On Twitter, auditor Truenfairview gets cross with the BBC's reporting of the recent shooting in County Durham on this morning's Today programme (For seven days from the date of this post, you can listen to the reporting here).

Watching an auditor criticising journalism set me thinking about how journalists criticise auditing. Take, for example, our old friend Ian Fraser, proof positive that a little knowledge is a dangerous thing:

Why does this matter? Because if audit firms are as cozy with their clients as they have been over the past 15 to 20 years, they are a waste of space. As I said in the opener, they may also have become a danger to capitalism itself.

Most of his work consists of diatribes like this, 'supported' by a list of the engagements where audit firms failed to meet all the requirements of ethical or auditing standards. Despite never having been on an audit or worked for an accountancy firm, he argues that he is entitled to criticise the audit profession in this way, even though he does so in a biased and imbalanced fashion that fails to take account of the tens of thousands of audit engagements that meet the exacting standards in full.

Of course, journalists aren't immune from public criticism; the Leveson enquiry has been probing certain improper practices that were apparently rife in some tabloid newspapers.  But Leveson has been focusing on activities that are already largely illegal rather than merely in breach of professional standards. Indeed, journalists have no professional standards because, despite their protestations, they're not a profession. That doesn't mean that some journalists aren't professional. But it does mean that journalists are held to a much lower standard of conduct than professional auditors.

Fraser, in criticising the Big 4, fails to demonstrate any causal link between the actions of auditors and any ultimate harm caused to third parties. In fact, in some cases - such as in the recent case over pwc and client money regulations at JP Morgan - he doesn't even show that any harm was caused. It's the mere breach of regulations that they were required to follow that matters. Now, don't get me wrong, I'm not suggesting that auditors shouldn't be required to follow the standards expected of them. But I do believe that any criticism of the profession should consider the work done by auditors in the round, rather than selecting the worst examples of their performance and pretending that they are representative of the rest of their work.

Similarly, nothing will come of the BBC's sloppy reporting this morning. It's virtually impossible to link a particular report to any harm caused. Even without this, there are no external standards that they can be held to. Of course, the BBC ought to hold itself to a much higher standard because, unlike commercial news organisations, the ultimate sanction - withdrawing your patronage - doesn't apply to them, thanks to the licence fee.

However, I wouldn't support a wholesale professionalisation of journalism, because it could be used to exclude amateur writers, such as this blogger, from writing and reporting. But I do think it appropriate for journalists who work for major newspapers or who want to be taken seriously to hold themselves to the same high standards some of their number seem to think appropriate for the Big 4.

So which journalist(s) will be the first to take the lead?

Filed under: Auditing, Ethics with tags audit quality, bbc, big 4, ian fraser, journalists, jp morgan, leveson, pricewaterhousecoopers, twitter
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Looks to be an interesting paper:

Abstract: There is a significant amount of research and models on ethical decision-making processes; however, there is limited research on how emotions affect ethical evaluations and decisions in an accounting context. Prior research suggests that emotions may shape ethical evaluations and choices made by individuals. This study contributes to the accounting literature by exploring the emotions an accountant may feel when evaluating earning manipulations. This study finds that accountants feel regret when evaluating earnings manipulations.

Keywords: Accounting ethics, ethical decision making, emotions.

Download it here.

Filed under: Academic research, Auditing, Ethics with tags audit quality, emotions, larry crumbley
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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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So we've had a few more weeks and a few more Tuesday afternoons with the Lords.  On 9 November it was the turn of Philip Collins and David Stallibrass of the Office of Fair Trading, Baroness Hogg and Stephen Haddrill of the Financial Reporting Council, Sally Dewar and Richard Thorpe of the FSA.  The uncorrected evidence is available here.

There's a peach of a quote from Thorpe, who was pressed repeatedly to give a view as to whether auditors failed in the crisis by not contacting the FSA to discuss concerns about their clients:

We have no evidence that there were examples of information that they should have given to us, which we didn’t get direct from their clients.

In other words, the disclosure regime seems to have worked properly.  It's just that they got the information they needed from the banks themselves, not from the auditors.  What's to complain about in that?

