Institutes concede reform required for audit

House of Lords

Senior figures at the UK’s accountancy institutes yesterday made a robust
defence of the audit industry to a House of Lords inquiry, but conceded that
reforms are necessary to protect standards and maintain public confidence in the

Their comments come amid growing support for overhauling the audit industry.

Earlier this month, the European Commission said that it was considering a
mandatory rotation of auditors and a cap on advisory fees. Mazars, a mid-tier
accountancy firm, has called for dual audits, while the chairman of KPMG in the
UK, John Griffith Jones, has called for a code of conduct to improve
communication between auditors and regulators.

Grant Thornton, the UK’s fifth biggest accountancy firm, has called for a cap
on the number of clients large accountancy firms can audit in order to reduce
the dominance of the “Big Four” firms — Deloitte, Ernst & Young, KPMG and
PwC – and improve competition in the audit market.

In their latest session examining the audit industry following the financial
crisis, members of the House of Lords economic affairs committee yesterday
painted an unflattering picture of the UK audit industry. Peers claimed that the
audit profession was dominated by the Big Four firms (Deloitte, Ernst &
Young, KPMG and PwC); suggested that some auditors were asleep at the wheel when
auditing banks before the financial crisis; and that auditors compromised by
conflicts of interest.

Lord Lawson, a former chancellor during the Thatcher government, said he knew
of no examples where an audit firm had managed to “catch the ball” that had been
dropped by regulators during the financial crisis

Robert Hodgkinson, executive director, technical at the Institute of
Chartered Accountants in England and Wales (ICAEW), responded to this by saying
that his institute was working on proposals to encourage better dialogue between
the Bank of England, the Financial Services Authority and bank auditors.

“When auditors catch [the ball] or influence outcomes it is quite invisible
to [to the public] because of the nature of the work,” he said.

Hodgkinson added that “professional scepticism” ran through auditing
standards like a “golden thread”, although he admitted that in some audits
during the financial crisis auditors should have been more sceptical.

Lawson looked unimpressed by the defence of auditor’s professional judgement
and questioned whether auditors were prepared to be corporate whistleblowers
when necessary. If an audit firm is worried that a client is taking excessive
risks, or is understating risks, would the audit firm have the confidence to
alert a regulator if their client remains unresponsive, he asked?

Committee members also raised a long-running criticism of the audit industry
– that the sale of advisory services, such as tax or IT, to audit clients
undermines auditors’ independence.

Institute representatives argued that a ban on the sale of non-audit services
could harm smaller businesses, in particular because they rely on their
accountants as general business advisers.

But other countries think differently. Lawson, noted that the US has banned
firms from selling advisory services to their audit clients, adding that the Big
Four firms would not “wilt away” if they were banned from providing internal
audit and advisory services to audit clients.

Audit firms would fight a ban on non-audit services, but concessions in other
areas seem more likely.

Helen Brand, chief executive at the Association of Chartered Certified
Accountants, said it would support moves to broaden choice in the audit market.
She also said that “restrictive” clauses in credit agreements that force banks
to choose a Big Four auditor should be removed. “[These] covenants are probably
a restriction of free trade,” she said.

Another option would be to extend the scope of audits to key parts of annual
reports — business model, strategy and market forces – rather than only looking
at a company’s financial performance over the past year.

Brand said: “We feel that maybe there is a need to extend the scope of the
audit, especially around internal controls and governance and forward-looking
part of the business.”

If the remit of auditors was to widen, perhaps regulators could review the
issue of limited liability for auditors – limiting their liability for damages
in the event of a company collapsing, Brand suggested.

Since 2006, UK companies have been able to agree limited-liability clauses
with auditors, but so far no major company is thought to have entered into such
an agreement.

Accountancy firms have warned that litigation from a large client could cause
the collapse of even the biggest audit firms — an event which would cause
serious disruption to clients.

Regulators have yet to be convinced about the need for change. Last month,
Baroness Hogg, chairman of the Financial Reporting Council (FRC), the accounting
watchdog, said that she did not foresee “rapid” change to auditor liability

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