Ouside the box: Transparency is key to accounting

When 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.