Simpler reporting: Are auditors doomed?

Demand for audit update courses is falling, notes financial reporting lecturer and AccountingWEB correspondent Steve Collings. With proposals on the table that will have a profound effect on auditors, he assesses what impact the reforms might have on the profession - and its clients.

Everywhere you turn phrases such as “the audit model needs to evolve”, “audit is costly” and, most commonly, “auditors are to blame” seem to be on the lips of commentators.

The constant backlash the auditing profession faces is annoying because, believe it or not, there are some good audit firms out there. With support from Europe, the Department of Business, Innovation and Skills (BIS) brought forward proposals to align the audit thresholds with the small companies test to save 36,000 businesses the need of having to undergo an audit. The government estimates this move would save businesses more £600m a year.

The responses to the proposals are very mixed – polarised might be a more accurate way of putting it. Many practitioners welcome the auditing proposals with open arms, while other firms and sole practitioners who deal with audit clients are worried about the impact the proposals may have.

Not so long ago there were very few auditing standards around and the audit was less rigorous. When I first started out in practice an unqualified auditor’s report was merely half a page long – these days it spans practically a full side of A4 and the Auditing Practices Board is still tinkering with it.

In recent years fewer delegates have been coming to auditing standards update courses, probably for two reasons. First, many audit clients were lifted out of the audit requirement when the thresholds zoomed up from £1m turnover to £5.6m, and then £6.5m from 2008. Second, many ex-auditors became increasingly fed up with the demanding audit compliance regime. Some of the new requirements in the Clarity ISAs are slightly over the top for smaller audit clients, prompting many audit firms to resign from their audits - particularly among smaller firms that had only a few audit clients.

Reasons for the audit

Banks and financiers - particularly for clients who factor or ‘invoice discount’ their sales ledger - require audited financial statements. The amounts owed to the finance company on the factoring/discounting account are often significant, particularly in these difficult times.

Some companies might also be required to have an audit simply because their articles of association demand one - though many changed their articles to be eligible for audit exemption. Other companies choose to have a voluntary audit because they view the audit as a seal of approval – which, to all intents and purposes, an audit is designed to be.

HMRC also feels more comfortable if financial statements are subject to external scrutiny, as the figures from which the profit (or loss) was derived is more reliable than a set of unaudited financial statements.

Aligning the audit requirement

Aligning the UK’s audit exemption thresholds with the small companies test will undoubtedly cut costs for some businesses, but not to the extent the government is estimating.  But many practitioners are asking is how aligning the audit threshold with the small companies test will affect auditors themselves?

Practitioners who struggle to make audit pay may welcome the initiative as it will allow them to devote the extra time to other activities such as marketing.

But there are specialists who work purely in audit including firms that only offer audit services, mainly to practitioners without practising certificates who want to act for clients within the audit limits. One practitioner told me he would lose approximately 40 audit clients and around £25,000 in fees if these proposals were introduced. “Where will I get another job at my time of life?” he asked.

As they stand, the BIS proposals simply don’t make any sense at all in terms of the information the accounts would present and how they would be used for the purposes of tax. The proposals don’t conform with the principles that have guided the accountancy profession for hundreds of years and would result in information being produced which is both unreliable and irrelevant – particularly for the purposes of tax.

All businesses, large and small, are required to provide some form of adequate financial information. Anyone can produce a receipts and payments account, but how useful would this information be to a business? How will a business be able to know if its gross profit margins have deteriorated given that sales won’t have to be adjusted for closing debtors and purchases won’t have to be adjusted for closing creditors? And if it doesn’t have to adjust for creditors, how will a business be able to keep a track of its expenditure levels?

The profession must still produce financial statements for companies of all sizes that fulfil the true and fair view requirement that has been in companies legislation for years, and that means doing so on an accruals basis.

Time for a rethink

The proposal to align the audit thresholds with the small companies’ test thresholds will reduce costs for businesses, but the savings estimated by government appear to be very much on the overly-optimistic side. No regard has been given to smaller clients who choose to have their accounts audited, or those clients where audit exemption is not an option because of financing requirements. The proposals for the financial reporting regime need to be substantially rethought and drafted by individuals who have knowledge of how the accountancy profession works.

Steve Collings is the audit and technical partner at Leavitt Walmsley Associates and the author of ‘The Interpretation and Application of International Standards on Auditing’ (Wiley March 2011) and ‘The AccountingWEB Guide to IFRS’ (Sift Media May 2011).

Continued...

