THE HOUSE of Lords has accused auditors of a “dereliction of duty” in their report into the audit market and the role of auditors during the financial crisis.
Complacency, and Big Four domination, were also among the damning indictments that emerged from the eight-month probe, which concluded audit “standards are slipping”.
The Lords committee has called on the Office of Fair Trading to launch an inquiry, and warned the Competition Commission – which investigates serious breaches of regulation – might need to be summoned.
Two distinct focuses emerged as the committee railed on the auditing of banks and the wider audit market. The sharpest words were reserved for bank auditors, but the Lords were insistent on the need for greater competition in the market.
The body said the failure of auditors and regulators to engage in meaningful dialogue fed the financial crisis.
“We regard the recent paucity of meetings between bank auditors and regulators, particularly in a period of looming financial crisis as a dereliction of duty by both auditors and regulators,” stated the committee.
International financial reporting standards also came under fire, as the committee argued the accounting rules had lowered audit standards. The international framework was accused of encouraging “box-ticking”, and moving away from the use of professional judgement to reach a true and fair view.
Chairman Lord MacGregor (left) said the risk of the Big Four becoming the Big Three was so severe that “a thorough review” by the OFT, and possibly the Competition Commission, “is now overdue”.
He said regular meetings between bank auditors and regulators would avoid the “serious failures of communications between the two which contributed to the financial crisis”.
Update 11.30am 30 March, 2011
The ACCA has warned that the House of Lords criticism of international accounting standards is misguided.
Helen Brand, chief executive of ACCA, said: “We are most worried by the Lords’ conclusion that the introduction of IFRS has led directly to a reduction in audit quality. ACCA does not believe this to be the case.
“The Lords have quoted many eminent participants in the inquiry process who have disagreed with the Lords’ assertion. ACCA does not believe the banking crisis was predominantly caused by accounting issues and we are not convinced that IFRS provides less scope for auditors to exercise prudent judgement, as is alleged.
“IFRS includes an overriding requirement that the financial statements should present fairly the position and performance of a company. An audit has always been, and continues to be, more than a report on compliance with a set of accounting standards. The Lords have overemphasised the differences between UK GAAP and IFRS in this respect.”
Update 11.43am 30 March, 2011
ICAEW chief executive Michael Izza has rejected the claim that auditors contributed to the financial crisis.
“We do not accept that auditors contributed to the severity of the financial crisis. They did the job that they were expected to do – provide an audit opinion on banks’ financial statements. However, as a profession, we recognise that the audit model has to evolve to continue to meet the needs of the market and society.
“For example, the Bank of England and the Financial Services Authority working with the profession has developed a draft code of practice for two-way dialogue between auditors and supervisors. Putting this dialogue on a statutory footing is one of the key recommendations in the House of Lords report and is a great example of supervisors and the profession working together to make constructive improvements.”
Update 11.55am 30 March, 2011
PwC reveals it is ‘disappointed’ at the Lords call for an OFT inquiry and rejected the claim that bank auditors were ‘complacent’.
UK chairman Ian Powell said in a statement: “This is a fiercely competitive market at all levels and the buyers of our services are highly sophisticated in selecting independent auditors on the basis of quality and value.
“I do not agree that we were ‘complacent’ and I am surprised by the Committee’s claim that there was a ‘dereliction of duty’ given their stated view that auditors fulfilled their legal duties.
“However, throughout we, as a firm, like other market participants, have accepted that there are lessons to be learned from the financial crisis and we have already implemented a number of measures to reinforce the relevance of the audit.
“We will continue to play an active and constructive part in this important dialogue.”
Update 12.08 30 March, 2011
Grant Thornton has welcomed the OFT investigation but revealed concerns about OFT attitude
Steve Maslin, a partner at GT, said: “While I welcome recommendations for a detailed investigation by the OFT, I am concerned about the OFT’s current perception.
“Some of the evidence it provided to the committee suggested that concentration was caused by investor needs for audit quality and capability to undertake complex audits across the World.
“The results of AIU inspections clearly show that Grant Thornton is capable of delivering high quality audits around the world, to most of the FTSE350, and indeed that our audit quality is on a par, if not higher, than the four larger firms. That is recognised by investors themselves, for example in the ABI’s own submission to the Committee.
“The OFT inquiry must, at the very least, lead to the banning of ‘Big 4 only’ clauses in bank agreements, which nearly all commentators, including the four larger firms, say are wrong. If not, it will show the UK regulatory framework in a poor light, with lots of regulators conducting lots of toothless reviews.”
Update 12.15, 30 March, 2011
The Chatered Institute of Internal Auditors has welcomed a call from the Lords to ban auditors from conducting internal audits at the same client.
Dr Ian Peters, chief executive of the body, said: “Allowing external auditors to do internal audit work for their audit clients creates a number of potential conflicts of interest that threaten the quality of the audit – not least being dependent on the audit firm to identify problems with its own work.
“However, we feel the Committee should have gone much further in exploring how future financial scandals might be averted by strengthening the role of the internal audit function.
“External auditing takes place on an annual basis, it looks at historic numbers and is narrow in its role.
“In contrast a properly working internal audit function is forward looking, continuous and broad in its remit.”
(Picture shows the Lords economic committee members delivering the report earlier today ©Iain Winfield/Incisive Media)
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