RSS feedsWhen accounting systems started to transfer from manual to computerised in the 1980s, auditors had a problem. For a time, until it became unfeasible, auditors attempted to audit around the IT, relying on the manual controls rather than the IT ones. Many auditors and finance directors will remember that the auditors’ systems diagrams used to chart companies’ accounting systems showing a box with data going in and data coming out.
Such black box auditing now seems laughable. But in the same way that auditors adopted a black box approach to computerised accounts, stakeholders have accepted a similar attitude to the governance of the auditing profession. As a society we have regulated the edges of the auditing profession by demanding certain standards, but auditors have been under little pressure to prove to the investment community and beyond, through published information, that they have the systems in place to ensure they perform a quality audit.
Despite the auditing profession’s best efforts, this privileged black box approach to their professional life has been steadily eroded over the years as they have been forced by politicians and regulators to increasingly open up to the public gaze.
The latest example of this scrutiny is statutory transparency reporting by auditors of listed companies. This legislation is driven by the European 8th Company Law Directive on the regulation of auditors, which was agreed in June and the measures have to be in place by the end of June 2008.
Transparency reports will cover three areas: financial information; governance/organisation; and quality, and will cover the entire firm, not just the audit practice. According to the Professional Oversight Board (POB) – the part of the Financial Reporting Council (FRC) responsible for audit regulation – the idea is to help investors to understand the strengths of particular audit firms. Clear information, says the POB, on a firm’s processes and practices for audit quality provides an incentive for all within the firm to live up to both the spirit and letter of what the firm has promised publicly.
As the POB points out, audit firms enjoy a privileged status in that they alone can act as statutory auditors. And the Big Four firms have an even more privileged position in that they all but dominate the lucrative quoted company sector.
Under this directive, firms will have to explain and prove that they have the skills and necessary processes in place to enable them to conduct audits objectively and effectively. A few years ago, under the auspices of the Audit and Assurance Faculty, the firms produced a substantial report on audit quality aimed mainly at the profession itself. One of the most fascinating elements of the process of producing the report was the discussions between the firms about what constitutes a quality audit and what are the various firms’ approaches, tolerance and definitions of doing a good job. As a result of legislation, regulation and auditing standards there is a tendency to think that all audit firms produce the same audit. But this is not a homogenous product. The firms produce noticeably varying audits, yet ones which those responsible would label quality audits. This issue of audit quality is being explored by the POB and the APB and they are developing a public consultation on the drivers of audit quality.
Setting out the drivers of audit quality may assist the audit firms to cope with enforced transparency. When the firms respond to the POB’s consultation, many could claim that they provide much of this information in other reports that are in the public domain.
Until a few years ago, most audit firms published little information about themselves, aside from incomparable and limited figures released to the press, so that league tables could be constructed. Two specific factors have driven a more sunshine policy. First, most firms turned themselves into limited liability partnerships (LLPs) in recent years. The privilege of LLP status came at the price of producing sensible reports and accounts. Second, the UK Government’s 2003 review of auditing in the wake of Enron decided that there was a legitimate public interest in public information of firms that audit public entities. In response, 13 of the 20 largest firms gave a voluntary undertaking to meet government proposals for transparency reporting. This they have done. However, the presentation is currently scattered and is as much promotional as information. Often, it is not couched in specific enough terms for those seeking to make a judgement about audit quality.
Transparency reports will provide public information on issues such as the firms’ processes and practices for quality control, for ensuring independence, for partner remuneration and on their governance and network arrangements. This is no longer just a job for the firms’ PR departments. The audit profession needs to see the transparency regulations of the 8th Directive as its Combined Code. The time for proper corporate governance of the auditing profession is arriving – and not before time.
