Making the most of Audit: True and Through

For some businesses, audit can be preceded by a string of four-letter words.
But if companies box clever, the process can be more about professionalism and
less about profanity. Audit is at a crucial juncture in the UK, with a raft of
sweeping changes in the pipeline. Whatever happens, there’s only likely to be
one winner – your accounts.

The process of laying your books open can be the accounting equivalent of the
dentist’s drill, which emphasises the importance a good relationship between the
auditor and client can play in numbing the pain.

Edward Middleton, an assurance and advisory partner at PKF, believes it is
crucial to get the fundamentals right to pre-empt any sticking points between
you and your auditor mushrooming into serious obstacles. ‘The key thing is
making sure the right information and documentation are available to the auditor
at the start,’ he says.

Middleton says it is not uncommon for a client to make such basic errors. ‘It
is not abnormal for information to be missing. It might be a set of draught
accounts or working papers or answers to unavoidable questions. The client needs
to be clear on timetables and processes because this makes the auditor’s job
easier. Generally speaking, an auditor will always say to the client, “let’s
make sure the relevant information is there”, but hurdles can still arise.’

David Herbinet, head of public interest markets at Mazars, says: ‘Companies
need to get the risk management and internal control aspects right. These are
key features. If they are in place, then the audit can be relatively easy.’ But
while the client-auditor relationship is clearly subjective, certain factors are
still needed to get the best out of the audit process. For example, chemistry
between the management and auditor is fundamental.’ says Middleton. ‘It’s
difficult to pinpoint other specific criteria a client needs its auditor to meet
because every job has its own singular characteristics, but clients setting out
exactly what they want in terms of audit and additional services is paramount,
so the chemistry must be there.’

Herbinet believes most auditors have the same level of competence, but
stresses that a personal fit between auditor and client is important. ‘With
personal fit, meaningful discussion becomes possible. There is a fine balance
between open and robust debate, and knowing where to draw the line, but that’s
what companies are getting less of these days because of tougher regulation.’

Middleton offers his own take on how to achieve the necessary balance. ‘It’s
a question of practice, experience and judgement, and knowing where to draw the
line; for example, the extent to which an auditor is able to prepare accounts as
opposed to just auditing them.’

The long-running dispute regarding audit choice and competition still rages
between the Big Four and the mid-tier chasing pack, which means the real winner
is likely to be the client as firms make a greater effort to retain their
clients.

Corporate governance reforms have increased restrictions on the non-audit
services that a firm can provide. They have received a mixed reception as the
traditional role of the auditor has been given another significant overhaul.
Herbinet supports the change as critical if the audit market is to become less
concentrated. ‘I think the rules which limit non-audit services are very good,
but it’s a bit of a shame we had to end up with a rules-based approach in some
respects, but I think it’s a good way to have a more open market and fairer
pricing because some auditors are less able to win audit work.’

In terms of a more competitive audit climate, the pendulum is swinging in
favour of the businesses as other key legislative changes are being hammered
out. Recently, opinion has been split in the audit community as a last-minute
amendment to the Companies Act has demanded that the FRC’s Professional
Oversight Board provide audit committees with detailed reports of the companies
it puts under the spotlight through the Freedom of Information Act.

Currently, the POB does not name audit firms or companies it has inspected
and publishes results of inspections only in the form of a general report. When
the move was announced, POB director Paul George responded: ‘We’re not convinced
it (the Act) is the right mechanism to determine whether a body should be
subject to the FOI.’ But this could lead to a revolution rather than an
evolution of the traditional auditor-client-audit committee relationship.

Some mid-tier firms have argued that not only is their audit work comparable
to the Big Four’s, it also blames the largest firms for some of the problems
mentioned in the current anonymised reports. Indeed, they believe that
anonymised reports fuelled the idea that a Big Four audit is more reliable than
those from other firms. Ministers argued that audit quality reports on the work
of major accountancy firms would otherwise remain private, with the publication
of ‘only the blandest summaries, despite the requirement under corporate
governance rules for the audit committees of company boards to make judgments
about the effectiveness of their auditors’, says opposition Treasury
spokesperson Baroness Noakes.

‘You have to draw the line before you overburden the audit committee and put
them in, a position where they are second-guessing the finance function, says
Middleton. ‘Personally, I don’t have a problem with greater transparency of
audit operations, but this could see the audit committee unable to give an
overview because they have become subjective.’

But is the audit landscape likely to change significantly, even if these new
initiatives are greenlighted? Oxera laid bare the extent of the Big Four’s
stranglehold on the audit market for FTSE 350 companies, identifying the fallout
from the Enron scandal as a major contributor. Arthur Andersen’s implosion
reduced the Big Five to Four, but only resulted in the remaining quartet
scooping up Andersen’s lucrative clients. This was attributed to one key facet –
reputation.

Oxera believed it was an important driver of choice, favouring the Big Four,
based on real or perceived differences with the mid-tier firms. The consensus
seems to be that the Big Four were better placed to offer two key components of
the audit product: value-added services on top of the audit, and insurance
against catastrophes and reputational risk.

Switching rates were low (about 4% on average for all listed companies), and
competitive tendering did not occur frequently, so the outlook appears less than
rosy for the mid-tier and its efforts to bridge the chasm between itself and the
Big Four’s audit operations.

But Herbinet forecasts that the audit market will undergo a significant shift
towards greater openness, but it could take time. ‘I think the market will
change in the next 5-10 years. We’ll have an open market with a lot more players
and greater transparency. My hope is that it will happen soon, but my fear is
that it won’t. The barriers that still exist are very strong and it will be a
lot of hard work to break them down.’