You can't scrutinise a company properly if you're trying to sell consultancy services to it at the same time.
Prem Sikka is an Emeritus Professor of Accounting at the University of Essex and a Labour member of the House of Lords.
Remember BHS, Carillion, Thomas Cook, Patisserie Valerie, London Capital and Finance, Redcentric, Quindell, Autonomy Corporation and the 2007-08 banking crash.
They are all examples of companies where auditors collected mega fees and delivered little of any value. Innocent employees, creditors, pension scheme members, taxpayers and shareholders were left counting the cost of dud audits.
The Financial Reporting Council, the auditing and accounting regulator, has stated that more than 80% of the audits in its sample needed “improvements required” or “significant improvements required”. The biggest culprits are the big four accounting firms – PricewaterhouseCoopers (PwC), Deloitte, KPMG and Ernst & Young.
The UK government has published its long-awaited White Paper on auditing reforms and it does not inspire much confidence. It clings to failed practices. For example, it says “Shareholders, as the owners of companies, have a vital role to play in the corporate governance framework”. This makes little sense.
There is no legal or economic theory to show that shareholders own companies. Under the Companies Act 2006, shareholders have controlling rights but “ownership” is something totally different At publicly listed companies, shareholders’ interest is only short-term. Increasingly, their interest only lasts for seconds.
Shareholders have little interest in invigilating companies and with one click of a computer mouse they can walk away. Auditor selection, appointment and remuneration fall upon directors, and they appoint poodles rather than watchdogs.
At privately owned companies, such as BHS, controlling directors and their families appoint auditors to serve their interests. Employees, suppliers and taxpayers have a long-term interest in the wellbeing of companies but have no say in appointing directors, or auditors. Rather than empowering stakeholders or letting an independent body appoint and remunerate auditors at large companies, as is the case for local councils and public bodies, the government recommends the continuation of failed practices.
Auditors are dependent upon companies for their appointment and fees. This dependency is worsened as auditors are permitted to sell consultancy services to audit clients and audit the resulting transactions. BHS paid its auditors PwC £355,000 in audit fees and £3,303,000 in consultancy fees. Fee dependency buys auditor acquiescence and PwC partner backdated the audit report.
For any semblance of auditor independence, audit only firms are needed, but the White Paper does not do that. At best, we may end-up with an organisational split of the big auditing firms i.e. a firm with two divisions under common control; one arm selling audits and the other selling consultancy to the same client. So auditors would continue to be mired in conflict of interests.
The big four accounting firms audit 96% of FTSE 350 companies and there is little choice at the top-end. The firms collect monopoly rents. The collapse of a big firm can create considerable turbulence. So what does the government advocate? Instead of joint audits, it calls for “managed shared audit requirement for UK-registered FTSE 350 companies”. This will subordinate the junior firm to the bigger firm and it will have no independence.
Currently, auditing firms can enter any market, but others can’t enter the audit market as there are statutory barriers to entry. No one says that only pilots can run an airline business, chefs run food business or pharmacists run drug companies, but the law requires that only organisations under the control of auditors can deliver audits. The government has no plan to remove barriers. So the supply of audits won’t increase.
The producers of potato crisps and toffees have to ensure that their product is safe and they owe a ‘duty of care’ to current and potential consumers. However, that does not apply to auditors.
At best, they owe a ‘duty of care’ to the company and not to individual stakeholders injured by their negligence. Successful litigation against negligent auditors is rare. Therefore, threat of liability laws does not act as a pressure point for improvement of audit quality.
The government is content to let auditors agree their liability with company directors and hints that more liability concessions may be showered upon auditors. This will not help to improve audit quality.
The government has no plan to add any transparency to audits. At BHS, the PwC audit partner spent two hours on audit and thirty-one hours on consultancy. The audit team was under the day-to-day control of a person with only one-year’s post-qualification experience and the audit team mix was poor.
Unsurprisingly, many of the basic audit tasks were not carried out. All this was acceptable to internal norms of the firm. Corrosive organisational culture can be addressed by empowering stakeholders to scrutinise auditors.
For example, auditors need to publish their time budget, composition of the audit teams, time spend by each grade of labour, a list of key questions and replies secured and a list of recent regulatory action against the firm. However, none of this is on the government agenda.
The government’s cosmetic reforms and will do little to improve audit quality or provide relief to long-suffering stakeholders. Those who cannot learn from history are doomed to repeat it, and that will continue to be case for the audit industry.
As you’re here, we have something to ask you. What we do here to deliver real news is more important than ever. But there’s a problem: we need readers like you to chip in to help us survive. We deliver progressive, independent media, that challenges the right’s hateful rhetoric. Together we can find the stories that get lost.
We’re not bankrolled by billionaire donors, but rely on readers chipping in whatever they can afford to protect our independence. What we do isn’t free, and we run on a shoestring. Can you help by chipping in as little as £1 a week to help us survive? Whatever you can donate, we’re so grateful - and we will ensure your money goes as far as possible to deliver hard-hitting news.