proposals.

Before reading our ten-point plan don’t forget the host of comment we also have this week.

Read our overview arguing the case for change.
We profile Harvey Pitt, head of the Securities and Exchange Commission, who could change the face of the profession. Our parliamentary staff consider the options for legislation while Rodger Hughes, of PricewaterhouseCoopers, considers issues in the profession and Michelle Perry looks at the organisations that bring about reform.

Ten-point plan
1. Audit Independence
2. Indemnity Fund
3. Auditors’ Reports
4. Publishing Annual Reports
5. Directors’ Remuneration
6. National Audit Offfice and Audit Commission
7. Late Payment
8. Statutory Audit
9. Mandatory Social Reporting
10. Tax Practice Committee

The fact that some auditors could remain in a post for a staggering 100 years at the same company (as Ernst & Young did at Equitable) has made people nervous and it once again raises the question of auditor independence.

Though extreme, such a long-term relationship illustrates a key issue about transparency: if auditors remain in place unchallenged for long periods and something goes wrong, shareholders (or in Equitable’s case, policyholders) feel they have strong grounds for complaint.

Some suggest that the answer is the mandatory rotation of auditors. A recent private members bill put forward seven years as the maximum length of tenure.

On the face of it this appears to be an over-reaction although the profession should take up the debate if only to convince the public of its concern.

At the very least, however, companies should be compelled to put their audit out for retender on a regular basis.

An existing auditor would have to re-bid for the work and other auditors would be permitted to pitch for the contract.

Failure to act – especially as the current government has demonstrated its willingness to intervene in the market, a la Railtrack – could bring the profession to a situation where mandatory rotation is impossible to avoid.

But the other tough question is whether the profession should still be selling non-audit services to audit clients.

It is obvious that not all non-audit services present a significant risk to independence. Indeed there are some regulatory and compliance tasks that are still best done by the auditor. But in some circumstances non-audit projects, for audit clients, achieve a scale so vast they pose real problems. Not least among which is that the auditor runs the real risk of having to examine his or her own firm’s work.

This is a clear challenge to independence. Audit firms insist they know where the boundaries lie. But they must make it explicit to the wider world where these lines are drawn and what their policies are. Only then will auditors be able to work without fear of their integrity being called into question.

Sir Peter says: ‘This is clearly desirable. We need to go back 30 or more years here. The audit/ reporting functions had a responsibility to shareholders and the public which is quite different to the accounting/consultancy responsibility, which is to internal management. There is a clear responsibility to avoid conflict. Firms won’t like it, because it will cost them money, though not necessarily the profession as whole. Nor will company management for all the wrong reasons. Self-discipline is needed and backed up, if need be, by professional rules or legislation.’
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The very public rows between auditors when they start pursuing each other for damages has become more than a little embarrassing.

The entire FTSE-100 is audited by the Big Five and if it all goes wrong and a company collapses, it’s more than likely that another Big Five colleague will be called in to handle the insolvency and immediately start the pursuit for damages.

It makes for a small marketplace.

To avoid the prospect of Big Five firms endlessly chasing each other through the courts those making claims against auditors need an independent body. It would rate damage only and issue an order to pay a charge. The money for this would come from a pool maintained and funded by participating audit firms. Determining ‘fault’ would be done by the fledgling Accountancy Foundation.

Sir Peter says: ‘The question here is first how to keep audit disciplines sharp and make sure that genuinely hurt people like creditors and the workforce are not disadvantaged, while at the same time not overly harming the reputation of the profession or taking up too much time or resources to resolve. Self-regulation would be a start, on the back of limited liability partnerships, but it may be that legislation would be needed. There are parallel situations in many other professions from which to draw good working models.’
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When scandal strikes, shareholders are quick to let the world know that there is precious little useful information made public in the auditor’s report.

Indeed the auditors’ section of the annual report of any FTSE-100 company provides barely enough text to fill the back of your average postcard.

Publishing the full auditors’ report is of course out of the question, given that it contains commercially sensitive information. But more information could be published that would doubtlessly increase transparency and aid shareholders in their decision making – without threatening a company’s commercial standing.

Sir Peter says: ‘This is a right idea that could be very useful but difficult to devise and enforce. It goes with the separation of audit and consultancy work just discussed. The public should be told, in case of big public companies, whether the auditors have points, on the one hand, about a company’s ethical or other behaviour and, on the other, about its prospects, if not adequately shown elsewhere. Company directors will resist and legislation might be needed but the idea of using auditors’ knowledge and experience generally and specifically must be right and feasible.’
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The entire FTSE-100 is now audited by the Big Five firms. Each of those companies publishes annual reports and accounts for shareholders and stakeholders to view.

And yet their auditors, the people responsible for ensuring those accounts present a true and fair view, are not compelled to demonstrate that they too can do their own accounts correctly. Two of the Big Five, KPMG and Ernst & Young, have led the way in this area by publishing their accounts for some time.

Auditors for publicly quoted companies need to practice what they preach and publish their own annual reports. In a market as big as the UK, revenues should also be broken down to country-level.

Sir Peter says: ‘This is an obvious requirement. It may need legislation, but hopefully a voluntary adherence to such a practise should be possible.

Clients or potential clients should bring pressure. So should the advent of limited liability partnerships. Firms may not like it, any more than other professions like lawyers, but these big powerful organisations cannot have it both ways.’
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The language used to describe directors’ pay is emotive: fat cats; golden handshakes, handcuffs and hellos; rewards for failure.

Everyone likes to read about what others are earning and most of us like to feel aggrieved when those pay packets are higher than our own – especially when executives fail to deliver the performance that bonuses and large salary rises demand.

