It is a truth universally acknowledged, that corporate blogs are boring, tedious affairs that are best given a wide berth. So it's with some considerable pleasure that I can reveal the exception that proves the rule - Oliver Tant's blog over at the otherwise tiresome KPMG UK blogs.

Today's post is a corker, in which Tant uses the issue of the auditor's responsibility to report weaknesses in internal control to those charged with governance (ISA (UK and Ireland) 265) to highlight possibly unforeseen consequences of forcing the Big 4 to separate their audit practices from their non-audit practices. He argues, convincingly, that such a move will force up costs and may cause internal control problems to be overlooked, if the firm that's responsible for advising on fixing them is different to the firm that first identified them (ie the auditor).

Unfortunately, as ingenious and intelligent as this argument is, I doubt whether it will make much of an impression on Michel Barnier and his team in the Internal Market and Services Directorate General. Specifically:

• Barnier will argue that the increased costs identified are a 'price worth paying' to ensure better audit independence. 
• Barnier will argue that the fixing of internal controls, as opposed to the identification of deficiencies in internal controls as a by-product to doing an audit, are indeed a peripheral, non-audit service. And he will be able to claim that allowing other businesses to muscle in on work that previously was dominated by the company's auditors will encourage new firms to innovate and produce even better value-added services for companies. They might even be able to do much more than auditors can over internal controls, other than internal controls over financial reporting. Who can prove him wrong?

There's also a general point, which cuts across almost all of the arguments made by the big firms. They have largely sought to rebut Barnier's leaked proposals by beseeching him to think of the impact on audit quality. But Barnier demands substantial change, in order to address what he perceives as profound structural problems in the audit market. Rather than try and identify specific fixes that might generate marginal improvements, Barnier has decided to rip up the entire audit market and start again. Plaintive appeals to "protect audit quality" are meaningless when Barnier has clearly already bought into the simplistic notion that this market has no quality.

Another line of attack, beyond audit quality, is needed. And fast.

Filed under: Auditing, Current issues with tags audit quality, european commission, internal control, international standards on auditing, kpmg, michel barnier, oliver tant
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Because I'm much too lazy to review the EC audit reform proposals myself, other than to express shock and surprise that Barnier could even conceive of a six-year maximum audit tenure, here are some thoughts from other people.

ICAEW doesn't agree with all of what the EC proposes. But it does find some areas of common ground, which it highlights. ICAS finds even more grounds for disagreement, in particular the burdens it will place on business. ACCA use their release to give an outing for their new-technical-director-on-the-block, Sue Almond. She, like ICAEW, is careful not to bash Barnier too heavily, and looks to find some points of agreement, such as the emphasis on the importance of audit committees, while fretting about the potential costs of mandatory rotation. Chartered Accountants Ireland have the smoothest response; while welcoming the proposals, they reserve the right to put the boot in once they've examined them in more detail and consulted with stakeholders ¹.

The firms have also been active. KPMG argue in terms of audit quality to put up a stern defence of multi-disciplinary firms, which would be prohibited by the proposals. pwc is even harsher; while also arguing for greater audit quality, they complain that the EC has missed an opportunity to really learn the lessons of the crisis. Deloitte avoids the audit quality argument altogether, instead preferring to highlight how the EC's proposals won't deliver its stated objectives ².

There are comments in some of the newspapers too: The Guardian says that Barnier is "taking on" the Big 4. The Telegraph echoes this, saying that he wants to break them up. It also notes that the proposals will seriously weaken the powers of national regulators, which presumably includes institutes as well as the FRC.

Accountancy Age snorts at the "watered down" proposals, which have dropped the notion of mandatory joint audits that was included in the earlier leaked drafts.

Filed under: Auditing, Current issues, Institutes with tags acca, accountancy age, big 4, cai, deloitte, ec green paper, european commission, guardian, icaew, icas, kpmg, meta, pricewaterhousecoopers, telegraph
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Accountancy Age reports that, rather than issue its audit proposals next week as had been widely expected, the European Commission will now take a further week. Who knows, they may even decide to delay it further.

This is a mistake. The draft proposals were leaked months ago and that led to a rather childish and unhealthy debate in which everyone had seen the proposals but no-one would publicly admit that they had. Rather than treat the targets of their proposed regulations with respect, the EC seems determined to spring sweeping regulations on the market. And, if European process repeats itself, they will allow a pitifully inadequate period to respond to them, a period that also includes a two week Christmas holiday.