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Comments

Fully agree

Ayesha Bham | | Permalink

We will lose all of our audit clients which will probably mean redundancies. The simplified reporting proposals are nothing short of ridiculous!

jon_griffey's picture

Audit    1 thanks

jon_griffey | | Permalink

There was much wailing and gnashing of teeth when audit exemption was introduced some 20 odd years ago, much from myself as an apoplectic newly registered auditor at the time, with cries that lenders and HMRC etc will insist on audited accounts, companies wouldn't get credit and so forth.  In all honesty in the time since I can say that not one single client of mine that has taken audit exemption has had any adverse effect whatsoever in terms of not being able to get finance, increased risk of HMRC enquiry and so on.  I have never known a bank, invoice discounter or any other third party to insist on an audit and so any client that has a voluntary audit for these perceived reasons is just naive or has been mis-sold.  The regulators have over regulated audit to such an extent that governments are exempting everyone from it, so that probably only 1% of companies now need one - that is virtual audit abolition.  I would support a return to a beefed up Auditors Operational Standard and Example 8 reporting (yes, I am showing my age), as let's face it, audit work these days is all about ticking boxes, compliance and ar*e covering than providing any value for the client. 

Steve Collings's picture

Missing 'Sometimes'    1 thanks

Steve Collings | | Permalink

I think (reading this back) that under 'Reasons for the Audit' it should say that banks and financiers SOMETIMES require audited financial statements because it's not always the case that audited financial statements are required.  I have clients that invoice discount that don't require an audit, but then I have known some clients who do have to have one because the bank/financier says so. 

Banks

Ayesha Bham | | Permalink

I have 3 clients all below the audit level which must have their accounts audited because they factor their sales ledger so I would say it is becoming more common now given that banks are learning lessons from their past mistakes.

It will come full circle

Martin_Finch | | Permalink

The relaxation of standards will happen but when there is a major corporate scandal the focus will return to the need for audit. 

Can't see how parental guarantees for subsidiaries will appease banks and reduce audit requirement because subsidiaries material to the parent will still need auditing.

jon_griffey's picture

Factoring

jon_griffey | | Permalink

Steve, Ayesha - I would be interested to know how big those clients are that require audits by their factoring companies and how big their sales ledgers are.  Who are the companies that are insisting on this?  I have some quite substantial clients who factor with RBS,Yorkshire, Lloyds and none of them have ever asked for audit.  If this is a trend then this will I would see it causing problems as these clients will end up being forced to use an audit firm, which given the dwindling pool of auditors increasingly means a bigger firm.  Big audit fee added to extortionate factoring charges - not good.

Auditing and simplified reporting

Roy Price | | Permalink

I would totally agree with jon_griffey's comments.

I work with private Ltd company's up to £3mn turnover.

My experience in industry and in practice is that decision making is so dynamic now, including bank lending decisions, that the most important financial documents are the Management Accounts, Budgets & Cashflow forecasts.

The annual statutory accounts come along after the event and are as much use as yesterday's newspaper.   They are usually given a 5 second glance signed off and then filed at Co house and with the tax office along with the Co Tax return.

They do however have an enduring quality and can be useful to look at trends over time.  If the business is to be sold then the signed accounts are required.  If accounting is over simplified then will they also lose this level of functionality.

The foregoing comment does not belittle companies as they do expect detailed and well prepared figure work for the MI information which should lead into the final accounts. 

I do not consider there would be any significant gain from removing the accrual accounting procedures in so called Micro companies (under £500k turnover band).  They still have to buy and sell on credit terms and pay and receive money monthly; they need to be able to chase debt. Preparation of acrruals / prepayments etc only take minutes of time.  Stock values and stock obsolescence are also of fundamental importance to any business.

Regarding Audit requirements, I believe the present thresholds are about right.  I also believe that the current auditing requirements have a one size fits all approach and so the same approach and standards are applied to a privately owned £7mn company as are to auditing BP plc - so perhaps there needs to be some simplification of the audting of smaller businesses.

Sorry to digress but I believe the subject is linked.

 

 

Banks

Ayesha Bham | | Permalink

We have one with Barclays and another with Santander. The one with Barclays was in pretty dire straits when they factored so I think that's why they insisted on audited accounts. The Santander one has a sales ledger of about £1.2 million approximately but deals with some high value goods.

Outsourcing

Paul1981 | | Permalink

The proposals will inevitably create a position where some firms with fewer audit clients have to consider whether to continue with their audit registration, or whether they can maintain the necessary skills, or whether audit can remain profitable. The one sure thing is they won't want to lose their clients This is where specialist firms who provide outsourced audit services to accommodate both conditions above will be able to help. Follow the link if this is of interest http://www.indaud.co.uk

 

Value for the client

Stanmon2 | | Permalink

Most small audit clients are owner managed businesses where the owner sees the audit as a requirement that doesn't benefit their business, merely an additional cost. Whilst an audit may add some value, if a client is on top of their administration and commercially aware, it is minimal.

If some of my clients ceased to be requried to have an audit, I would welcome the change as I would prefer them to be able to spend resources on matters that add value to their business. 

