27 June 2018 by Anthony Hilton
The assurance business needs a reboot
The auditors are in trouble. Carillion’s collapse more than anything else has put them there. The outsourcing group entered compulsory liquidation in January, with £7 billion of liabilities and just £29 million in cash, and in May, after several hearings and mountains of evidence, an all-party group of MPs wrote a highly critical 100-page report.
It gave no quarter to anyone involved. The business model was characterised as ‘a relentless dash for cash, driven by acquisitions, raising debt, expansion into new markets and exploitation of suppliers’. The report singled out the auditors, lambasting them for signing off the accounts and with it a healthy profit just months before the group’s demise.
Although KPMG was deemed culpable, it was not alone – all the auditors and accountants were involved. ‘It was symptomatic of a market which works for the members of the oligopoly but fails the wider economy,’ the committee noted.
The big four accountants manage almost all the FTSE 350 public companies and accounting regulators dare not push one over the edge. Arthur Andersen met this fate in 2002 with the collapse of Enron. It was the fifth firm of the then big five, but the remaining firms have since effectively been given a ‘too big to fail’ card. They receive penalties and fines for bad work, but these are always well within their pockets. If not, the four might become three.
But questions remain. Does the comfortable structure really promote audit quality? Is this key function dominated by the big four auditors, who play ‘Buggins’ turn’ (by which appointments are made in rotation rather than on merit) when an audit comes up for grabs? Is it the case, as MPs allege, that Carillion was a ‘cosy club incapable of providing the degree of independent challenge’?
Interestingly, the auditors are alive to some of the barbs. The senior partner of KPMG talked about conflicts of interest, while Kevin Ellis of PwC thought the industry should be investigated by the competition authorities.
Ellis is smart. The accountants have huge consultant arms which are far more lucrative than audit, but they still need the auditors for themselves and because they require the skills to move on and do the forensic work of the consultancy. If audit were hived off, the accountants would find it very much harder to attract consultancy work.
“We must make the disciplinary process for management fit for purpose”
So Ellis envisages a competition investigation which concludes that no change is necessary. Perhaps a greater emphasis on quality but no breakup. The competition authority would decide that public companies need multinational auditors of sufficient size, scale and expertise – in other words, the big four.
In return, the auditors have the expertise in the related disciplines of tax, technology and actuarial services their clients rely on. A sometimes flawed but far better system than any other, he says. But is it? Stephen Kingsley, originally from Arthur Andersen, takes a more nuanced view. He agrees that the breakup of audit firms, while it might produce schadenfreude, will not address the real issues and argues more proactive legislation is needed.
Kingsley says that the population of stakeholders of audits – shareholders, creditors, current and former employees, regulators and government – is far greater than the current law suggests. We, the stakeholders, will continue to moan about auditing unless we can define who the stakeholders are in law and what they are entitled to expect from the auditing process.
The profession has established its own terms of reference, its own professional standards and, largely, its own disciplinary processes. There is neither statute nor case law which covers this, but that is not the crux of the matter. Through legislation, we also need to spell out what we expect from the audit process – to include the truth and fairness of accounts, the existence or otherwise of material fraud, the survivability of the firm for a reasonable period and the quality of capital and cash management.
At the same time, we must make the disciplinary process for management fit for purpose, so it is tougher and speedier to enact if the company does fail egregiously.
There is also another approach. Some 40 years ago, in the 1970s, there was a move to make public company auditing a public sector matter. The auditors would become public servants by nationalising that part of the accountancy profession with a statutory role in audit. The newly created civil servants would cater for all stakeholders, not just the shareholders. The fees would be paid to the government and the accounting firms would do consulting without the audit kicker.
The Labour government was replaced by a Conservative one and the proposal was dropped. I see no sign of it moving back up the agenda, but if the big four continue to make a mess of their auditing, what else is there?