The recent story on the FRC absolving KPMG for its HBOS audit sparked a thoughtful debate on the purpose and state of the audit profession on AccountingWEB.
In the case of KPMG’s HBOS audit, both the bank and the auditor claimed they couldn’t know the banking sector would collapse. An argument that the FRC seemingly accepted in its assessment.
It’s a conclusion that prompted AccountingWEB member Sheepy306 to comment: “So the audit committee of a bank, and the senior partners of the largest auditors in the world, sat around a table and were oblivious to what state the market was in and what risks there may be? Despite banks having a credit and risk committee specifically dealing with things like this, and KPMG getting paid millions for advising banks day in day out.”
KPMG's troubles don’t reflect too well on an audit profession that is, at present, extremely top heavy. As Paul Merison, a lecturer in audit at the London School of Business and Finance, points out: “under the Big Four, the size of firms drops off quickly – if you merged firms 5-9 they still would be no higher than fifth biggest”.
The disproportionate clout of the Big Four makes it hard to see beyond them, too. “Even if you did want to consider a firm from outside the Big Four, the costs of putting the tender together for a smaller firm might seem excessive,” says Merison. “Especially given the unlikelihood of winning.
“So imagine you use one of the Big Four as auditors and want to switch. You have a choice of three others. And if you already get significant other services from the others you might be down to a choice of one only (or possibly even none).”
The example Merison points to is BT’s recent troubles with PwC, after the audit giant failed to spot accounting irregularities at BT Italy. It’s a mistake for which PwC is being investigated. Left without an audit firm, BT jumped ship to KPMG. “It could not consider Deloitte because of IT consultancy work Deloitte does for BT. So it had a choice of just two – EY and KPMG,” Merison says.
It also seems as if - perhaps understandably - the government finds the idea of the Big Four shrinking into the Big Three unacceptable. The chances, according to Merison, of one of the Big Four being either fined so much they collapse or “being told by an investigation that their work is negligent and thus suffering huge reputation damage, seems small”.
It creates a status quo that the big firms have an interest in protecting, Merison tells AccountingWEB. “Under the status quo, the value of an audit report is being eroded by audit failure after audit failure. The FRC either fails to find fault, or where it does the fines are pitiful.” The FRC’s current record fine is about £5.1m, levied against PwC for its audit of RSM.
So what can be done? If auditors can’t be truly independent of their clients, what are the other options? ”Abolish the audit requirement entirely as the whole endeavour is inherently pointless?” stated AccountingWEB regular JohnGroganja, “Or nationalise the auditing profession and make them all civil servants remunerated from public funds?”
Not a bad idea perhaps, says Merison. “Maybe companies should pay audit fees into a central, independently run fund which then allocates audits to audit firms. I mean, do shareholders (who currently choose auditors) really care which firm they get?”
But a more reasonable solution is for big audit firms to become resolute when they deal with their clients. “Big firms pay good money, attract high quality staff, and, one would hope, develop improved rigour in audit going forward. If their work is properly scrutinised and penalties applied of sufficient size, we should be able to rely on high quality auditing,” concluded Merison.
About Francois Badenhorst
I'm AccountingWEB's business editor. Feel free to get in touch with comments, tips, scoops or irreverent banter.