Question

The auditing profession has been criticized recently for its role in monitoring potential corporate failure. Radical reforms have been called for in the way audits are regulated. For example, politicians have stated that there should be a change of legislation in the following ways: (i) Non-audit services (ii) Non-audit services supplied to an audit client should be stopped.

Required:

(a) Critique the current regulatory and professional requirements relating to each of the main headings listed above in no more than 300 words. It must contain at least 3 - 4 core ideas from those requirements.

(b) Post your responses in the discussion forum and respond to the posts of at least two of your peers.

Answer 1

Audit has never had such a high political profile. In the UK, Brussels and the US the global financial crisis has sparked a series of high-level inquiries into the role and effectiveness of audit, while in Singapore, among others, regulators are actively engaging with stakeholders to assess how audit can be enhanced.

Expanding the role of audit

ACCA argues that audit should be enhanced to take on areas such as risk management, corporate governance and testing of the assumptions underlying companies’ business models. This would meet stakeholder needs more effectively, address criticisms of the narrowness of the audit role and so help to bridge the ‘expectations gap’.

Audit committees

ACCA agrees that audit committees, acting independently from executive directors and management can do much to provide additional confidence in the integrity of the accounting and auditing processes. But we caution that recent inquiries may have invested too much reliance in audit committees – they are usually small groups with limited resource and not everyone on them are technical experts.

Going concern

ACCA would support reform of the current ‘all or nothing’ report to allow a more graded approach. Ways must be found to break the logjam whereby any modification to a clean audit report can trigger immediate loss of confidence in a company by investors or credit providers.

Audit of small entities

Ways of auditing small and medium-sized enterprises (SMEs) need to be revised to ensure direct relevance to those entities. An internationally agreed range of assurance services for businesses not subject to audit is needed. But policymakers should not conflate audit with ‘red tape’. Audit adds value to businesses’ financial statements and makes it more likely that they will raise finance effectively.

International Financial Reporting Standards

ACCA rejects claims that the IFRS regime has led to a lessening of prudence or judgement in audit. While prudence as an accounting concept is not central to IFRS, the system demands that companies present their position and performance fairly. Criticisms of the accounting standards on this issue have been misplaced and their perceived effect on audit mistaken.

1. Audit concentration

2. Audit independence

(a) Non-audit services - For many years politicians and other commentators have been exercised by the issue of auditors’ provision of additional services to their audit clients. In the recession of the early 1990s, there were claims that firms ‘low-balled’ – ie cut their audit fees in order to get a foot in the door for more lucrative non-audit work.

(b) Mandatory rotation - In evidence presented to the Lords’ inquiry, several headlines were generated by the fact that the average tenure of one of the Big Four firms is an eye-catching 48 years.

(c) Joint audits - Joint audits are another idea being floated in Brussels – but at the EC’s two-day conference on audit and accounting in February 2011, it was noticeable that loyalties divided sharply along national lines.

3. Expanding the role of audit

4. Audit committees

5. Going concern

6. Auditor/regulator dialogue

7. Audit of small entities

8. International Financial Reporting Standards

(b)   It is right, given the scale of the global financial crisis and the extent of taxpayer bailouts of banks in several countries, that the role of auditors and accountants should be questioned. Despite the inquiries, no one has argued that audit itself is unnecessary, at least not for larger companies. The crisis and its aftermath have not dented ACCA’s belief in the importance of the role of quality audit for building trust in company statements. We believe the role needs to expand, as we have argued consistently since 2009. This would be much more pertinent an answer to the issues of the expectation gap and lack of competition than some of the solutions proposed by other parties, which we have covered in this paper and which would amount to little more than re-arranging the deckchairs. We also believe the biggest audit firms are well placed to innovate to meet market needs and would be willing to take on an enhanced role, particularly if the corresponding liability issue is addressed. The defensive mindset often attributed to the profession, pre-crisis, is being replaced by an acceptance that change is necessary and desirable. As this paper was going to press, PwC announced the creation of its first-ever head of reputation, as a direct response to criticisms it had endured in the Lords report. The firm said: ‘the debate on reputation and regulation of the profession is likely to be one of the most significant challenges PwC faces’. As the international debate on the role of audit continues in the second half of 2011, ACCA will be publishing more research and evidence to strengthen and inform that debate.