Auditors are not watchdogs, they are bloodhounds on a tight leash

HEAD OF POLICY, ACCA

THERE are two sides to every story. This particular story concerns audit and its value to society. Are you sitting comfortably?

“Extraordinarily self-satisfied” is how the former chancellor Lord Lawson described the suggestion by top auditors that there hadn’t been a failure of audit prior to the financial crisis. “You were the auditor of [a bank] which went belly-up within a few months of you giving it a clean bill of health,” he told one Big Four chief who was giving evidence to a House of Lords inquiry.

Unfortunately, though Lord Lawson’s criticisms grabbed headlines, they didn’t really capture the nuances of the debate about the role of audit.

It’s easy to accuse auditors of failing to spot the financial storm on the horizon, but in reality, that wasn’t really their job. Lord Lawson said that auditors were the dog that “didn’t bark”, but auditors are more like bloodhounds on a leash than free-roaming watchdogs. There wasn’t anything worth barking about where they were being told to look – a point agreed on by many reviews preceding the Lords’ inquiry.

That still leaves a question to be answered though. If it wasn’t the auditors’ job to look out for the problems that rocked global banks then what exactly is the point of audit? The problem however, for those that try to define and defend the value of audit for society is that until recently there’s a been real paucity of research into this area.

To rectify this, the Association of Chartered Certified Accountants (ACCA) has spent the past twelve months running a series of roundtables around the world looking at the value of audit. They brought together businesses, finance providers, regulators, auditors, ratings agencies and others to tell us what they think of and expect from audit.

And the message delivered was clear. Audit is valued by stakeholders, but they are increasingly expecting more from it. Picking up on the problems at the banks may not have been in auditors’ job description at the time, but it could well be expected of them in the future.

Though audit is seen to be an incredibly valuable tool to increase public and investor confidence in businesses and therefore the wider economy, problems were highlighted, particularly about the relevance of the information presented by auditors and how that information was communicated.

A WISHLIST
The first step in the hoped-for evolution of audit is an increase in its scope. If auditors didn’t spot the problems at the banks and other companies it wasn’t because they missed them, it was because they weren’t expected to look for them. The problem wasn’t misrepresented accounts – auditors would have raised an alarm if it had been – but rather it was the underlying business models that weren’t sustainable. If the scope of audit was expanded to look at things like business models or even the assumptions that supported them, financial crises like the one we’ve just experienced could maybe have been averted.

Roundtables in Britain indicated that they would appreciate auditors looking at forward-looking information. Malaysian roundtables wanted more information from auditors on a company’s risks. Roundtables in the above two countries and also in the Ukraine all hoped for almost real-time reporting as opposed to the easily out-dated end-of-year report that is currently the norm.

Alongside expanding the scope of audit, the idea that attracted most widespread support was throwing open the audit “black box”. Frustration was expressed that despite paying for the audit, all shareholders ever get to see of the extensive work done by auditors is a two-page boilerplate, once a year, which mostly consists of a detailing of auditor responsibility anyway.

Audit reports may give an answer to shareholders, but they don’t tell them what the question was in the first place. Malaysian participants were keen to see “red-flags” waved at shareholders by auditors ahead of any impending problems. Communicating the detail of the audit process more widely than just the audit committee could re-assure shareholders that auditors really do put a company through its paces.

A REALITY CHECK
No point on the audit wish-list can be implemented easily, however – something recognised by the roundtables. Some wishes are potentially mutually exclusive. Real time audit reporting could hamper attempts to broaden the scope of audit because of the amount of required work, while increasing the scope of work required could push audit fees up. Requiring auditors to be more candid in their published statements could risk the openness of auditors in their dealings with management.

The biggest problem with changing the role and scope of auditors is auditor liability. If auditors are asked to do more then there are more things that can go wrong. This wouldn’t be so much of a problem if liability was reformed alongside audit, but even minor attempts at reforming audit liability have run aground.

A change in British rules in 2006 which allowed the possibility of ad hoc restrictions on liability was a welcome step, but it floundered on American regulatory scepticism and other practical issues. Without audit liability reform, auditors are unlikely to want to expand their roles.

It’s interesting to note at this point that those countries, such as Germany, with some sort of statutory limited liability have been most successful in increasing the pool of audit firms that operate in the listed sector. Addressing auditor liability could help kill two birds with one stone.

Caught in the middle of all these questions and caveats is the audit profession itself. Auditors were criticised for not doing what wasn’t their job, and they now find that an important part of living up to such expectations is out of their hands. Audit is valued by those that use it, but it is beginning to test the patience of some stakeholders. Consequently and appropriately, auditors are feeling the pressure to change, but audit liability is not a hurdle that the audit profession can overcome by itself. Action will be needed by governments to help break the log jam, but until we get that, we’ll be stuck in a very unsatisfactory place; indeed we’ll be stuck where we were three years ago.

Auditors may not have barked, but were they supposed to in the first place? There are two sides to every story.

Ian Welch is head of policy at the Association of Chartered Certified Accountants (ACCA)

ROUNDTABLES | ACCA

Poland – Delegates believed that auditors had to do more to re-assure shareholders that their investments were being looked after

Ukraine – Delegates, including Big Four auditors, called for monthly management accounts to be available online and audited

– Leading auditors were concerned that fees weren’t high enough for firms to be able to invest in quality improvement procedures and employee training

UK – British roundtables welcomed the inclusion of forward-looking information.

– Delegates urged that the “audit black box” be opened, and process communicated much more effectively to shareholders

Malaysia – Shareholders wanted to see more information on risks from auditors.

– Shareholder groups wanted to see more interim reports and auditing so “red flags” could be raised at the first sign of trouble.