And currently there are very real concerns that the wrong people are being paid too much at the wrong time for the wrong performance. Some of it is perhaps inevitable in a downturn.

But today’s concerns appear to have momentum. And the government should strike while the iron is hot.

At the moment, the salaries of chairmen and chief executives are published with those of other directors published in bands. The salaries – and all other forms of remuneration – of directors of all UK listed companies should be published in full.

And, where large, bonuses should be justified in the annual report.

Auditors could be asked to play a role though they would probably balk at this. But there is no reason why membership of the remuneration committee should not be widened: to include worker and shareholder representation and perhaps even representation from the auditors themselves.

Sir Peter says: ‘This one won’t go away. And it’s tricky. People are pretty two-faced. Many big earnings are accepted – footballers, lottery winners, people who are perceived to have ‘earned’ (take Lord Hanson).

But others are not, especially when associated with failure or job losses down the line like BT and Marconi. Openness in disclosure, some commentary by the auditors or a reformed remuneration committee is needed. Good companies and the institutes need to get their heads around this. Or the government will do it for them and they won’t like that.’
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The National Audit Office is recognised as a powerful and thorough investigator when it comes to dealing with government departments and projects.

But the scope of its investigations is limited as it currently cannot audit nor investigate private companies that have received central government money.

The Sharman report published last year advocated widening the NAO’s powers so that it could do so – but to date the government has so far remained silent though some comment is expected at any time.

The move would increase accountability and transparency at a time when there is an increasing overlap between the private and public sectors.

Sharman’s report also recommended that 25% of the NAO’s work could be outsourced to the private sector – in the short term this would solve the resource issue were the NAO’s remit to be widened. There is no reason why the Audit Commission should be left out of this arrangement.

Sir Peter says: ‘The state takes some up some 40% of public expenditure and of course has a significant affect on the economy as a whole. Sharman’s report has so far been a huge missed opportunity. There should be much more interaction and liaison. This is down to government, but also requires a freeing up of attitudes on both sides. With the wholly desirable blurring of the public/private sectors, the audit split looks decidedly old fashioned.’
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Struggling with cashflow because of unpaid bills is the bane of an SME’s life. Without money coming in, even though services have been provided and further orders taken, materials cannot be bought, suppliers cannot be paid – a company’s very existence can be threatened. 1998 saw the government introduce legislation that allows companies to charge interest on unpaid bills, but surveys have shown this has barely scratched the surface of the problem.

Companies need a further sanction. An easy one to achieve would be to allow companies in their annual report to publish a register of ‘bad’ debtors, the amounts they owe and how late the payments are. Public humiliation is one sure way of helping to persuade people to pay up on time.

Sir Peter says: ‘Not perhaps a wholly reporting matter, more one of good management and openness. It goes with the whole question of reporting.’
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Broad consensus stands in favour of a rise in the audit exemption threshold to the European maximum of £4.8m.

It would free around 725,000 UK businesses from the burden of annual statutory audit – ensuring credibility for the government’s stated policy of making the UK a place to foster entrepreneurs.

After three years of intense scrutiny an emphatic recommendation to raise the threshold came from the company law review steering group, made up of some of the UK’s most switched-on business leaders.

Ultimately it is market conditions that will dictate whether a company needs an audit. Banks have confirmed that if necessary they will always request an audit.

The debate should now focus on when to take the step and not if it should be taken.

Sir Peter says: ‘Government should be in favour of this as an example of deregulation and potential cost saving. Banks and others – eg: the tax authorities – may still want something, as may organisations with public or semi-public responsibilities, eg charities. Professionals may miss the work, but on balance they are likely to prefer voluntary commissioning on a worthwhile basis to poorly paid work born out of compulsion.’
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We live in an age when corporate social responsibility is viewed in terms of ‘when’ it should happen not ‘if’ it should take place.

The benefits are obvious: forcing companies to make public their performance in these areas will compel them to do better.

Complaints that the measures are not available to ensure that such reporting would be fair are increasingly spurious as more and more bodies and institutions produce metrics that will work.

The voluntary approach is not working and compulsion is now the only way forward.

Sir Peter says: ‘This has to come, initially for big/global concerns, but eventually for all. Legislation will be needed. Neither firms nor clients may like it, for various reasons – it shows up bad practices and gives ammunition to the likes of Greenpeace – it’s costly, or gives more exposure to potential claims in a necessarily touch-feely area. But it must come, and people should start planning for it.’
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The tax system is unthinkably complex. Some suggest it is even nearing the point at which it could cease to function.

Efforts have been made to rewrite legislation to make it easier to understand but that ducks the real issue and has failed to simplify the system.

This is a democratic point. For those unversed in the esoterics of tax – i.e. most of the taxpaying public – their obligations are increasingly difficult to understand. Obviously, governments must retain responsibility for setting rates but there is a course that could be taken to help matters.

A special committee made of experts, politicians and stakeholders could view proposals in terms of their potential to limit administrative burdens and test compatibility with existing legislation.

A formalised body such as this could publish minutes, like the Monetary Policy Committee and record its verdicts publicly. It could also be the vehicle for undertaking a review of the tax system and publishing the results.

Sir Peter says: ‘Certainly the tax system needs simplification, but care is needed. One can argue whether it should be simple revenue-raising apparatus, or an instrument of social policy. It is both of course; the Conservative chancellors tended to the first, while the present chancellor goes to the second. A committee to look at potential and proposed legislation, and what is needed, could be useful. But it would have to recognise that its functions and power would be quite different to those of the MPC.’
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