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The Financial Director interview – Professional Sceptic

Ian Plaistowe has been chairman of the Auditing Practices Board, the UK standard-setter for the auditing profession, since 1994. In 2002 a new Auditing Practices Board was established under the umbrella of the new Accountancy Foundation and Plaistowe was invited to remain as chairman.

An auditor all his working life, he joined Arthur Andersen in 1964 after graduating from Cambridge. By the time of his retirement from the firm in June this year, aged 60, he was managing practice director for assurance and audit practice for Europe, Middle East, India and Africa, and was concerned with quality of work and risk management issues in that area of the world. He was president of the ICAEW in 1992-93.

Our interview took place as the “certification” requirements of the US Sarbanes-Oxley Act were beginning to bite. While Plaistowe was prepared to comment on the developing regulatory regime in the US and on differences between the US and UK approaches to financial reporting and auditing, questions relating to the performance of his former partners at Andersen or their clients were not part of this discussion.

How would you characterise your approach to audit? What is your philosophy?
Auditing is very much about common sense. As a result of that, (by) focusing on principles of auditing as we do in the UK, you also have to investigate and question how auditors have applied those principles; that, to my mind, is a very effective way of regulating auditors. That is in contrast to the US where they like a lot of “thou shalt nots” and a rulebook. If you look at their auditing standards it is a great big thick book and you are supposed to comply with it all. It is very difficult to for anyone to understand everything that is written (in it) – let alone remember it.

But while we like to think that UK accounting and auditing are principles-based rather than rule-based, the truth is that we are getting more and more accounting and auditing standards, and they are getting more detailed: aren’t we, in fact, becoming more reliant on rules than principles?

To some extent we are and the danger the UK faces in all these areas of accounting, auditing and ethical standards is that, as the world tries to end up with a single set of global accounting standards and a single set of global auditing standards, we end up in discussions with our American brethren: they have had accounting and auditing standards much longer than the rest of the world and have the largest capital markets in the world. This makes them very influential at getting what they want to see.

They have big, thick rulebooks and we have thin rulebooks full of principles. Trying to get the two to work together means there is a danger that we move from principles to more rules.

What’s your view on how the regulatory environment is developing in the US?
The US has just passed the Sarbanes-Oxley Act which is really picking up on the structure the UK (already) has, in many ways. It is not exactly the same and the powers and authorities are a bit different. But it seems to pick up a lot of the UK principles and we will have to see how it turns out in practice.

They have prohibited accountants providing nine (types of non-audit) services to audit clients. Most of these are pretty reasonable and consistent with the line the SEC took two years ago in its statement on auditor independence.

There are issues on how (Sarbanes-Oxley) is going to apply to oversees auditors that audit US public companies because it requires them to comply with US rules and in theory gives the regulators power to demand the working papers of non-US auditors. That will upset auditors in this country.

What else can be done to restore confidence?
It’s very difficult. People have been talking about expectation gaps as to what auditors do for as long as I can recall.

The US has adopted the view that CEOs and CFOs will have to sign off on the truth of their financial statements. CEOs and CFOs for the first time are saying, “How do I know the financial statements are right?” That will help. We already have this in the UK when two directors have to sign the balance sheet of a public company. Whether people understand what they are signing, I don’t know.

The APB appeared to be ahead of some of the recent scandals with the publication of the discussion document on aggressive earnings management.
One of the things we identified in that paper was the conflict that company directors have. A director of a public company may say, “Gosh! I have a duty to present true and fair financial statements. That is a duty set by law. On the other hand, if I can get my earnings per share higher by a penny, I will get megabucks. Accounting is full of estimates and judgements – so can I tweak this here and there?” What are the boundaries of acceptable presentation and where does that become fraudulent misrepresentation?

The border between the two is not defined and it is very difficult for independent directors to make their minds up about it – and it is even more difficult for external auditors.

In the US, that conflict is exaggerated because instead of individuals receiving a sensible bonus of a few thousand pounds, their bonuses can run into several millions of dollars. That is the starkest conflict directors have.

PricewaterhouseCoopers recently came out with report damning company directors for taking short-term measures to meet earnings forecasts. AEM falls into the same category.

So how can we motivate FDs to grab the bull by the horns and communicate the real financial situation to the City, not just tell the City what it wants to hear?
It’s very difficult. You can only do it by giving up elements of the free market economy such as bonuses and stock options – which is highly unlikely to be acceptable. You can also increase standards of supervision and enforcement. The audit committee is seen as being the way forward for supervision. Enforcement takes the form of being thrown out of an institute or being publicly hung out to dry through something like a JDS (Joint Disciplinary Scheme) enquiry. But there do need to be ways of enhancing corporate governance.

