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Dispatch
| by Paul Gosling 08 May 2006 Topic: News |
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“audit market not fully functioning”, says DTI report The audit market for large listed companies is not fully functioning. Some companies have no effective choice in selecting auditors, according to an eagerly awaited study commissioned jointly by the UK’s Department of Trade and Industry and Financial Reporting Council (FRC). And another crisis comparable with Enron and Arthur Andersen, leading to the collapse of one of the Big Four, could produce even more serious problems for major companies and a loss of investor confidence, concludes the report carried out by an economic consultancy, Oxera. The study found that 97% of FTSE350 companies are audited by one of the Big Four accountancy firms; that many large listed companies report an effective choice of only two or three audit firms and, in a small number of cases, companies may have no effective choice of auditor in the short-term; that barriers to entry into the market for FTSE350 audits are high and that, in current conditions, a substantial new entry either by a mid-tier or a new firm is unlikely; and that any new entrant would need to overcome perception barriers and demonstrate sector-specific skills, international coverage and high-quality staff to win audits. A consultation programme has now been initiated to consider the results of the study and what might be done to overcome potential further undermining of the competitive market for auditing large listed companies. Options will include reducing the prospects of the failure of existing Big Four firms, contingency plans for such a failure and considering removing barriers to entry into the market. The consultation will also consider the limitations of any discussion given the international character of the market and the consequent implications. Paul Boyle, the FRC’s chief executive, said: “A well-functioning market for audit services is essential to ensure confidence in corporate reporting and governance. The report from Oxera raises a number of issues about the structure of the audit market in the UK.” Trade and Industry Minister Gerry Sutcliffe added: “An efficient and effective market for audit services is vital to confidence in UK capital markets and financial reporting, and the report is particularly valuable in drawing out and giving better definition to the different barriers to entry to the market.” “what's bad for General Motors... It used to be said that what was good for General Motors was good for America. If so, the United States needs to be seriously worried. The car giant has just reported a $10.6bn loss for 2005, including a $2bn loss relating to an accounting error at its mortgage subsidiary Residential Capital Corp. The crisis afflicting General Motors - and it is a crisis, with some commentators speculating that it is heading for bankruptcy protection - has led to the urgent sale of some commercial interests, including the finance arm GM Acceptance Corp, sold for $7.4bn plus annual royalties of around $100m. GM has sold its stake in Isuzu car manufacturers for $300m. General Motors has admitted that even before making its dire financial statement, the corporation had dramatically scaled back its research and development expenditure when it became clear that the company was heading for a large loss, equivalent to about $20 per share. Much of the GM crisis arises from its commitments to current and former staff on healthcare and pensions. The corporation’s recovery plan aims to reduce staff by 30,000, cut healthcare liabilities by $15bn and reduce its long-term pensions liability by $1.6bn. But the impression of GM’s underlying weak financial position has not been helped by notable accounting failures at the Residential Capital Corp subsidiary. A review of the situation at ResCap reportedly determined that some mortgage activities were not properly classified as either operating cash flows or investing cash flows. This led to the need for GM to restate its financial reports for 2002-04 and for the first three quarters of 2005, with the effect of reducing operating cash flows and increasing investing cash flows. GM then had to admit that its consolidated financial statements for the same periods could no longer be relied upon. A new tax regime for accumulation and maintenance trusts and interest in possession trusts was announced by the UK Chancellor of the Exchequer, Gordon Brown, in a Budget otherwise short of controversy and significant initiatives. But tax accountants have reacted with anger to the new arrangements for taxing trusts widely used by families for tax planning and which bring them into line with discretionary trusts. Accumulation and maintenance trusts can provide an ongoing benefit for children, with the income paying for education or maintenance without touching the capital in the fund. Interest in possession trusts provides a fixed income to a specified individual. Under the Budget’s announcements, new A&M and IIP trusts will be subject to an immediate inheritance tax charge of 20% on the property value in excess of the IHT nil rate band. In addition there will be a maximum 6% charge on the value of the trust on every 10th anniversary of the creation of the trust. The Chartered Institute of Taxation (CIOT) responded by claiming that it represented the least cost-effective tax-raising measure in history, since the tax was likely to collect a mere £15m a year. At least a million people will have to review and rewrite their wills at a cost of about £250 each, calculates the CIOT. On this basis, it will take over 16 years before the immediate costs to the taxpayer will have been raised by HM Revenue & Customs (HMRC) in additional taxation. Anne Redston, chair of Personal Taxes at the CIOT, said: “It costs two pence to collect £1 of capital gains tax, 1.34 pence to collect £1 of income tax, and only a halfpenny to collect £1 of national insurance contributions. But this new tax, which raises £15m a year, will cost ordinary families £250m.” Life insurers, which use trusts to support many life