ARGA: New name, same failingsby
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.
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.
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.
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:
- Minimise under recoveries.
- Try not to get sued or hauled up before the FRC.
- Avoid offending valuable clients.
None of these helps stakeholders who are entitled to rely on competently audited accounts.
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.