Finally, in the article "One practitioner told me he would lose approximately 40 audit clients and around £25,000 in fees if these proposals were introduced." Does that mean the audit costs £625?  

 

John Stokdyk's picture

Article amended, as requested

John Stokdyk | | Permalink

I've inserted the word "sometimes" in the sentence "banks and financiers SOMETIMES require audited financial statements..." as suggested by Steve Collings in a comment above.

Audit is a burden

Ayesha Bham | | Permalink

It's true to say that audit is a burden for smaller firms but I trained back in the early 80's when it wasn't as bad as it is now but over the years we have taken on audit clients from firms that have charged ridiculously low fees and done next to nothing audit wise so it wouldn't surprise me if many smaller firms were cutting the audit fee purely to get the other non audit services. We charge £800 for one audit purely because it is a property holding company with net assets of £5 million but it doesn't actually trade as such so the only audit work we have to do is purely on the rents in and property valuations - it takes us about 1 day tops but only because of the setup.

And the purpose of an audit is ? .....    1 thanks

JC | | Permalink

Over recent few years there have been some real howlers in this field and yet there is still no concept of accountability (duty of care)

With this in mind why bother to have an audit because to all intents & purposes it is a worthless exercise if it cannot be relied upon

Obviously I have failed to grasp something here

Bearing in mind that an auditors’ primary duty is to the company under the terms of the contract by which they are engaged, what is an auditors duty to 3rd parties (i.e. shareholders, bankers, factors etc.)?

On the face of it auditors liability to 3rd parties is very vague because no contractual arrangement exists - why therefore do these orgainsation require an audit?

Furthermore, an auditor will only be held to owe a duty to a third party if it can be shown that they knew, and intended, that their statement as to the audit client’s accounts would be communicated to, and relied upon, by a particular person or class of persons for a particular purpose in connection with a particular transaction.

Could someone please explain why this principle does not seem to exist when public companies are audited and the results published. Especially, if a 3rd party used the audit commentary to invest in shares of the company or place their money with a bank which subsequent went down.

For example one or two banks have had problems over the past years and clearly the auditors overlooked something - so why has no-one been held to account?

Perhaps this is the perception of the public at large as well - there alsways seems to be a 'get out of jail' card available

 

Are auditors doomed

Business Advisor | | Permalink

 

I would in turn totally agree with Jon Giffey and mainly with Roy Price but would go further and abolish all private company audits if turnover under £50m, Assets £50m and employees 50. I would also relieve those companies from CH filing as in my opinion this is no business of the public at large

Banks must decide whether the risks they are taking require an audit and therefore should pay for it as no doubt they will be able to charge the client by way of set up charges. Consequently the auditor will be acting for the Bank and will ensure that his audit report reveals all on pain of future legal action.

Audits should only be required for Public Companies mainly to prevent fraud as no amount of auditing opinions can prevent a company’s demise where negative outside trading circumstances prevail.

Accountancy and accrual standards should remain for private companies and also for micro companies with turnover under £1m and if the government decides that cash accounting would be helpful  then this could be done by way of tax adjustment from movements in trade debtors/creditors or something similar.

 

Clarifies ISA = Compliance ticking

Billy Kang | | Permalink

Clarified ISA emphasized on rule-based compliance rather than judgement/opinion-based. From that perspective you are right, auditing had been reduced to ticking boxes. However, are we relying on the result of the ticked-boxes to form our professional opinion? If so, audit opinion is, then, reduced to 'statistical opinion'! Then, do we still need 'professional judgment'; 'skepticism'; 'opinion' in this profession?

Audit and accounts for the small private company

adam.arca | | Permalink

There are two separate issues here (IMO) which as usual non accountants, the DTI in this case, have conflated. Steve touched on this in his article.

The first issue is that accounts aren't valued as a product by many clients. That may be partly our fault in not selling their usefulness, but I'm also convinced that the typical small company client is put off by the denseness and opaqueness of a even a FRSSE-trimmed set of statutory accounts.

My opinion is that small companies should be able to produce accounts in the same format we would use for a business with absolutely no additional disclosures (although abbs would presumably still be required to avoid public availability of the detailed P&L). That would go a long way towards re-engaging many smaller companies with their figures.

Indeed, I would extend non-disclosure to non-consideration of the vast bulk of the accounting standards library that has now been built up. Even consideration of many of these totally irrelevant standards takes time, and where there has occasionally been a sensible accounting treatment introduced that has by now moved on into GAAP and is most likely applied without thinking about it.

The second issue is the need to re-invent audit. I trained as an auditor and still believe it has a role to play, but personally I am no longer registered as it failed my cost benefit analysis a few years ago.