This is no way for a responsible regulator to behave. Barnier should meet his original deadline, even if he feels the papers are half baked. He should allow a proper period for discussion: say, six months. And he needs to listen to the evidence and feedback, and accommodate it. The listed company investment market is too valuable to the European economy to be treated in this lacksadaisical manner.

With markets showing falling confidence, Barnier must show how he intends to help restore it - and fast. A week could be a luxury he, and we, can't afford.

Filed under: Auditing, Capital markets with tags accountancy age, audit policy, big 4, confidence, michel barnier
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There is a small band of lazy journalists and bloggers who have stumbled across a winning formula (for them, at least): to catalogue every single instance of lax or sub-standard work performed by the Big 4 audit firms and then to sew it into a grand conspiracy about how these firms are systematically attempting to undermine the lives of ordinary people while enriching themselves. You know who these people are.

I have long argued that this style of journalism is lazy and unacceptable, because it fails to take account of the work they perform to a satisfactory level or higher. Such work is almost always performed in private; generally speaking, the only time we ever get to see what auditors have done is when they screw it up.

So there's some bad news for the sloppy crew today:

OLYMPUS changed its auditor because of an argument about accounting for its purchased businesses, rather than it reaching the end of its contractual obligation, according to reports.

The camera-maker, which has seen its share price slump after its new chief executive revealed concerns over advisory payments related to acquisitions, replaced auditor KPMG with Ernst & Young in 2009.

The auditor swap took place because of a re-tendering process following the end of KPMG's contract, Olympus had stated. However, Tsuyoshi Kikukawa, the Olympus chief at the time, allegedly told management there was a disagreement with KPMG over its accounting for goodwill and its acquisition of UK business Gyrus, reported Reuters.

This simply does not fit their narrative. In standing up to Olympus, even apparently at the cost of the ongoing engagement, KPMG's behaviour confounds the Big 4's critics. Their simplistic, naive reporting, from which they make their (in some cases substantial) livelihoods, trivialises a complex situation and gravely insults the many thousands of honest hard-working Big 4 staffers around the globe. In order to provide a credible analysis of the Big 4, it's necessary to account for their quality work as well as their inadequate work. It's time for Frannie, Ritchie, Ian and Prem to grow up, and the Olympus story provides them with a good opportunity to do it.

Filed under: Auditing, Ethics with tags accountancy age, big 4, francine mckenna, ian fraser, idiots, kpmg, olympus, prem sikka, richard murphy
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Intrepid Accountancy Age reporter Rose Orlik had a busy day tweeting from the Meet the Experts conference. Here's an example:

Aarrgh! Please excuse me while I chew off my own arm in an attempt to distract myself. On the basis that "BIS's Carter" is Richard Carter, their Director of Corporate Law and Governance, I'm finding it hard to explain how someone of his experience and standing could get something so horrendously wrong.

Just open up the book of ISAs and it's there as plain as your face. ISA 200 sets out the overall objectives of an auditor seeking to perform an audit in accordance with ISAs. Paragraph 11 states:

In conducting an audit of financial statements, the overall objectives of the auditor are: 
(a) To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework; and 
(b) To report on the financial statements, and communicate as required by the ISAs (UK and Ireland), in accordance with the auditor’s findings.   

You really couldn't get more principles-based than that! The other auditing standards then set out further guidance on what these two objectives mean in practice. But, while the other standards matter - and must be followed - an ISA audit must deliver these two objectives or it ought to be deemed to be inadequate.

Within the detailed standards themselves, there is further evidence of the intention of the standard drafters. They quite clearly intended these standards to be principles-based. Paragraph 21 of ISA 200 states that it's the objectives of each ISA that must be achieved by following each ISA's 'requirements'.  The requirements are the short instructions at the front of each ISA. The long, explanatory information at the end is there to help with following the requirements. What's not principles-based about that?

