Senior auditors renew calls for liability reforms

Tucked away on page 26 of the Liberal Democrats’ manifesto was a relatively
minor campaign pledge that has raised eyebrows in the offices of London’s audit
firms.

“We will reintroduce the Operating and Financial Review (OFR), dropped in
November 2005, to ensure that directors’ social and environmental duties will
have to be covered in company reporting.”

The reintroduction of the OFR, scrapped by Labour, via the personal
intervention of then chancellor Gordon Brown it was rumoured, raised the
possibility of reform to another, more contentious, area – auditor liability.

Senior auditors hope a new parliament may resurrect liability reforms quashed
six years ago. In exchange, auditors say they are willing to provide a greater
assurance role and increase their dialogue with investors.

“As we move into the next political era, as is often the case with new
parliaments, the opportunity arises to reopen previous issues,” said Martyn
Jones, audit technical partner at Deloitte.

Frustration continues at current liability arrangements, which enable a
company to enter into a limited liability agreement (LLA) with their auditor.

Companies have proved reluctant to sign up.

“I’m not aware of any listed company that has entered into an LLA,” said
Jones.

Auditors say the agreements simply don’t work for dual-listed companies,
which includes most of the FTSE 100. US regulations discourage any contract
which could undermine auditor independence, including LLAs. This attitude has
proved contagious among listed companies in the UK, with few wanting to take on
the contracts.

In exchange for liability reform the industry says it is willing to provide
an expanded statutory audit, which at the moment carries unlimited liability.

Audit was criticised in the wake of the crisis for not providing useful
information to investors. A Treasury select committee report last month said
audit reports “can seemingly omit crucial information”.

This has led some to push for an expanded future role for auditors.

“The concession that the profession will have to make for additional
liability limits will be to extend work that the auditor does at the front of
the book,” said Graham Clayworth, audit partner at BDO.

At present auditors examine the “front half” of an annual report, insofar as
it is consistent with the “back half” financial statements.

“We have to ask what comfort the auditor can give in terms of the information
that is in the front,” ­Clayworth said.

However, some auditors advise caution. Oliver Tant, head of audit at KPMG,
said it would prove difficult to audit what might amount to forward-looking
predictions.

“You can audit an order book – that’s hard and fast…but you can’t audit what
the order book will look like the week after next,” he said.

“The further you move away from the hard and fast facts the more the auditor
is going to require some sort of protection.”

Last week Steve Maslin, chair of the partnership oversight board at big six
firm Grant Thornton, said the current reporting model “doesn’t go far enough in
the modern world to give users all the information that they are entitled to”.

He added: “We can’t just say ‘there has been a crisis – it’s nothing to do
with us…There is a pent-up desire from users to get even more relevant
and useful information in accounts and if there are going to be more reliable
disclosures there needs to be some assurance.”

The Financial Reporting Council will examine the role of audit later in the
year. In the industry there are also suggestions the professional bodies should
investigate the subject.

Interest in the ideas are picking up. Earlier this month Pauline Wallace,
head of public policy and regulatory affairs at Pricewaterhouse Coopers, said
there should be an open debate about what information investors want.

“The question I would ask investors is what is it exactly you are searching
for?” she said.

She said there was still a lack of understanding about what value auditors
provide.

“We suffer from the classic problem – people don’t really understand what we
are doing and it is not terribly sexy. It’s only when there is a problem that it
comes to light,” she said.

IN OUR VIEW

In the wake of the crisis, auditors have to prove their relevancy to capital
markets. It’s not enough to say “auditors had a good crisis” and walk away. The
question needs to be asked – are auditors offering investors the information
they need? Liability reform has to be part of the response. So finally the
public can see a little more of the good work done by auditors.

Further reading:

frc.org.uk