Ill-advised changes to audit which add costs to business for little benefit could result from the volume of official inquiries internationally into the role of audit in the financial crisis , warns ACCA (the Association of Chartered Certified Accountants).
ACCA, in a policy paper Audit under fire: a review of the post-financial crisis inquiries, addresses the issues which have been raised during investigations by the UK House of Lords, the European Commission and the US senate. In Singapore and elsewhere, regulators are also actively engaged in stakeholder consultations to assess how audit can be enhanced. The EC has promised legislative changes by the end of 2011.
Ian Welch, ACCA Head of Policy said: "Audit is under unprecedented scrutiny in the UK, Brussels and the US, following the global financial crisis. We have already had the European Commission promising that 'the status quo is not an option'. In this paper we examine the various proposals put forward in the course of these inquiries and set out some recommendations for positive reform. Audit plays a vital role in the global economy by instilling trust in company reporting and we believe it needs to be enhanced for the greater benefit of investors and business.
“But it is essential that the changes made add value and are not motivated by the need to be seen as 'doing something'. Any changes need to meet an appropriate public interest test. Some of the suggestions that have been mooted during the various inquiries, would be, we believe, ineffective and costly."
Several recurring themes have emerged from the various inquiries including audit concentration, going concern issues, joint audits, mandatory audit rotation and the effect of International Financial Reporting Standards. ACCA is concerned that the political imperative for visible change may result in the wrong measures being adopted. ACCA believes some of the key issues include:
Audit concentration: If competition concerns are to be addressed, policymakers need to take action on restrictive covenants and audit liability. Restrictive covenants are an anti-competitive tool, while current audit liability rules provide a powerful disincentive to any firm looking to challenge the ‘Big 4’.
Audit independence: Calls for bans on non-audit work are wide of the mark, as are calls for the mandatory rotation of firms; ACCA believes joint audits to be ineffective but are the lesser of two evils compared to rotation. Independent audit committees need a more powerful role and should provide a fuller disclosure on their choice of auditor.
Audit’s role: Audits should be enhanced to include perspectives on risk management, corporate governance, and testing the underlying assumptions in business models. There is an ‘expectations gap’ between what stakeholders think auditors are supposed to do and what auditors are actually asked to do. Expanding the role of audit would help narrow this gap.
Going concern: Reform of the ‘all or nothing’ approach to going concern should be supported, and a more graded approach adopted. The issue whereby any modification to a clean audit report becomes in itself a going concern problem needs addressing urgently.
Auditor-Regulator dialogue: Regulators and auditors need to collaborate with one another rather than work in silos. Mutual trust and understanding are important drivers of effective communication.
Small business: The audit of small and medium-sized enterprises needs to be adjusted to ensure audit remains relevant to those entities. An internationally-supported range of assurance services for small businesses is needed. But policymakers must stop linking audit with ‘red tape’- audit can help small businesses add value to their financial statements, helping to improve access to finance.
International Financial Reporting Standards: IFRS did not lead to a lessening of prudence or judgement in audit prior to or during the financial crisis; the system maintains a requirement that companies fairly present their position and performance. Criticisms on this issue are misplaced.
Ian Welch concluded: “Policymakers and legislators have had every right to ask tough questions of auditors in the aftermath of the financial crisis. We believe enhancements to the role of audit can and should be made. But the changes which ultimately arrive as a result of all the inquiries need to bring real benefit and not be costly tinkering.”