WHEN the European Union launched its plans to reform the audit market across 27 countries, the proposals referenced the word “quality” no less than 113 times. Robust audits were held to be the key to re-establishing trust and market confidence following the 2008 financial crisis.
It seemed a laudable objective to ensure that auditors (alongside bankers, ratings agencies, central banks and regulators) learn the lessons from what went wrong. We support new policies and ideas to improve audit relevance, scepticism and quality in the context of wider reform.
But five months on, there appears to be a gulf between the stated intention of driving a “higher quality, dynamic and open audit market” – and the actuality of the debate.
Many of the proposals appear to stem from a view that market concentration among the Big Four auditors has led to poor audit quality. They have focused almost entirely on structural reform, including the forcible rotation of auditors every six years, a ban on many non-audit services to audit clients and possibly even the complete separation of an audit firm from its advisory arm if certain revenue and market share thresholds are crossed.
There is, however, no empirical evidence to link either the existing concentration with lower quality or the changes proposed to any improvement.
Indeed, there are potentially damaging unintended consequences of the reforms currently proposed. Under mandatory firm rotation (MFR), there is a real danger that quality will suffer as knowledge is lost through auditor changes. And MFR has just as much potential to increase concentration in the market as it has to broaden competition. It will necessarily encourage a new breed of audit partners acting primarily as sales people. We are very concerned that this is likely to change the culture of our firm and to detract from rather than encourage a sceptical mindset in our auditors.
In addition, the creation of audit-only firms would ignore the combination of experience, judgment and specialist skills only found in a multi-disciplinary professional environment. The modern audit requires specialists in many areas, including actuarial services, IT, tax, financial instruments and valuation.
There are, however, lessons to be learned from the financial crisis which can be directly translated into improvements to audit quality without these potentially harmful side effects. I urge the European Commission to allow us to work with it, the European Parliament and our national governments to design appropriate measures under the following four headings:
■ Fully empowered audit committees ensuring that the auditors are both independent and suitably sceptical. They should be expected to test the quality of service they are provided with on a regular basis with formal feedback and, if that is what they deem appropriate, a tender, accompanied by clear explanation. This also needs to be supported by a robust and independent audit inspection regime (such as exists for example in the UK).
■ A sensible limit on other work performed by the auditors that meets the “independence” test without unreasonably constraining the potential to protect value that comes from the auditor’s knowledge.
■ An appropriate reporting mechanism, that may or may not include the auditors, on the risk profile of a company’s business model.
■ Clearer understanding of the extent and limitations of the forward-looking aspects of auditing, in particular the going concern judgements required, especially in the financial sector.
The Big Four are accused of arguing in their own self interest. We hear the criticism, but we are also the people who have to do the job well, and as experts we feel entitled to speak out to protect audit quality. All my experience at KPMG has taught me that it is a lot easier to destroy quality in people businesses than it is to create it, when imposing well-intentioned but misdirected change. In any event, in the UK we now have the Competition Commission looking into the issue of concentration. Perhaps all of us in the profession would be wiser on this occasion to allow it to gather the facts before diving in with our many and diverse opinions on structural change.
John Griffith-Jones is the UK chairman of KPMG.