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FRC chief calls for audit overhaul

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30th Apr 2010
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The value of the audit function needs to be reviewed as investors fail to perceive its importance in a highly regulated era of greater corporate governance.

That's according to Stephen Haddrill, chief executive of the Financial Reporting Council, which plans to publish new guidance on the subject later in the year. This will address a number of key issues, including:

  • How to achieve a strong alignment between the auditor and the interests of the shareholder
  • Whether the form of the audit report  needs to be changed to make it more useful
  • Whether more needs to be said in the front of the report about risk and the business model and should the auditor provide greater assurance about such matters
  • Whether auditors can give more help to regulators and avoid conflicts of interest in doing so

Speaking at the  ICAS Aileen Beattie Memorial Event at Stationer’s Hall this week. Haddrill said: “Audit is a key part of high quality governance. The auditor sees the company’s approach to risk. The auditor challenges management’s judgement on the financials. The auditor reports to shareholders on whether the company is providing a true and fair view of the business. The investor only sees the tip of the iceberg of work. But nevertheless investors are relying on that work being done.”

Haddrill questioned whether statutory audit be dropped and assurance needs left to the market.  “The financial crisis of the last two years has its roots in a hundred causes. One of the more important is the significant failure of corporate governance in the banking sector,” he argued.  “By governance I do not just mean the principles of the Corporate Governance Code. Governance encompasses a chain of activity and stewardship. From the strength of risk management within the company and its internal controls, to the quality of the oversight of the Board, to the quality of public reporting, to the stewardship role of investors.”

Within those parameters, the audit process plays a critical governance role. “The auditor sees the company’s approach to risk. The auditor challenges management’s judgement on the financials. The auditor reports to shareholders on whether the company is providing a true and fair view of the business,” said Haddrill.

He suggested that the scope and depth of the auditor's work is not always appreciated by others. “The investor only sees the tip of the iceberg of work,” he said. “But nevertheless investors are relying on that work being done. In practice they are more in need of good audit than ever before. Yes, there is more analysis about companies than before. More reports and more studies. But investors themselves have less power to challenge because shareholdings are becoming more and more fragmented.”

However, he went on, just when audit is needed more, the impression is growing that it is delivering less. There are, he suggested, a number of factors behind this impression that are responsible for it.

“Firstly, accounting standards have allowed management more discretion in the valuation of assets, values that are hard to pin down for complex instruments. The auditor cannot say that discretion and judgement should not be used,” he said. “It is not surprising that people ask about the value of audit if it can allow a wide range of valuations of the same asset.

“Second, the role of the auditor has apparently become more confined,” he said. “The days of auditors talking quietly to regulators are long ago. Indeed the crisis developed partly because everyone with an oversight role concentrated on their job rather than thinking also about what they could add to the work of others in the interests of a wider objective of financial stability.”

All of this has prompted Haddrill and his colleagues at the FRC to conclude that there is a need to review the value of audit and whether there is a need for statutory reform or whether it can be left to market forces to carry out any needed correction.  There are pros and cons to each approach, said Haddrill.

“It is hard to see how the market can deliver in a world of fragmented shareholder power,” he suggested. “The UK has had a statutory requirement since 1844 and I doubt that now is the time to abandon it. And in any event European law would step in even if we wanted to.

“But statutory provisions tend to provide a minimum standard. There is a role for the market in setting higher expectations of auditors. So far the market has not played that role. Quite the opposite. It is more likely to applaud lower audit fees than higher quality.”

He concluded: “The challenge is to find ways for investors and auditors to come together. To learn about each other’s concerns and so support innovation in audit and better understanding. I would hope that investors would mount an effort to achieve that.”
 

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By User deleted
05th May 2010 10:12

Lets start

By looking at every auditor who was involved in any way with the recent banking disasters and investigate their 'negligence'; with appropriate fines - say to the value of the taxpayer bailout

 

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