The FT has reported this morning that the Financial Reporting Council, who regulate the UK's large auditors, are to undertake a review of that sector as they believe that there is insufficient competition within it.
This, as an exercise in missing the point, is just what the FRC want and as far from what is needed as is possible. The failings in audit have nothing to do with competition. They have to do with:
1) control of the regulator by those they regulate;
2) the systemic failure to appropriately define an audit, which is at present considered to be a check on compliance with what are inappropriate rules for disclosure, with little consideration given to meaning;
3) the failure to recognise the importance of any stakeholder barring shareholders and the suppliers of commercial debt;
4) the FRC's own failure to take account of public demands for for better corporate reporting, as best represented by country-by-country reporting, to which it has never given attention.
Pretending that improving competition in the audit market will change any of these issues is absurd, and the FRC know that. What they are doing is crude politics to prevent any suggestion that a failing large auditor must pay the price for their incompetence.
That suggests one thing: if there is a reform required in this market it s to replace the inept, and captured, FRC so that audit might be subject to effective regulation.
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Richard is correct in that increasing competition in audit will have no effect on the quality or meaningfulness of the work.
There are so many things wrong with the conduct of audit.
1) Companies appoint their own auditors. Much as ratings agents were paid for by those seeking ratings with the obvious consequence that the agencies represented the issuers of securities not the purchasers of them so too auditors represent the company appointing them and don’t act as independent analysers of company accounts.
2) Auditors like bankers hate risk. They are thus averse to accepting responsibility for company numbers and hide behind statements such as -audit opinion has been supplied solely for the shareholders and others should not rely on their opinions-. Also audit opinion is secondary to the fact that it is ultimately the responsibility of management to prepare the accounts who will do so in a way that reflects the best image of the company. Auditors do not seek to change that view or offer a tempered opinion in most circumstances.
3) Audit ground work is carried out by trainee accountants not those with substantial experience in company accounts or business. Audit relies on statistical sampling but where there is so much scope for nuance in accounts preparation it is fairly easy for management to explain away any queries to the satisfaction of auditors only too willing to accept the explanation.
4) Auditors do not pay sufficient attention to management forecasts of future trading positions and more importantly cash flows instead basing their opinions on historical data. An opinion on the viability of the company’s future budget, cash flow and the assumptions around the basis of their preparation should be mandatory. At present most accounts contain glib phrases about risks and future trading contained in the Director’s Report.
5) Auditors provide lucrative non-audit services to the companies they audit creating a conflict of interest in which audit becomes secondary.
6) Most companies do not collapse giving rise to an attitude of hope for the best. Audit opinion does not take into account probability based on a spread of risk. To do so would leave the auditor open to a claim for damages if share holder value is damaged by an opinion that reduces the share price but where such an opinion does not have a 100% chance of being correct.
7) Beyond a statement that a company’s accounts have been prepared under some generally acceptable set of criteria and that in all probability the company will continue audit opinion is generally meaningless.
What needs to improve is the standard of management. Directors and companies should provide statements as to what their future plans and predicted positions will be and be benchmarked against the actual outcome. Company information should not solely be historical as historical information is no predictor of future performance and it is that that counts. Management does not base its actions on what happened in the past but seeks to perform based on predictions of the future trading landscape and prepares copious amounts of management information to inform their decisions. It is this management information that should form the basis of company reporting. Directors are absolutely aware of the forward looking risks they face and should report those publicly and explain how they intend to tackle them. If they did directors and management would be less willing to take on risks in the hope that they can exit early with their wealth intact and pass the risk to the next incumbent. Carillion’s risk analysis in its 2016 accounts suggested that risks were at best medium on an impact basis and carried only a medium probability at worst. There were no figures as what this risk analysis actually meant nor as to how management had arrived at these conclusions although information must have been internally available. Clearly this was a woefully inadequate assessment of risk at best.
Thanks