Audit Standards – One size will not always fit all

It is also buying the firm’s auditing standards, the firm’s signature on the audit report, and the technical expertise to make sure the numbers that matter get past the Review Panel.

What it is not buying are the auditing standards issued by the APB in the UK, the IAPC internationally, or any other auditing standard setter.

Auditing standards setters don’t have the high profile that the accounting standard setters do and, in any case, the Big Five all claim that their auditing standards exceed any national requirements.

But there are problems with the Big Fives’ standards.

In the US, no less than three committees, all established within the last three years, have been taking a particularly aggressive line with auditors and the standards they apply because of a continued loss of public confidence in the effectiveness of the audit process.

A Blue Ribbon committee established by the Securities and Exchange Committee has been making recommendations on strengthening the role of audit committees.

Panel on Audit Effectiveness has been set up by the Public Oversight Board to assess the impact of recent trends in auditing on the public interest And the Independence Standards Board was set up to look at the independence of auditors auditing SEC-listed companies.

The European Union has been concerned about the lack of uniformity in auditing standards in Europe for a long time and has been working with FEE, the profession’s voice in Europe, to sort out to what extent they can be harmonised. IOSCO, the umbrella organisation for the world’s securities regulators, has indicated that it wishes to see further progress in the harmonisation of auditing standards – the list goes on.

Two problems here both involve the Big Five.

The first was highlighted a year or so ago after the collapse of a number of Far Eastern financial institutions. Several large firms were forced to admit their global brands were not as global as they might be, and that some of the auditing and accounting standards applied by their offices in the Far East might not pass in the West, largely as a result of local regulation. For this, they might be forgiven, at least in part.

The law in this country gives auditors permission to demand information from companies and imposes sanctions on companies that do not provide it; the law in certain other countries gives auditors no such rights.

In many countries the law requires accounting treatments that seem to fly in the face of what we understand to be fundamental accounting principles, and even the Big Five can’t do much about that. But when it comes to financial statements purportedly prepared and audited under international standards, to complain that local auditors do not properly apply the Standards, or that they understand them in a ‘different way’, simply won’t do.

The IASC has no teeth. If a company’s accounts state that they are prepared in accordance with IASs, and they are not, the only organisations that are really able to do anything about it are the Big Five auditors who can threaten, under international standards on auditing, to qualify their audit reports.

Unfortunately, the evidence suggests that the firms are not qualifying as often internationally, where there is no equivalent of the Review Panel, as they do at home. IFAC is planning a Transnational Audit Committee to promote compliance with International Standards on Auditing within large firms, but committee members are likely to be the firms themselves, and without some sort of independent representation, the committee will inevitably appear to be yet another forum in which the Big Five avail themselves of the opportunity to rubber stamp their own activities.

In any case, plans are still at the drawing board and it is, therefore, a little disappointing to see that the main thrust of the profession’s most recent public initiative in this area amounts to educating the locals.

IFAD, the International Forum for Accountancy Development, was set up last year by IFAC, the Big Five and a number of regulators and financial institutions such as the World Bank. Its objective, as its name suggests, is to aid the development of accountancy in developing and transitional economies and to promote ‘the value of transparent financial reporting in accordance with sound corporate governance’.

And fair enough. Anyone who has ever worked in a transitional economy understands only too well the problem of poor accounting standards. There is an enormous amount of work going into the harmonisation and development of accounting standards around the world and there is no doubt that these accounting problems will gradually diminish over the years. But none of this deals with the inability of the Big Five to apply their own standards uniformly, nor does it deal with their other problem, which is still in the making.

Over the last ten years, the Big Five have invested enormous amounts in the development and roll-out of their new audit methodologies.

These methodologies are designed to provide business assurance to their clients and they involve a major shift of focus, away from a narrow, financially oriented concept of audit risk, to a broader concept of business risk. US regulators, particularly the SEC, are bristling. The firms stand accused of abandoning proper auditing, refusing to do things the tried and tested way – which involves getting hard, documentary evidence, crawling over the figures with a microscope and asking difficult questions – in favour of wishy-washy risk assessments which involve endless meetings with the client at the expense, in every sense, of the shareholder.

Firms are accused of putting competitive advantage and the expansion of business assurance services before their stewardship function. The firms are equally adamant that ticking everything in sight was fine in the 1950s, but that business has changed so much since then that it would be quite impossible and, more to the point, totally ineffective to apply such procedures today.

They argue that their methodologies enhance the audit process by putting audit risk into the business context in which it belongs; audit risk does not exist in a vacuum and if auditors do not understand business risk, their analysis of audit risk will be fatally flawed.

As ever, both sides have a point, and some compromise has to be worked out. Unfortunately, there is probably a long and acrimonious battle in store because the firms are not be prepared to lose their investment and their critics are increasingly irked and worried by the fact that the Big Five seem answerable to nobody and ever more successful at the same time.

– Elizabeth MacKay has worked for the Big Five and for regulators both in the UK and abroad. She also writes and lectures on global audit and regulation.

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