By Ian Welch, head of policy, ACCA
In last week's Budget the Government called upon the Office of Fair Trading to assess whether bank clauses in lending agreements unfairly restrict competition in the audit market. I wondered whether that might have stolen some of the thunder from the House of Lords Select Committee on Economic Affairs' inquiry into audit competition. From today's inquiry report I can safely say I was wrong.
The Lords Committee has called for a full-scale investigation into the audit market by the OFT (with a possible referral to the Competition Commission), on the basis that the highly complex issues raised go beyond the time and resources available to the Committee. Some of these issues include: lack of choice; higher fees caused by lack of competition; lower quality and the huge risks to the market if one of the Big Four was to fail.
ACCA agrees that greater competition would be a good thing - the Financial Reporting Committee bemoaned last year that previous measures to bridge the yawning gap between the Big Four and the rest had failed. An oligopoly is never a healthy situation, as we saw with 'too big to fail' banks. ACCA believe the Lords recommendation for the OFT to examine the issue of restrictive covenants and audit liability would be an excellent move - both these issues clearly act as a roadblock to competition. We strongly disagree with the view put forward by some of those participants referred to in the Lords report that potentially ruinous liability somehow 'keeps auditors on their toes' - the threat of reputational loss from poor performance is enough to do that. And with audit firms being named and shamed by FRC monitoring visits, this is a reality.
We do not agree that fees are too high - there is genuine competition between the top 4 firms. And the ‘living wills' concept being floated should help to address the 'Big Four becoming a Big Three' issue.
We are very pleased with the Lords’ endorsement of ACCA's long-standing call for the audit to be expanded in scope to provide broader, more up-to-date assurance on matters such as risk management, the business model, and the business review. We believe such reform would do much to reduce the ‘expectations gap’ and meet stakeholders’ needs. Even though most of the investors quoted in the report acknowledged the value and importance of audit in the economy - which we welcome - nonetheless expansion of scope, in conjunction with the necessary liability changes, would be a good thing.
But ACCA is worried at the Lords’ claim that audit quality has been reduced, partly as a result of the introduction of IFRS. ACCA does not believe the banking crisis was predominantly caused by accounting issues and we are not convinced that IFRS provides less scope for auditors to exercise prudent judgement, as is alleged.
It is important to note that the specific IFRS weakness identified by the Lords – around expected rather than incurred loan losses – is already being remedied in the revised IFRS9. The recommendation that UK GAAP should be continued ignores the fact that the key accounting standards in UK GAAP – on financial instruments – are virtually identical to existing IFRS. The IFRS regime includes an overriding requirement that the financial statements should present fairly the position and performance of a company, and we feel the Lords have over-emphasised the differences between UK GAAP and IFRS in this respect.
And we are even more anxious at the message that the inquiry will send to other countries, especially the US as it gears up to make its decision in the next few months over whether to join 126 other countries in adopting IFRS. Of course the standards have to be good enough - and the committee report has quoted many eminent participants in the inquiry process who have disagreed with the Lords’ assertions on IFRS. But any shortcomings of the accounts and audits of banks should not be either a reason to deny global standards to other companies or a justification of continuing to impose on other UK businesses the extra costs of maintaining both systems.
There are other issues with which we disagree. On the thorny topic of non-audit services - always a favourite with politicians both in the UK and in Brussels - while we accept there is a strong case for auditors to be excluded from internal audit work, we do not feel that tax advisory work should be included in any ban, and certainly not for smaller entities. Most companies will feel aggrieved at the prospect of having to take on another firm of advisors to do tax work, something that seems costly and unnecessary.
And on smaller audits, the report almost ritually calls for a reduction in the audit requirement for smaller companies in order to ‘lower regulatory costs’. The Department of Business, Innovation, and Skills (BIS) has also recently suggested this, but both the Lords and BIS have failed to recognise that there would be a downside to removing external checks on small companies’ finances. Audit must not be so lazily confused with red tape.
On the brighter side, the Lords have rightly rejected the idea of compulsory rotation and joint audits, both of which have been floated by the European Commission but which ACCA believes would actually do little to increase audit market competition. Proposals for risk committees in banks and more regular dialogue between bank auditors and regulators should also be supported.
So, in all, a mixed bag. The issue of going concern and how the auditors applied that on bank audits will probably generate headlines but we should let the FRC continue its review into revised guidance in this area. The OFT certainly have a role to play in examining aspects of the audit market - notably restrictive covenants and liability - but on other issues mentioned by the Lords it might do best to dampen down expectations of huge changes which the committee report will inevitably have raised.
I think we should also highlight the aspect of "Substance over Form" along with stressing Auditors' liabilities to implement this. Today's finacial crisis is a result of major oversight by the management wings of the society, where Audit is only a smaller cell. Holistic approach to combat waste is imminent.Auditors can obviously do Taxation works along with External Audit as there is no apparent conflict of interest. Audit report is directed to shareholders and Tax returns are submitted to Tax Authority having no conflict with the only issue of excessive dependency of fees (10% threshold of Uk ). With more and more emphasis of Professionalism in Audit Exams, we are confident that tomorrow's Auditors will yield ven higher quality of Audit but society also has to offer them equivalent social securities of the past, & in this Government,Political bodies and economists play higher & pivotal role.
Posted by: Debdulal Karmaker | 02 April 2011 at 16:38