Re-inventing audit for me means scrapping the plethora of auditing standards, abandoning the tick-box mentality these cause and getting back to judgment. I studied accountancy at university (sad, I know) and could still churn out now an essay on the concept and approach for an audit, but wouldn't have a hope of telling anyone what subsection X of para Y of standard Z either says or most likely actually means. I can also remember reading audit reports from the 19th century which were actually written in English and actually said something intelligent.

Of course, re-inventing the audit also requires a re-balancing of auditor liability in this litigious age. I can't see the DTI looking at that as that would involve work rather than public flannel.

Paul Scholes's picture

My days are numbered

Paul Scholes | | Permalink

I've been a registered auditor for 30 years and, hopefully, will be signing my last audit report before the end of this month, when I give up my registration. Oh Joy!

I value the core audit approach and judgment, that others have mentioned, and it still stands me in good stead with so much else that I do for clients but I have been driven to give up auditing because the regulations I'm now required to comply with are sole destroying and a waste of my time both personally and in what else of real worth I could be doing for my clients.  What's ironic is that the process I now have to follow can actually counteract my ability to stand back and look at the client as a whole, as in "wood for the trees".

So, the proposal to widen the threshold to small businesses in general makes sense.  I applaud Adam's call for a re-invention to recognise the realities of owner managed businesses but share his doubts that we'll ever see it.  

If we did I feel there should be a more targeted approach where the value of the truth & fairness of the accounts is used to determine whether an audit will be of any use, or reduce the risk of loss to shareholders, creditors and stakeholders in general.  We already see this in a clumsy degree in not allowing certain types of companies to claim exemption but we could be far more sophisticated.

On the subject of cash accounting, I'm still scratching my head.

I am for simplification and removing the mystique of accounting that so many in our profession still use to keep clients "in their place".  The day will come when accounts and tax return preparation and submission will be so automated that client's computers will do all the number crunching and will talk directly to the government's systems relegating our role in the process to supervisors rather than doers.  

Even the most basic of systems can determine an accruals based profit and balance sheet to reflect what a business did in a year, and how it stands at the year end, we have it pretty much down to a fine art and my clients understand it.  A cash based R&P account might be easy to prepare but, as others have said, it's of no worth to the client or anyone else.

I'm not going to lose sleep over this, I don't believe it will happen and if it does then it will be the nudge I need to retire or maybe apply for David Attenborough's job?

Value of audit - to the clients?

Billy Kang | | Permalink

I would agree with Stanmon2's comment, and to a large extend Adam.arca's too.

Auditors must articulate the benefits (values) of audit to the business owners. Otherwise, they will not pay you the right fee! I have been in practice for 20 years now. In the end-of-audit (exit) meeting I seldom talk about standards and compliance (they are the fore-gone conclusion). Instead I would use ratios, graphs etc to assist the client to 'visualise' his performance. This will then progress into discussion on his business plan. In this manner he can 'see' the value of my work. 

I deal with mainly SME.  Playing the role of business advisor is more meaningful (to the client and me) than just plain auditor. To the SME, audit = expense, but advisor = value.

How do we make our value 'seen' and how do we make our work more meaningful is a skill an auditor must excel.

Paul Scholes's picture

Billy - and there you have the problem

Paul Scholes | | Permalink

You have described exactly how it works here in that, regardless of whether I carry out an audit or not, these days clients expect, deserve and get in-depth valuable analysis & opinion of their businesses. 

This was not how it was in earlier decades when it was the audit process that enabled the extra work so my problem now is that, having to do an audit, rarely adds anything to my ability to service the client's needs and so slips into the realm of pure compliance, for compliance sake.

carnmores's picture

@paul

carnmores | | Permalink

wise decision i gave up auditing  about 15 years ago - clouds lifted

Tom 7000's picture

supply and demand    1 thanks

Tom 7000 | | Permalink

Why do you think audits are there, to protect the shareholders interest, thats what they told you isn't it? Nope, its there to ensure the accounts are right so that HMRC can take tax off companies. If you are the owner and MD of a £50m t/o company you dont want to pay £40k for an audit, what a waste of money, you already have 10 people in the accounts dept and an FCA FD giving monthly accounts and forward projections. Yes maybe its of use to plcs, because the MD isnt the owner and could squirrel away some cash in his own pocket. Thats it practically from that side of the fence.

From our side theres 2 ways of looking at it, we will lose clients if its abolished and no one likes that. There will be less auditors as what used to be a general qualification becomes a niche specialist, and so the fees go up of those that are left. Simple supply and demand.

I am sorry but you cant do an audit properly for £800, well you can but you make no money. It takes 2 days to fill the planning and completion forms in before you even do any work. Even if its a days work of actual ''auditing'' thats 3 days and you are making £250 a day. Well I guess its £30 an hour and better than selling fast food.

And the answer, its not the biggest or the fittest that survive in the jungle but those most adaptable to change