Calls for more clarity in annual reports are forcing auditors into a corner. Diana Hay says clarity will boost confidence, while Gavin Hinks says it's time for stop hiding behind 'client confidentiality'.
Clearer picture is vital for survival
Everyone is aware that there is a serious crisis of investor confidence in the UK concerning the reliability of accounts and the role of auditors.
What reliance can be placed on accounts when apparently healthy companies, with unqualified audit reports, turn out to be so sick that they cannot survive?
In a recent ProShare survey, 71% of individual shareholders felt that the level of disclosure by UK companies was inadequate to protect them.
It is not difficult to understand why. The private investor, without the analytical resources of the big battalions, has one independently examined information source – the annual audited accounts. Even then, the individual investor will not have the same access to the company as an institutional investor when it comes to interpreting the accounts.
One fundamental problem with the annual accounts is the nature and role of the audit report. Private investors tend to expect an unqualified report to be some sort of guarantee that the company is (and will continue to be) in a healthy state. But the audit report is far narrower in scope.
I believe that there is now every justification for widening it.
The anodyne wording used in audit reports is so couched in generalities that it makes one’s eyes glaze over. I believe that it should draw shareholders’ attention to any major areas of concern considered by the auditors and give details as to how those concerns were resolved.
So if the company appears to be prima facie insolvent, yet is given an unqualified audit report, why doesn’t that say what the auditors did in order to satisfy themselves that the business was still able to pay its bills.
I realise that this would represent a substantial change from the current system, where no hint is given of the nature of the detailed work performed or the evidence produced by the company in support of its accounts.
Some will no doubt try to argue that it would expose the potential weaknesses of a company to the world and that commercially sensitive information might be disclosed for no good reason.
But investors (current and potential) should be entitled to as much transparency as possible. The bald fact is that, while the company may pay for the audit, it is performed for the benefit of all the shareholders.
Investors have a right to know
In an age of mass share ownership, stimulated by the privatisation boom of the 1980s, it seems to stand to reason that listed companies provide as much information as possible to their investors.
Caught in the middle, in what can sometimes be a fractious relationship, are the auditors and the reports they produce for the annual reports and accounts.
When a company goes under it is often the auditors who find themselves in the cross hairs of investors who have lost out. Auditors are told they should have known what was going on and should have done something about it. When investors cast around for the useful information they invariably focus on the auditors’ report and more often than not will find themselves disappointed.
Though they can vary an auditors’ report frequently amounts to no more than can be written on the back of a post card. Not much for investors to base an assessment on.
Auditors will rush to tell inquisitive investors that their hands are tied and that client confidentiality restrains them revealing any more.
More than that they might even go so far as to say that increasing information published in an auditors’ report is not the issue – the real problem, they might claim, is ensuring company directors reveal everything to the auditors.
There are a lot of issues here.
One of the first claims will be that addressing the issue of audit reports will be confused with a question about what is an audit for.
But that should not stop us. The issue about the report is about what is disclosed – there is little to be confused with there. But pointing the finger at directors is not going to wash either, even if it is correct, because Enron has thrown up an even more pressing issue – ‘public perception’.
Auditors need to be seen to be doing their jobs.
And there’s good reason for this, not least among them is that they do good work.
They have been responsible for forcing the resignations of FDs, CEOs and even company chairmen in the interests of a company’s finances. Such decisive and influential actions are worth telling for the sake of investors and the company.
And this is the pressing challenge facing auditors – to show the world they are doing good and worthy work.
Indeed that they should do so seems inevitable. They will be forced out from under the cover of ‘client confidentiality’ and will have to find ways of proving to the public that they are doing their work and demonstrate that they are doing it effectively.