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ARGA: New name, same failings

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If a rose by any other name would smell as sweet, then swapping one regulatory body for another with a new name isn’t going to cover up the stink around auditing. 

8th Jun 2022
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Juliet was adamant that “a rose by any other name would smell as sweet” but, on the other hand, a bad egg smells terrible whatever you call it.

It doesn’t take a genius to work out that if a business changes its name, it is rarely an indicator of major success, especially given the inevitable cost of rebranding, not to mention the confusion for all stakeholders.

Harrods and Marks & Spencer have been with us for centuries, while Amazon seems happy with the current branding and profitability. The companies that keep changing their names are often the ones that are bought and sold on a regular cycle, quite possibly out of liquidation, or those that have been subject to an embarrassing scandal.

If you prefer a political analogy, despite regular changes in fortune Labour and the Conservatives have always seemed happy with the names that they acquired a century ago, while Reform UK (if that’s what it’s still called) has with a few minor changes of direction been Brexit and UKIP in the past five years.

What’s in a name?

Therefore, the news that the heavily underpowered and constantly criticised Financial Reporting Council (FRC) is to be replaced by a new Audit, Reporting and Governance Authority (ARGA) may not have quite the impact the government would like.

It has hardly helped that having established long ago that FRC was not fit for purpose, the gestation period for the new body has been long and painful and, even then, the new proposals are heavily watered down from earlier consultations.

Indeed, before anyone gets too excited about the advent of ARGA, it may not happen. That is because its anticipated existence is being introduced in the middle of the Parliamentary programme that hopes to get 38 different acts through by the summer recess, while being led by a government that currently seems more interested in infighting than action.

Audit failures

Anyone who has read this column in the past few years will be all too aware of the weaknesses in the audit market, particularly among the firms that should be the leaders of the industry. They have consistently failed to meet even basic standards, been hauled up before the FRC on a conveyor belt basis and even in one case been found guilty of fraud and forgery. There has been no significant effort to set their houses in order, although EY has recently announced that it is considering selling off its audit practice.

Most of the concentration from the political types who are behind the creation of ARGA has focused on independence. There is no doubt that if you have a client who threatens to withdraw millions of pounds of consultancy business, it must be difficult to make controversial audit decisions, or even uncontroversial ones that the client doesn’t like.

However, while that is clearly a significant shortcoming, many of the problems appear to have a different source.

Anyone who has worked in a mixed service accountancy practice will know that audit recovery rates are always regarded as terrible. While consultancy projects might come in at 60% to 80% or even 100% in some cases, audits are more likely to be in the 30% to 40% range.

Rather than accepting that this is a worthwhile investment, management teams have a natural inclination to beat up the auditors and demand that they improve financial performance.

In a market where lowballing fees is standard, the only way of achieving this is by doing an even worse job, reducing staff numbers and cutting back work to a point where it will sometimes be ineffective.

Pure inefficiency

This observation seems to be supported by this week’s FRC report into another pair of failed audits, by PwC on Galliford Try and Kier. Since these audits were led by the firm’s global engineering and construction leader, they should have been in safe hands. Far from it, since they resulted in fines of almost £9m, reduced for cooperation to a mere £5m.

The worrying part of the report is that PwC had failed to identify and correct errors or show sufficient professional scepticism and the FRC did not believe that the breaches were intentional, dishonest or reckless. In other words, it was pure inefficiency.

It therefore seems that doing a proper job is not high on auditors’ lists of priorities. Instead, there may be just three considerations:

  1. Minimise under recoveries.
  2. Try not to get sued or hauled up before the FRC.
  3. Avoid offending valuable clients.

None of these helps stakeholders who are entitled to rely on competently audited accounts.

Stinking rose

What would make a difference? It is unlikely that introducing a watered-down ARGA will be the magic bullet. In addition, unless it bares far more teeth than the FRC, perhaps by increasing fines on both directors and auditors by a multiple of 10 or even 100 and facilitating lengthy bans on substandard auditors, this particular rose will continue to stink.

An alternative approach might be to nationalise audits. This sounds good in principle but the government would then have to pay a large whack to get enough competent staff. We all know how they love cost-cutting and therefore this is probably out, although arguably given the state’s funding of bailouts this could be a sensible commercial path.

Maybe this accountant’s natural cynicism when it comes to substandard auditing is unjustified, but the smart money should be on ARGA doing little better than the FRC and requiring a new branding effort within the next few years.

Replies (2)

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paddle steamer
By DJKL
08th Jun 2022 17:06

I thought this was what well paid professionals had in their kitchens, "you must see my arga, its wonderful, warms the house splendidly ".

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By tedbuck
09th Jun 2022 12:00

This really is a problem that won't be solved by installing an ARGA - more of the same old, same old.

The problem is that the FRC doesn't have the power to do what needs to be done and this really leaves the Auditors at a big disadvantage.

Auditors Ltd has a client for whom they do other work. That is a problem in very large Companies because it is the other work which pays the bills. The bigger problem is that the management in Client Ltd is only interested in profits in the accounts so that they can get their bonuses, shares, dividends etc. and liquidate their holdings before it all falls apart.

So what are the incentives for management? Fudge the figures to show profits as large as possible by looking at contracts and seeing the maximum profit wherever possible. Then they can sell the company and walk away with millions.

The Auditor really stands no chance here if we are honest. Couldn't we, if we so desired, bull up the profits if we wanted to and would it be obvious? We could and it wouldn't. Fortunately for most of us our clients are more interested in minimising their tax bills so have a different view. When talking about PLCs the view is automatically the other way around for the reasons above.

So the problem, initially, is with the Directors and management pushing for paper profits. They will try to hide their antics and may well succeed. Beating the auditors over the head may be of marginal assistance but misses the point which is that it is the Directors and management which is at fault.

Until the law bashes them firmly over the head and seeks recompense from them personally there will be no change to the situation and the fines will go on. If the Professional bodies had any b***s at all they would be saying this to the FRC and telling them to make the real culprits pay.

Once that was done there would be a basis for audits less biased against the Auditor although they might still have to tighten up their game a lot but, at least, they and the Directors would be more on the same side as the Directors wouldn't wish to see the world falling on their own heads.

Come on ICAEW and ACCA let's have some original thought on the subject.

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