PracticeAuditThe auditor of last resort

The auditor of last resort

The wind of change is about to blow through the world of corporate governance and the accountancy profession will not be able to escape the draught.

While some have declared that an Enron or Worldcom could not happen here, I don’t agree and in any event the UK will not be left unaffected by the outcome of US corporate excess.

Quite clearly, boards will need to re-examine how they are constituted and this will place new focus on the role of the non-executive director.

This role must be redefined with greater emphasis on the non-executive as the guardian of the interests of stakeholders rather than as just being a part of management machinery.

As regards the number of non-executive appointments any one individual can take, common sense must apply. Four or five appointments is feasible for an accomplished non-executive, 20 appointments is not. The quality of non-executives must be of the highest order and they should be required to avail themselves of ongoing internal and external professional training.

Monitoring of cross directorships
Cross directorships where executives in one company sit on the board of another as a non-executive and vice-versa need to be carefully monitored to ensure that independence is not compromised.

Further definition of the role and responsibility of non-executives should concentrate on how independence can be defined and maintained.

Remuneration committees should assume responsibility for the appointment of the external remuneration consultants and responsibility for the process of appointment of auditors must rest solely with the independent audit committee and not with a company’s management. Further, the audit committee should be responsible for managing the relationship with the auditors and establishing a process to ensure that auditors maintain their independence from the company.

All non-audit services provided by the auditors should be subject to review and approval by the audit committee. Annually, the audit committee should report on all these matters both to the board and to the shareholders via the report and accounts.

No longer will it be feasible for audit firms to sign off the report and accounts of public companies yet produce not a single integer of information about their own financial information. Audit firms must produce full sets of audited accounts, which should also include segmental reporting so that any issue about selling audit as a loss leader, or excessive dependence (nationally or by office) on certain clients can be easily observed. Firms must also provide details of their own quality control processes and preferably provide independent reports thereon.

Scope of service
Scope of service will need to be considered in a new light, provision of internal audit services to a company by its external auditor should be disallowed.

Indeed, external auditors should undertake no task that could be construed as auditing their own work, nor acting as an agent for an audit client company.

Partners acting as signing partners for an audit client should not serve in that capacity for more than five years. On a similar basis, no members of an audit team should work on the same audit for longer than seven years.

One of the most significant concerns of governments, regulators and companies is that the demise of Andersen has left the world with just the Big Four.

Sir Howard Davies, head of the FSA raised this issue at the recent Treasury select committee hearings, where he and I gave evidence.

It is unlikely that competition authorities would give permission for the merger that formed PwC in current circumstances. Perhaps it is too late to unpick this merger or require significant divestment of audit clients, but many believe that with the end of Andersen it would be preferable for competition and conflict of interest reasons to have a Big Five rather than a Big Four.

If second tier firms are unable to step up to the mark in terms of providing viable alternatives to the Big Four we may have to look at fresh ideas.

When under my leadership KPMG published the first ever set of report and accounts of a major accountancy firm we asked the Comptroller and Auditor General if his office would take on the role of auditor (this innovation was considered as a possible alternative to being audited by a rival firm).

While the CAG was very interested in this approach he was unable to commit to it as under current legislation the CAG may not audit limited companies.

In my report to government on the audit and accountability of central government, Holding to Account, I recommended that the CAG should be able to audit limited companies and government has accepted this.

NAO public audit
In the UK on the basis that legislation could be enacted that would permit the CAG, through the National Audit Office, to audit public companies this might be an interesting route to providing greater competition and diminishing the conflict of interest problem that might arise with just the Big Four.

If nothing else this could provide an ‘auditor of last resort’ in the same way as the Bank of England is a lender of last resort.

It is quite possible to over-regulate an industry and I consider that the current level of regulation for the accountancy profession is appropriate.

However, regulation must be seen to be independent.

For this reason the accounting foundation and the standards setting bodies must be independently funded and not be financially dependent, to any extent, upon the firms they regulate. I regard the publication of joint monitoring unit reports on audit firms as a necessary and desirable aspect of regulatory transparency.

I am completely confident that if audit firms rededicate themselves to their stated obligation of working on behalf of the shareholders then the wind of change will only have blown beneficially for corporate governance.

  • Lord Sharman is a Liberal Democrat Peer and former chairman of KPMG International.

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