If there is a showdown between the client and the auditor, isn’t it the auditor who will blink first?
Where you get into difficult areas in relation to accounting estimates, the auditor must say whether the financial statements give a true and fair view. They are helped in that with the financial reporting standard that has recently required directors not to chose an acceptable accounting policy, but the most appropriate accounting policy in the circumstances.

How does a difficult client differ from a model client?
There are clients that do not co-operate in the audit. They may think you are unnecessary and resist everything you say. But, at the end of the day, if you don’t have a reasonable relationship with a company then you should resign.

There is a lot of talk about mandatory rotation of auditors and the idea that we must avoid auditors getting “cosy” with management. But they forget that no auditor can do an audit unless he has a reasonably close relationship with management. If management doesn’t talk to him, the auditor cannot do an audit. So, if the auditor has a difficult client he has to think as to whether he can carry out an audit of that client. If an auditor resigns and other auditors refuse to work with the company, that is a pretty clear message to the market.

Does that happen?
When people are concerned about the integrity of the management it does happen.

In order to make the auditor’s job easier, should there be a kind of auditing standard that applies to client company directors? We note, for example, that the company law white paper proposes making it a requirement for directors to volunteer information to their auditors.

If APB decided to produce some standards for client directors we would have the world screaming. The only people who can do that are the FSA, company law or code of corporate governance-type activities. My experience of FDs is that they always have a very good idea of what’s in their numbers.

They know where the cushions are, where things are a bit tight. Chief executives are different – they rely on the finance director. And whether different rules should apply to them I am not sure.

One interesting subject is how the role of auditing committees is going to develop. APB has, for many years, tried to talk about how we can enhance the independence of auditors, and in a document entitled The Future Development of Auditing, published in the early 1990s, we talked about the idea of setting up shareholder panels, whereby shareholders would appoint panels to represent their interest and they would appoint the auditor. That didn’t get off the ground, so we thought about applying those ideas to the audit committee when we published The Audit Agenda in 1996.

Certainly, the Co-ordinating Group on Audit and Accounting Issues (CGAA) proposes a number of things for audit committees and it has referred to the Financial Reporting Council the task of coming up with some guidance for audit committees. I hope that we will have a role in the process where we can put forward our ideas, which are very similar to the co-ordinating group’s ideas on who should appoint auditors. Should it continue to be the shareholders with guidance from the directors, or should it be the audit committee? Who should be on the audit committee? What sort of training and skills should they have?

Might a better idea be to have a two-tier board that’s got real authority to deal with the auditors and look at what the executive is doing with regard to its earnings communications?
That’s an interesting idea. I have always been attracted by the idea of introducing two-tier boards. Everyone from Cadbury onwards has thrown them out. I don’t think directors want them because they think it will somehow interfere with executive management. I’ve always been interested in the idea because things like audit committees, in the way that (the CGAA’s) interim report discusses them, are a substitute for two-tier boards.

I’m in theory in favour of looking at the pros and cons because they may take away some of the problems we have with the unitary board. But they are often dismissed rapidly – maybe they are too theoretical.

You’ve written in the APB’s annual report and in a Times article about the need for auditors to have a degree of “professional scepticism”. How do you reconcile that with the fact that the auditor is in effect reappointed by the board every year?
That is one of the things we are trying to deal with in relation to the role of audit committees. Professional scepticism and rigour are key to the performance of auditing. I think one of the things that may have happened in recent years is that while auditors say professional scepticism and rigour are incredibly important, there have been other things on their minds, including changing methodologies and time-budgets for audits. Are people sceptical enough? I don’t know. But if you ask institutes what training they give in professional scepticism, I think you will find they give very little.

Name: Ian Plaistowe
Age: 60
Qualifications: FCA

1964-2002: Arthur Andersen; partner since 19761984-1987: In charge of accounting and audit practice in London
1987-1993: Practice director for UK and Ireland, responsible for managing quality and risk management
1993-2002: Managing practice director, Europe, Middle East, India & Africa

1992-1993: President of the ICAEW
1994-: Chairman of the Auditing Practices Board

What one company would you personally most like to audit?: Shell has always intrigued me: two holding companies, all the different forms of financial reporting and huge exposures. It would be an intellectual challenge. But I don’t know easy the audit would be.

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