Audit quality: a dangerous path

People outside the business community would imagine that the audit of annual
accounts produces a ‘right answer’ or ‘wrong’.

Yet life is never that simple. Putting together financials requires
professional judgment, which creates shades of grey.

The best interpretation of accounting and governance standards should present
the most accurate and transparent picture of a company’s financial status.

Auditors check the numbers, and use their judgment to decide whether they
present and true and fair view of annual accounts.

Those representing the biggest investors in the world want better information
to help them decide whether to hold an investment, or move clients’ money

They believe that auditors have an easy ride, and fail to look rigorously
through businesses’ collective books. Auditors need to show a greater duty of
care, be more liable for their own mistakes and uncovering their clients, argue

Providing ‘boilerplate’ statements in accounts is unhelpful and opaque, they
add for good measure.

Unsurprisingly, tension exists between auditors and investors. A healthy
situation, but recent attempts to meet each other in the middle have shown how
entrenched each party’s position is.

Both put forward their cases to industry minister Margaret Hodge during the
formation of the latest Companies Act.

But the introduction of a new criminal offence for auditors who ‘knowingly or
recklessly’ provide an incorrect audit opinion could be toothless, argue
commentators. Attempts to limit audit firms’ liability could also fall foul of
the courts.
So what are we left with?

Some of the most outspoken investment representatives are still fuming about
the liability issue. They see the Big Four as looking at any means to further
limit their liability, whether audit quality is improved or not.

Other concerns have been voiced in the community, albeit from behind
‘screens’. The issues raised include longstanding issues over whether auditors
could have done anything about companies that ‘blow up out of the blue’. ‘We
don’t like surprises’ is a regular comment made by the investment community.
They also say auditors are too focused on producing boilerplate sign-offs of an
audit, without really getting into the nitty-gritty of the numbers, or really
understanding their client.

On top of that, the Companies Act and previous case law has left auditors
with little risk and therefore little impetus to provide the best duty of care,
according to many in the City.

One body looking to make a positive difference in recent times is the Audit
Quality Forum.

Chaired by Ernst & Young partner Gerald Russell, the ICAEW-organised body
has met to discuss investor concerns and those of all stakeholders in the audit
process, including the audit firms themselves and standard setters.

Unfortunately, it appears that the issue of audit quality is one that could
be impossible to reach agreement on, according to Russell. ‘The trouble is that
quality means different things to different people,’ he explains.

Russell confirms that there is little to raise cheer for investors from the
recent Companies Act, as it provided nothing directly related to improving audit

What he does see buried within the legislation is wording that could have the
opposite effect, meaning an increase in box-ticking and the removal of
professional opinion from the audit itself.

The ‘knowing or recklessly’ aspect of the Companies Act’s drafting on a
criminal offence for auditors is actually split in two.

The first part describes anything material missing from the audit, but the
second part relates to the omittance of a statement required under sections of
the Act relating to accounting standards.

Russell explains that the second part could open up auditors to being held
criminally liable for not checking the minutae of a company’s accounts, as it
does not relate to material matters. ‘Our fear is it might damage audit quality,
that boxes are ticked and people have their backsides covered, so auditors could
move away from being thinkers,’ says Russell.

Auditing the very smallest details of the accounts detracts from quality
rather than adds to it, he believes Companies producing controversial figures,
or at least those that cause consternation among auditors, often have the
contentions issues ironed out through discussion and negotiation.

This use of experience to come to a sensible conclusion for all parties
interested in the financials could be removed because of the criminal offence,
so more audit qualifications could follow.

Even without looking at the particular wording of the Act, Russell argues
that as good audits are a matter of professional opinion, the one thing that
investors hate ­ box-ticking ­ will become the audit norm.

Yvonne Lang, national technical director at Smith & Williamson, agrees
that the biggest hurdle for audit quality is the difference in views of what an
auditor does and why the auditor does it. In turn she sees the AQF as a ‘useful
body’ that is trying to look at auditing and make recommendations to raise

But while investors want auditors to provide greatly detailed information
about the things a company does and why it does it, there will always be

In reality, Lang argues, auditors are just not there to serve that purpose.
‘Disclosure of information is set in accounting standards and legislation,
there’s more emphasis on the discursive side at the moment, but it’s always a
balance of commercial sensitivity and compliance,’ he says.

‘The expectations gap is still there. Different people have different views
of what they expect auditors should achieve.’

But auditors can’t really give a statement on how well a company is managed,
Lang explains.

‘What about information about the company? It’s fraught with problems and the
risk to the auditor is huge. So what would you be trying to achieve?’

Investors want auditors to dig deep and reveal more about clients. But the
more they do so, the bigger the risk they put themselves in over what they
reveal and how that information is interpreted. Auditors do not sit on boards
all year round, says Russell.

This is the counter argument to those opposed to limited liability.

More protection for auditors will open up the possibility of more rigorous
and better quality work.

But the time is ripe for change, or at least evolution of an auditors’ duties
and the way they are presented.

The Auditing Practice Board is about to open up consultation on the topic of
audit quality.

Lang believes that in reality the relationship between investors and auditors
are ‘not bad’.

Both sides have expressed concern over the potential shift to more
rules-based accounting and auditing standards, something that could be on the
cards as US standards setters attempt to throw their significant weight about in
the convergence arena.

Inevitably, attempting greater audit quality through limited liability, and
concerns of a US dominated regulatory climate, will lead to some interesting and
passionate comments when consultation begins.

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