But what really gets my wick is that Carter is a civil servant at BIS. BIS is the body that has ultimate responsibility for audit regulation in the UK, a role it fulfils via the Financial Reporting Council.  So he really ought to know why auditors are, to use his term, auditing in a rules-based way. It's because of the system of regulation that has been laid down by the FRC through its oversight and inspection regime. A rules-based regulator necessarily instils rules based regulatees. So if Carter genuinely wants auditors to audit in a more principles-based way, his first port of call should be to wander down to Aldwych to bang some heads together at the FRC. They should be required to explain how their regulation is conducive to high quality, principles-based auditing in the UK.

Filed under: Auditing with tags accountancy age, bis, frc, idiots, international standards on auditing, isa 200, principles, richard carter, rules
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So a survey finds that the vast majority of senior finance staff actually do support mandatory auditor rotation after all...

MANDATORY AUDITOR ROTATION is supported by almost nine-in-ten (87%) finance executives, and the group is calling for a shorter rotation period than the European Commission's porposed nine years.

The survey by recruitment specialist Robert Half questioned 200 chief financial officers and finance directors.

Almost half (49%) plumped for a new auditor at least every four years, while 82% called for rotation on a three-yearly basis.

This flies in the face of feedback from the 100 Group, made up of FTSE-leader FDs, who said mandatory rotation and other proposals "show a fundamental misunderstanding" of the issues and are "deeply concerning".

The results indicated large and listed companies are most in favour of mandatory rotation every three years.

I haz solution! If you want to change your auditors, just do it. There's no need to be forced to do something you already want to do and can quite easily do.

Seriously, it makes these finance directors sound utterly pathetic. Like a whiny bunch of smokers who want smoking to be banned everywhere just because they're too weak to give up on their own.

Ironically, if they really do want auditor rotation then there will be no need for the European Union to act on the matter. Because it will just happen.

Filed under: Auditing, Regulation with tags 100 group, accountancy age, auditor rotation, european commission, finance directors, robert half
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A mostly good personal think piece in Accountancy Age ends thus:

Lastly has the quiet migration from general partnerships to limited liability partnerships diminished responsibility of the accounting profession in performing audits?

Short answer: No.

Slightly longer answer: Picking on the Big 4 firm I know the best, KPMG, their listed audits are performed through KPMG Audit Plc. This company had, in 2010, current assets of £53 million and net worth of nearly £13 million. I think it's ridiculous to suggest that, because the audit vehicle can now lose only £13 million instead of potentially unlimited sums, individual partners will suddenly act recklessly.

The main reason for partners wanting limited liability is to limit their damages due to other partners' reckless behaviour, not to limit the damages due to their own.

Filed under: Auditing, Other blogs with tags accountancy age, kpmg, limited liability
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Interesting stuff from KPMG here:

We’re left therefore, with unresolved tension between the fact that stakeholders want clearer reporting of business risks and the view that providing those disclosures with credibility, through assurance, is too expensive.  Now clearly auditors cannot be taken to task for failing to identify misstatements in narrative reporting that has been scoped out of their work for cost reasons!  But what is the point of audit if audit is not to the point? The point is that stakeholders increasingly focus on leading indicators of performance and not past financial performance.  It is by assuring these data points that audit gets to the point – this is how we will refocus audit to make it fit for today’s world. 

I'm not sure I entirely agree with this. You see, the auditors opine over a long document that, frankly, virtually nobody (Oliver Tant excepted, perhaps) actually reads. Sorry guys. You work incredibly hard through dark evenings in the winter to produce an audit report over a set of numbers that no-one looks at.

Because the market never sits around waiting patiently for the auditors to tell them the numbers are okay. The markets are constantly moving up and down in response to new bits of information, intelligence about market opportunities and investment decisions, and assessments of risk and consumer confidence. Through the year, directors of companies are required by the Listing Rules to disclose salient bits of information to the market (on pain of extreme penalty). So, by the time the annual accounts come out, the market has a pretty clear picture of how the past year has gone.

Those investors who don't track the market every day are also extremely unlikely to read the accounts in full. Although their influence has declined, lots of people still get their financial information from the media. Journalists tend to not really understand accounting, so they pick bits out of the accounts in search of a good story. This means that the papers often report proforma or non-GAAP figures as if they have equal authority with the statutory numbers.