policies, also expressed unhappiness with the new tax measures. But HMRC rejected the criticisms, saying that £15m was likely to be the minimum raised and that the measures limit possible future use of trusts by very wealthy individuals to reduce their tax liabilities. ACCA has joined a coalition of other professional groups, including the CIOT and the Law Society, to oppose the introduction of the new tax charges without further consultation. FSA reveals scale of market abuse The Financial Services and Markets Act has produced no discernible reduction in the level of market abuse, according to the results of analysis conducted by the Financial Services Authority (FSA) of trades prior to takeover bids and result statements. Comparing the volume of trades preceding major market announcements regarding FTSE350 companies before and after the act took effect in 2001, the FSA found no change in “market cleanliness”. The analysis considered large or abnormal share price movements apparently triggered by unpublished information. It included consideration of five prosecuted cases of misuse of information relating to takeovers in 2004, when there was a small but statistically insignificant increase in market abuse. Having established a methodology for evaluating market cleanliness, the FSA will use it to measure on a regular basis its effectiveness in carrying out the requirements to tackle market abuse, established under the Financial Services and Markets Act as part of the duty to maintain market confidence and fight financial crime. Hector Sants, FSA’s managing director, said: “Our future success in reducing market abuse should be measured not by gut feel or fines levied, but by using a robust, analytical tool that will stand the test of time. The methodology we have developed gives us such a tool and is an important step forward in establishing the starting point against which the FSA’s future work in tackling market abuse should be judged.” He added: “The analysis shows that there was no improvement in market cleanliness in the period after the introduction of the FSA’s new powers, and before any high-profile enforcement cases were concluded. This suggests that visible enforcement action may be the key tool in our work to reduce market abuse.” Results of the analytical exercise do not provide clear evidence of the extent of market abuse, but do show that insider trading may have taken place prior to nearly 30% of takeover announcements and more than 20% of trading announcements from FTSE350 companies. EU auditor independence reforms take hold FEE, the European Federation of Accountants, says that the European Union’s auditor independence reforms have been effectively implemented, but it urges the EU to allow the measures to fully beddown before any new reforms are introduced. David Devlin, FEE’s President, said: “The principles-based approach to auditor independence as set out in the EU Recommendation on Independence is now widely used throughout Europe. It is important that there be a regulatory pause to allow this new approach to auditor independence time to prove its worth to users of audit reports.” FEE’s Ethics Working Party’s chairman, Harald Ring, added: “The accountancy profession has strongly supported the independence reforms. Any further regulatory initiatives must not precede an evaluation of the results of the many initiatives recently enacted and which are currently being implemented throughout Europe. A stable platform on independence is required to focus more broadly on the common goal of high audit quality.” A survey conducted by FEE found that over three-quarters of the 25 EU member states had implemented the EU Recommendation on Independence by the beginning of this year. The Recommendation has now been given legal force by the Statutory Audit Directive, which also introduces additional obligations on auditors. However, FEE warns that attention should be given to independence benchmarks for group audits, where varying extra-territorial requirements of national independence regulation are a cause of concern for audit quality. HM Revenue & Customs (HMRC) is conducting a public consultation to review the powers of the recently merged single UK tax authority. The department says the exercise is designed to ensure that HMRC powers are fair, efficient and make it easy for people to meet their obligations and claim their entitlements, leading to a balance between a system that is customer-friendly, including for tax credits claimants, while being vigilant against those who are non-compliant. When HMRC was created last year, the existing powers of the two legacy departments, Inland Revenue and HM Customs & Excise, were ring-fenced and carried forward into the new HMRC. Leaving the powers unchanged for a limited period assisted the transformation involved in the merger. The Paymaster-General, Dawn Primarolo, said: “This is a unique opportunity to develop a framework of powers, deterrents and safeguards that meets the needs of our taxpayers and allows HM Revenue & Customs to carry out its wide range of responsibilities fairly and efficiently. We know from our discussions to date that people believe strongly that life should be made easier for the compliant and harder for the non-compliant. “The consultation document sets out our emerging thoughts on what powers we think are necessary to properly fulfil our responsibilities, and how this fits with wider work to modernise tax administration.” ACCA’s head of taxation, Chas Roy-Chowdhury, is a member of the HMRC Powers Consultative Committee advising the department, and is pleased with the approach taken by HMRC. “I think the committee has worked very well - it is very transparent,” he said. “HMRC has been receptive to what people on the committee have said. I think the powers consultation document is going over quite a lot of the ground we [on the committee] have gone over already, but I don’t know what will come out of it. The committee has been a model example to other HMRC committees on how they should be run.” Comments on HMRC’s powers can be submitted to the department until 23 June. In brief...
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