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Keeping up standards

06 February 2019 by Anthony Hilton

Keeping up standards

The auditing profession has been under the cosh this past year, but hasn’t it always?

Back in the 1970s, the profession decided to devise auditing and accounting standards to cut down on the judgement calls with which the profession was known at the time. The catalyst was GEC, one of the takeover titans, who publicly questioned the profits of one of the companies it had bid for. The auditors did not really have any answers. The scandal duly erupted.

Though leaders of the profession were in favour of standards there was still a lot of opposition among the grass roots because they thought judgement was what the profession was for. Standards in contrast codified and commoditised. This meant the profession had less flexibility, but in the end the users of standards prevailed. Indeed each decade they have become more intrusive.

In the early 1990s the Cadbury Code was launched. Its author Sir Adrian Cadbury at the 25th anniversary of the Code’s launch reminded us that one of the major objects of promulgating the code had been to halt the trend towards two-tier boards. The other was to limit the discretion of accountants and auditors. The Maxwell scandal and the collapse of Polly Peck were at that time massively important, and it was the accounting profession which bore the brunt of media and shareholder criticism. The Cadbury Code was the direct forerunner of the FRC’s Governance code. 

Meanwhile the accounting and auditing standards were merged in to a new body, the Financial Reporting Council (FRC) because it was felt that the profession should not be judge and jury of those who had fallen foul of its rules. Instead the FRC would do the work with greater powers and a broader remit. Thus the profession had its wings clipped further.

The FRC then called for large corporations not to be audited in perpetuity by one firm. Rules were established to put audits out to tender, and separately to find a replacement once the auditor had done 20 years.

Whilst this was going on, the accounting profession had not stood still either. In the 1970s the top firms were known as the big eight. Through mergers and the demise of Arthur Andersen they became the Big Four and the auditing of the FTSE 250 companies today are almost exclusively the Big Four’s province whereas 40 years ago it was much more evenly spread. Auditors have to be paid, and when there is no money coming in the (non-audit) partners get a bit restive.

So it is easier and more lucrative for former auditors to retrain to work in consulting. This is ironic because the Big Four firms – apart from Deloitte – got out of consulting in 2002. The US Securities and Exchanges Commission, after Arthur Andersen/Enron’s demise, sought to restrict consulting to non-audit clients. So PWC sold its business to IBM, KPMG sold out to Atos, the French firm, and EY sold to Cap Gemini.

Deloitte was going to sell out but stayed its hand, and then decided not to. The SEC had lost interest, so the accountants after only a few years of trying to make a go of audit, decided again to build up their consulting. They have not looked back. It is also interesting to note that the Big Four managing partners were not heads of audit, and neither were their predecessors. Audit is still important, but it is no longer the breadwinner.

Accountants want the skills of audit but then they want to move on. Even those who want to stay are chary about the possibility of litigation if they mess things up. The Big Four are finding it harder to keep good people in the discipline. So now we have yet more proposals, this time from the CMA and from Legal & General’s chairman Sir John Kingman. The FRC should be replaced by a more robust body says Kingman.

Audit should be ring fenced and legally separate, suggests the CMA, to avoid conflicts of interest. In addition one of the smaller firms should partner one of the Big Four as a joint auditor for the biggest companies. The CMA is also mulling over whether to break up the Big Four or put a legal cap on the amount of big company audit work. 

Interestingly BlackRock thought the FRC should be given more power, but there should not be huge upheaval. The FRC is, by and large, doing a good job, it said. I do not know whether these measures, if they come to fruition, will improve audit but I would guess not any more than the efforts of yesteryear did.

The reason is that audit has developed so that accounts are in essence forward looking guidance to help shareholders. This is very different from their original function as an exercise in stewardship. Companies – or some of them anyway – want to get their share price up and the pressure on auditors is therefore immense. When the management dupes the auditors, as is bound to happen occasionally, it is the auditors who get blamed. No amount of change will change that.

Anthony Hilton is financial editor of the London Evening Standard

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