Auditing… set for a major overhaul

Published on The Malta Independent¸ issue 13th March 2011

To the layman¸ company audits are a nuisance; a fact of life one endures but not loves. Certainly only a few welcome it while others pay for it grudgingly. But previous international scandals placed audit and auditors under the spotlight. Mishaps included the fall of Enron¸ the scandal of a falsified bank deposit in Parmalat and the fraud discovered in the Dutch supermarket chain Ahold¸ and locally the Price Club saga when the inventory values in filed accounts changed on investigation by the liquidator.

Quite recently¸ the Madoff Ponzi scheme shocked the hedge fund industry. The negative publicity associated with these scandals led investors to believe that auditors should also provide comfort regarding the financial health of companies. Specifically¸ investors underline the importance of the going concern assumption¸ both in terms of its disclosures by the company and its validation by auditors¸ as well as the “fair” valuation of assets. Following the economic crisis¸ auditors started to face a deluge of new international auditing standards. This partly reflects the importance that regulators give to tightening the grip on business governance and the drive to weed out potential abuses. Thus it comes as no surprise that Internal markets commissioner Michel Barnier left the audit profession in no doubt that reform was on the way. He said the financial crisis had dented the image of audit and auditors and announced the issue of a Green paper on the subject. This started with an animated consultation on audit reform last year. The project has since received 700 responses or 10¸000 pages of documentation. The deadline for responses closed last December and the Commission will shortly decide on the need for any measures this year. In the UK¸ the House of Lords is also considering the domination of the audit market by the Big Four audit firms. It published a call for evidence last year and is currently reviewing the responses.

Back to the Green paper¸ which proposes ideas considered to be controversial. They include eight points that attracted the attention of the profession. The first comment deals with making the appointment and remuneration of auditors the responsibility of a third party¸ such as a regulator (rather than the company being audited). The second topic concerns the mandatory rotation of the audit firm while completely prohibiting the provision of non-audit services by audit firms. At present they can provide such services subject to safeguards to preserve audit independence. The third topic talks about the intention of the Commission to address the issue of contractual clauses in tendering of audits that are informally referred to as “Big Four only clauses”. This creates a close-shop environment and perpetrates the domination of larger audits by the Big Four firms. To address the threats posed by the risk of a systemically important audit firm from failing¸ there will be a contingency plan for its replacement.

It is suggested that the EU reverses the trend of recent mergers which led to a heightened concentration in the audit market. Finally¸ it has been rumoured that the idea of having a single European passport for auditors and audit firms is desirable. This implies a European-wide registration system with common professional qualification requirements and common governance¸ ownership and independence rules. There are other issues involved in this project but the primary one concerns how to tackle concentration and market structure. The most pertinent question to ask is: how can we encourage the emergence of new participants capa