New figures reveal an auditing sector that is beyond repair

A huge portion of audits are 'poor quality'. What other sector would be allowed to get away with this?

Suppose the law compelled you to buy a product, even though it did not meet your requirements? Meanwhile nearly all the producers continued to sell shoddy products. There would be calls to put producers out of business and start from scratch. None of this applies to the auditing business.

This week, the Financial Reporting Council (FRC), the UK’s accounting regulator, reported that 33% of the audits delivered by the UK’s seven biggest accounting firms are of poor quality. The public exposure of poor audits and the related publicity arising from cases such as at BHS, Carillion, Patisserie Valerie, London Capital and Finance, Autonomy and the 2007-08 banking crash has not persuaded auditors to improve the quality of their work.

The FRC reported that 39% of the audits delivered by KPMG were deficient compared to 35% for PricewaterhouseCoopers (PwC), 29% for Ernst & Young, 24% for Deloitte and 45% for Grant Thornton. Yet these failing firms dominate the UK audit market. They audit companies, universities, hospitals, trade unions, housing associations, local authorities and public bodies. Audit firms collect millions in audit fees and deliver little.

Dangerous dependency

Accounting firms claim that they deliver ‘independent audits’. This is misleading. No UK company has ever had an independent audit. Companies shop for auditors – a system that means those giving the right answers are appointed. Directors are not in habit of appointing troublesome auditors. Shareholders rubber-stamp the directors’ decision at the annual general meeting.

Auditors are dependent upon company directors for their tenure and fees. They use audit as a stall for selling consultancy services, such as tax avoidance and regulatory arbitrage, to audit clients. Scandal after scandal suggests this fee dependency buys silence, and all too often Nelsonian auditors let the lying dogs sleep. An independent body should appoint and remunerate auditors, but corporate elites and accounting firms oppose such reforms.

The state guaranteed market of auditing is not accompanied by adequate pressures to deliver robust audits. In general, auditors owe a ‘duty of care’ only to the company and not to any individual shareholder, employee, creditor or any other stakeholder even when they are affected by auditor negligence.

Case after case

Audit failures at Carillion affected 30,000 suppliers who were owed around £2bn. The company’s pension scheme had a deficit of around £2.6bn and eroded the pension rights of 43,000 employees in the UK and elsewhere, but none can seek redress from auditors. Without the pressure of lawsuits, accounting firms have little incentive to improve the quality of audits.

The UK has had a banking crisis in every decade since the 1970s. The mid-1970s secondary banking crash, the collapse of Johnson Matthey, Barings, the Bank of Credit and Commerce International (BCCI) and the 2007-08 crash showed auditors to be asleep. Little has changed.

Audit failures are revealed by scandals rather than any voluntary admission by accounting firms. At Wirecard, the auditors failed to independently corroborate the company’s bank balances, a very basic task. This may have revealed the alleged €1.9bn fraud.

BHS collapsed in 2016 and a subsequent inquiry by the FRC showed that the PwC partner in-charge of the audit spent just two hours on the audit and thirty-one hours on the lucrative consultancy work. For all practical purposes the audit team was led by a person with only one year’s post-qualification experience. Most aspects of the BHS financial statements were poorly audited. The now-banned partner signed off BHS’s accounts as a going concern – only days before it was sold for £1.

Major omissions

Despite the public revelations, company audit reports are still not accompanied by information such as the audit time budget, composition of the audit team, audit tender, audit contract, key audit questions, and related management replies, incidences of regulatory action, or audit weaknesses found by the regulators.

The public provision of such information has the capacity to encourage reflections on corrosive organisational cultures, which prioritise profits and produce dud audits. Stakeholders should be able to examine auditor files so that they can form opinion about the quality of an audit. Sadly, the firms oppose that and the FRC has done nothing about it.

After the BHS and Carillion audit failures, the government commissioned the Kingman Review, the Brydon Review and a report from the Competition and Markets Authority. Even if their recommendations are implemented in full, they will make little difference to audit quality because they do not address fundamental questions about auditor independence, liability, accountability and rotten organisational culture.  

Start again

Current auditing practices are the Humpty-Dumpty of the finance world: the sector has had a great fall and can’t just be put back together again. Accounting firms have had more than a century to get their act together, but still can’t deliver honest and robust audits.

It is time to sweep them aside and appoint a statutory body, similar to the National Audit Office or Her Majesty’s Revenue and Customs, to conduct audits of large companies.

Accounting firms have long been used to having their way and will oppose such reforms. They need to be reminded that audits were introduced not to fill their coffers, but to secure corporate accountability and protect people from financial fiddling and fraud.

Prem Sikka is Professor of Accounting at University of Sheffield and Emeritus Professor of Accounting at University of Essex. He is a Contributing Editor to LFF and tweets here.

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