Taken together, this means that the audited accounts are a pretty useless source for forward-looking market-moving information. They're too big, too unwieldy and are produced too late to do that. But they do serve a very important governance function, which is this. Without the audit, there would be nothing to ever hold directors to account. Investors would be unable to know whether directors were telling them the truth or whether they were being sold a tissue of lies. Because of the auditors, the directors must (broadly) tell the truth to the markets because they'll be unable to get a clean audit report at year-end if they don't. The auditors are the ultimate day of reckoning for dodgy directors.

Which, I'm afraid, means that Tant's cant about refocusing the audit report on forward-looking leading indicators of performance simply isn't necessary. Auditors are already vital. They're the anchor that help keep directors grounded in reality, not the telescope that helps users see where the company is going. Auditors have got to re-educate a sceptical world about what the audit can and cannot do.

Filed under: Auditing with tags annual report, audit reports, big 4, kpmg, listing rules, marconi, oliver tant
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Allister Heath, the only business journalist I actively rush to read every morning has had a funny turn this morning: 

CABLE RIGHT FOR ONCE

EVERY little helps. Vince Cable’s business department plans to make 36,000 small companies exempt from having to audit their accounts – a process that currently costs almost £10,000 per year. It will also allow 83,000 subsidiaries to opt out.

While it doesn’t go that far, this is nevertheless one of the few genuine deregulatory measures taken by a government that has otherwise continued to add extra red tape (contrary to what it claims). For once, therefore, Vince Cable deserves to be congratulated. I can hardly believe I have just written this – but I mean it.

Well, he's right that this government, like the last one, has categorically failed to deliver any meaningful improvement in business regulation. But it's unfortunate that he shares with Cable the misguided notion that audit is an unnecessary regulatory burden.

It's important to distinguish two issues here. Firstly it's right that the government should be very careful about what it mandates. So I have no problem with the government reducing the number of companies that are required to have an audit by law. But Cable has gone further. By articulating the cost of audit, he's incorrectly ignoring the benefits that those companies get from their audit. For some of them, the cost will not exceed the benefit. But for others the benefits can be significant. Audit helps give owner-managers a better grip on their business. It may help identify internal control weaknesses that could damage the business, or to find improvements that could boost profitability. Most vitally, an audited set of accounts can help convince lenders that the company is a better credit risk, reducing their borrowing and credit costs.

But, even worse, Cable's rhetoric is unacceptably disparaging of an important business process. As an analogy, imagine for a moment that the government were to decide to do away with the annual MOT for cars. While this would be bad for many garages, they would be outraged if government were to paint the MOT as an unnecessary burden on motorists. Doing so would undermine any hope they might have of selling an annual car health-check to motorists on a voluntary basis. Given the the importance of growth to the government's agenda, it's astonishing that Cable would put the boot into the accountancy sector in the way he has. And even more incredible when you think that his department has responsibility for the sector (through the Financial Reporting Council).

Audit wasn't invented by government. However, the current audit requirements, some of which are felt by politicians to be burdensome, are entirely due to government. They have some serious chutzpah trying to take credit for destroying a market which, were it not for them, would happily offer value-added services to business. Only, thanks to the graceless nature of Cable's withdrawal, that now looks unlikely.

The ACCA don't like Vince's proposals, while the ICAEW are decidedly lukewarm and are asking their members for feedback.

Filed under: Auditing, Regulation with tags acca, allister heath, audit exemption, city am, frc, icaew, red tape, vince cable
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The lefties are all excited today because Simon Jenkins has written an article in favour of the 50p rate. So the usual cabal of mongs have been queuing up to say that, no, they don't usually agree with Simon Jenkins but today they do.

As a former auditor, this makes no sense. Auditors are required to think about the reliability of their sources when undertaking an audit engagement. So, having built lucrative careers out of telling the world that Simon Jenkins is a dribbling fool, why do Owen and Ritchie expect us to take him seriously now?

The answer, my friend, is cognitive dissonance, under which evidence that is felt to support one's position is given undue weight, while that which contradicts it is ignored. This is the antithesis of audit, under which reliable sources which undermine your financial statement assertion must be given weight and unreliable sources that support it should be ignored.

Having told us that Simon Jenkins is a foolish old duffer, the left can't now expect us to take this article seriously, even if it agrees with them.

Filed under: Auditing, Current issues, Economics with tags cognitive dissonance, idiots, income tax, owen jones, richard murphy, simon jenkins
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