There's then an odd exchange between Lord Lawson and the witnesses as to whether auditors should have in some way raised the alarm earlier.  I find this idea wholly unconvincing.  There is a point in time, let's call it t, at which the crisis was obvious to all.  So the crash happened.  Does this mean that the crisis could have been averted if someone had said "there's going to be a crash!" at time t-1?  Evidence suggests that it's the interpretation of the same information that changes, not the information itself.  So any early warnings would simply be ignored.  It's vital that we see auditors and their opinions as trusted.  The suggestion that they become watchmen for the rest of society risks turning them into a Cassandra profession.

Filed under: Auditing, Politics with tags audit quality, baroness hogg, david stallibrass, frc, fsa, house of lords, lord lawson, office of fair trading, phillip collins, richard thorpe, sally dewar, stephen haddrill
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Via the wonderful Ruth Bender (@Ruth999), I'm directed to a post from Francine McKenna - think an American Richard Murphy in a dress - who is wibbling about auditing again.

10. The Big 4 audit firms don’t bother looking for fraud.

Absolute, complete nonsense.  Auditors' responsibilities in respect of fraud are prescribed in auditing standards.  There's an entire auditing standard - ISA 240 - dedicated to explaining what auditors must do in respect of assessing the risk of fraud in the financial statements.  The big firms now follow a global methodology that is consistent with ISAs.

ISA 240 makes it clear that the primary responsibility for preventing and detecting fraud lies with the management of the company and with those charged with governance. Not the auditors.  However, they do have some responsibility, as set out in the standard. 

There's a neat article by Martyn Jones that explains more here.

9. The Big 4 firms aren’t comfortable being watchdogs. They don’t even like being CALLED watchdogs

Francine is woefully confused here.  The 'watchdog vs bloodhound' distinction comes from a judgement by Lord Justice Lopes in Re: Kingston Cotton Mills Co. (1896) in which he was arguing that auditors are not responsible for detecting fraud.  Auditing standards in recent years have extended their role considerably, beyond the plodding watchdog.  So it's small wonder they don't like being called watchdogs; the term simply isn't relevant any more, unless you like living in the 1890s.

8. Big 4 firms should NEVER be asked to conduct internal investigations into alleged illegal activities for their audit clients.

Rubbish; it makes sense to permit those charged with governance complete freedom to decide for themselves who is the best appointee.  The alternative means hiring a complete unknown who will need time to get up to speed with things, in a situation where time is usually of the essence.

7. You know what Global Network means. It means shifting blame.

The firms' structures are largely a result of national regulation.  Until fairly recently, many regulators required all local audits to be undertaken by local audit firms, owned by local partners.  This meant that they had to be separate partnerships, bound together by good intentions only.  Now, McKenna's charge is blown apart by events, as we see regional and global partnerships being set up by the big firms.

6. The Big 4 will never again be indicted for an audit failure.

McKenna makes two basic arguments - the firms are too big to fail because (1) there already isn't enough competition and (2) the government can't afford to lose 100,000 jobs.  The second point is idiotic - the employees at Arthur Andersen aren't still unemployed; most of them found work immediately at the other accounting firms.  Similarly, if a Big 4 firm were to fail, those audits would still need to be done, and would probably get done by many of the same staff who currently service them.

I tend to view the fact that the audit firms aren't being indicted as evidence that they haven't done anything indictable, rather than being part of some grand conspiracy.

6.a “Final Four” means no competition and no straight answers. Ask a Big 4 audit partner for a Yes/No answer on valuation, for example, and you won’t get one.  

Well, jeez, Francine.  Maybe that's because valuations are just a teensy bit complicated and don't lend themselves to childish 'yes/no' answers?

5. The  auditors have a lock on the business (read, “ratings agencies”).

There are loads of auditors to choose from.  Unfortunately most of them are too small, too inexperienced or lack the global reach that big companies need.  And those charged with governance are always going to pick a big firm with a reputable name over some lesser firm, because they need to demonstrate that they appointed a sensible firm of auditors instead of some pushover.

