Extended remit: KPMG's audit model

IN 2009, KPMG designed a tailored audit package for Rentokil that caused uproar in the accounting world. Critics said the deal – which shaved 30% off Rentokil’s bill by taking on some internal audit functions – went against the basic principles of independence and ethics.

The Audit Inspection Unit’s annual report is due in July and its view on KPMG’s brainchild will be closely scrutinised. One source close to the matter said the audit watchdog sees the package in a positive light. But it begs the question: is the Rentokil model an aberration set to be discredited, or has the Big Four player struck gold?

So far the Rentokil model has attracted support. A report last year found that 17% of FTSE-350 companies had already bought some form of extended audit, and finance directors have emerged to defend their right to buy such services.

KPMG’s UK head of audit, Oliver Tant, says it enhances the audit service by avoiding duplication of external auditors’ work by internal auditors, leaving the latter free to direct their attention elsewhere.

Critics’ primary complaints centre on the self-review threat, whereby an external auditor relies upon its own internal audit work, and the management risk, which warns against internal auditors assuming the role of management.

The Chartered Institute of Internal Auditors, unsurprisingly, views the deal with a cold eye. Chief executive Ian Peters says the service could be perceived to breach ethics and is therefore potentially damaging. He argues that the perception that there may be a conflict of interest undermines the industry at a time when building respect and credibility is paramount.

Such crossover is not permitted in the US and many other jurisdictions. KPMG has been reprimanded in the past for blurring the lines between internal and external audit: it was providing staff to undertake internal audit-like functions in the workplace under the direction of an Australian client. A stop to this was ordered by the US Securities and Exchange Commission earlier this year.

Other critics have claimed auditor independence could be eroded by increasingly lucrative contracts and ever-closer ties between auditor and client. Peters argues that because greater sums of money are involved – with savings for the client and larger contracts for the firm – KPMG is sailing close to the wind in terms of acceptable auditor behaviour.

However, Steve Maslin, Grant Thornton’s head of external professional affairs, says positive messages on cost control for Rentokil created confusion over KPMG’s new product. “It is unclear exactly what KPMG was doing, but it seems to me it was increasing the scope of work on financial controls in order to save time and money on internal audit,” he says.

Extended understanding

On this basis, the concerns over conflict of interest would not necessarily apply. Rather, as Tant claims, “this work does not replace, conflict with, or undermine the independence of the external audit. It simply extends our understanding of the business and its controls, and hence the breadth and depth of insight we can offer.”

Enhanced audit is certainly something in which the major firms are interested. Many audit committees are seeking greater guidance on risk management and they often ask external auditors to focus on potential trouble spots. This does not constitute an undermining of internal audit when it is consistent with external audit services that would anyway be carried out, though the Rentokil package takes things one step further.

While the Rentokil package is considered by most to be firmly on the side of internal audit, objections may be muted because there is little evidence to show it violates the two primary risks of self-review and assuming the role of management.

This could mean the time has come to re-examine what constitutes internal and external audit. David Herbinet, head of corporate public interest markets at Mazars, says the last decade has seen unprecedented growth of internal audit, and this may have led to it swallowing some traditional external audit functions. With reviews of external audit underway in the UK and Europe, now could be the time to take a closer look at its sister function, internal audit.

On the other hand, the mood coming out of the studies is stern and they may result in stricter controls over the audit market. This could mean strengthening the laws governing non-audit services and might stymie the potential gravy train of KPMG’s new product. ?