Audit quality under pressure as firms cut costs

Audit quality could be the latest casualty of the downturn as accounting
firms cut costs in some of the toughest market conditions seen in ten years,
regulators warn.

The Financial Reporting Council (FRC) wants accounting firms to maintain high
audit standards despite near unprecedented pressure on profit margins.

Paul George, head of the FRC’s Professional Oversight Board, is concerned
that a general downturn in audit work might see firms concentrate on their
bottom line at the expense of audit quality.

Markets rely on auditors to provide assurance and comfort about company
performance and data. It’s feared cost cuts could promote a culture where their
own business growth is more important than audit quality.

“Any prolonged reduction in investment in audit, be it recruitment, training
or investment in systems or any behavioral changes to a realignment of personal
objectives will have a long-term impact on audit quality,” he said.

“[The FRC] has an important function as a counter balance in the equilibrium
between commercial pressure and audit quality.”

The board has found no drop in audit quality, but noted one case where audit
man hours were cut and another where staff rewards were altered to reward
business growth at the expense of audit quality.

This year industry giant PricewaterhouseCoopers changed its bonus criteria to
emphasise business growth, which jumped from 25% to 40% as a proportion of its
KPIs. Meanwhile, audit quality portion dropped from 25% to 20%.

The FRC’s audit inspection unit, which investigated the issue, said the
underlying message represented “a potential risk to audit quality”.

It noted however the change was small in terms of total remuneration “and was
not intended to undermine the importance of audit quality”.

The inspection unit also found that in one case PwC staff were told to reduce
audit hours by 5%.

In its 2009 transparency report, PwC said bonuses are arrived at against
individually tailored balanced scorecard of objectives, including member’s
responsibilities, performance and overall profitability.

Richard Sexton, head of assurance at PwC, said he would noever compromise
audit quality on cost grounds. “Quality is a must have and it is just part of
the job… Quality is what drives our reputation and if we let quality drop then
our reputation drops and we may as well not be in the business,” he said.

The unit also inspected PwC’s big four rival KPMG and found audit quality was
not significantly represented in performance assessment.

“We concluded from our review… that the achievement of audit quality
objectives does not have as significant an impact on partners’ overall
performance assessment as their achievements in other roles,” the report found.

According to a KPMG report, the firm rewards its staff based on service,

professionalism, knowledge, accountability, business focus, problem solving,
relationship building, staff development, drive, resilience and “making an
impact”.

KPMG, along with the rest of the industry, is under considerable pressure
since the recession. In August, Ernst & Young’s head of assurance John
Flaherty said retendering “driven on the grounds of price” was at its highest
level in 10 years.

George said he was conscious of commercial pressures and said he had noted
actions taken to maintain margins.

“While we have not identified that any individual action has had a direct
adverse impact on audit quality, we are highlighting the risk,” he said.

IN OUR VIEW

Who do auditors service – investors or themselves? The answer to this
question will colour your view on close to every emotive audit issue, not least
of all this one. The Big Four and their mid-tier cousins are suffering. Revenue
is down. Competition is stiff. Something needs to give. Audit quality,we are
repeatedly told, is sacred. Now,many will see just how sacred it really is.