4. Why do the auditors support IFRS and mark-to-market accounting? International Financial Reporting Standards (IFRS) are supposedly on the way for the US, the last big holdout. Forget rules-based guidance, where it’s easier to say an accounting treatment is right or wrong. Principles-based guidance leaves wriggle room and a pretty sure shot at sneaking liability caps for the auditors in through the back door. 

I'm with Ruth on this one.  Francine's point doesn't stand up to scrutiny, when you consider that US GAAP is one of the most detailed bodies of accounting literature imaginable, yet still suffered the most horrendous problems in variable application.  Rules-based guidance isn't easier to apply; it merely translates a single judgement into a thousand judgements over whether the detailed rules have been followed properly.  She really couldn't be more wrong on this point.

3. Campaign candy from K Street. 

In other words 'policy makers didn't enact the policies I wanted them to, so I'm going to throw my toys out of the pram'

2. Big 4 firms have systematically avoided liability for audit failures. 

This is patently a lie.  Big 4 firms have been sued successfully for large sums all over the world where their audits have been found wanting.

I guess she means they haven't been sued enough for her liking, but that's merely in her opinion, which hasn't exactly proved to be accurate in preparing the article.

1. AND THE #1 THING TO KNOW ABOUT ACCOUNTING FIRMS…

Lawyers are perceived as part of the problem

Well, lawyers are part of the problem.  The best bit about America is that lawyers are widely recognised to be part of the problem too.  But McKenna's article was written for a roomful of lawyers so it's no surprise she was sucking up to them.

If McKenna really wants auditors to do the right thing, she has a funny way of going about it.  Threatening them with bigger fines and more swingeing penalties won't encourage better auditing, but more risk averse behaviour.  It will also suppress economic activity, to the detriment of investors and people generally.  That's a heavy price for everyone to pay just so the anti-audit brigade can have their day in the limelight.  Don't buy it.

Filed under: Auditing, Other blogs with tags audit liability, audit quality, big 4, francine mckenna, idiots, ifrs, lawyers, too big to fail
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Other than his unerring ability to suspend facts while delivering his truly unexceptional blog entries. This time, Ritchie crows:

What’s exceptional about E & Y’s performance. They:

- alloweed window dressing

- put fornm over substance

- ignore the true and fair over-ride

- box ticked to confirm compliance with an accounting framework they helped create and which is itself misleading

That’s what auditors do. There’s nothing exceptional about this. The only odd thing is no one has appreciated it - bar the likes of Prem Sikka, Dennis Howlett, Francine McKenna and me.

I wonder if Dennis Howlett and Francine McKenna are entirely happy being lumped in with Tweedledum and Tweedledumber. I doubt it; Francine's article on Lehmans is pretty good, as you'd expect. Not for her the dribbling conspiracy theories beloved of our old friends Sikka and Murphy.

A measured observer, looking at what auditors do, would conclude that they do an excellent job. That a handful of audits end in failure among the many millions undertaken in recent years is evidence of high overall audit quality, not that the audit process is subverted and rotten.

Ritchie hasn't done an audit in years and I doubt he's ever done an ISA audit. He is simply ignorant of what auditors do in accordance with either ISAs or PCAOB standards. We know this for sure, because he muddled the two up in his previous article, as I pointed out before.

On the accounting standards side, far from SFAS No. 140 being "created" by the (then) Big 5, Michael Crooch (an Andersen partner) abstained in the vote to endorse it. There wasn't an E&Y partner on the FASB at the time.

"True and fair override" is a UK GAAP concept that has no direct equivalent in IFRS or US GAAP. However, there are protections in both IFRS and US GAAP against the form over substance problem. As the examiner's report makes clear, US directors are not permitted to prepare financial statements that are misleading. And it's the directors who prepare financial statements, not the auditors.

As for his first two statements, I think we'll just have to wait and see. The examiner's report said that there were "colorable claims" against E&Y. He didn't sign their death sentence, even if that's what Ritchie would have liked.

Filed under: Auditing, Current issues, Other blogs with tags audit quality, ernst and young, fail, fasb, idiots, lehman, prem sikka, richard murphy
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