First published in the November 2007 issue of Accountancy Age Best Practice.
One of the most significant suggestions made by the Financial Reporting Council as part of its investigation of ways to break the stranglehold of the Big Four on major audits is that auditors should be forced to disclose their profits on audit work. This is a suggestion of which I not only approve whole-heartedly, but which, if implemented, might just have a chance of achieving its aim.
Whilst accountants are presently only required to state revenues, the FRC has made it clear that it hopes that making audit profit disclosure mandatory will open the way to more audit players for plcs in the market.
Such a move would enable clients to see for themselves just how much profits the Big Four accountancy firms make from their audit departments. These profits are possible partly because, in practice, the Big Four typically adopt a broad brush approach to auditing where work is designated to as junior a level of staff as practicable and the involvement of the audit partner is minimised. This broad brush also extends as far as the levels of materiality – perhaps as high as £500,000 – that applies in Big Four audits of multinational businesses where turnover, and sometimes profits, can be counted in billions.
Indeed, insofar as most plcs are concerned, audits are generally regarded as little more than a legislative requirement. That is why they will typically look for external auditors to do what they have to do as quickly as possible and with the minimum of fuss and disruption. After all, plcs have their highly-skilled in-house internal audit divisions which are more than capable of fulfilling their own audit function.
This is a way of working that contrasts sharply with the audit work undertaken by a mid-tier firm where, rather than adopting the broad brush approach, the audit team of a mid-tier firm is more likely to be in daily dialogue with the finance director of a plc client. Typically here, partners are on hand throughout the process, supporting the audit team by offering guidance on tricky issues and reassuring the client of the validity of the exercise; not simply turning up at the end of the audit for a cup of tea and a cosy chat.
Nevertheless, many finance directors will insist on appointing Big Four firms because they regard the Big Four as providing a ‘safe pair of hands’ so that there is less risk of criticism arising as a consequence of appointing a Big Four auditor than there would be from the appointment of a mid-tier practice. One consideration here is that the finance director is so remote from ownership that considerations of value-for-money audit so dear to owner-managed companies tend not to have much impact. Another, of course, is that one need only reflect upon the various major corporate frauds and scandals that have arisen over recent years to remind ourselves that, in each and every case, the audit was undertaken by a Big Four firm.
Andersens, by reputation after all, was once regarded by many serious and influential business people as the ‘gold standard’ in auditing professionalism.
Other suggestions by the FRC include opening up the files of outgoing auditors to their replacements, requiring companies to provide investors with more information on the audit selection process and allowing shareholders to vote on audit committee reports. However, these proposals are far less likely to have any effect on dismantling the stranglehold that the Big Four have over audits than making the disclosure of audit profits mandatory.
Few outgoing auditors, Big Four or otherwise, (myself included) would welcome the suggestion that they should open up files to their replacements, though we are of course, obliged by professional standards to disclose all relevant information. Similarly, allowing shareholders to vote on audit committee reports is likely to be a complete waste of time. After all, shareholders already have an opportunity to vote on whether or not to reappoint auditors at the AGM. Besides, given that the main shareholders in plcs are typically institutions and pension funds, allowing shareholders to vote on audit committee reports would make little, if any, difference.
Yet, whilst the suggestion that auditors should be forced to disclose their profits on audit work has a great deal to recommend it in principle, in practice, it could have significant cost implications for mid-tier firms for which the production of such disclosure is unlikely to be straightforward, partly because their audit departments and partners will not always be devoted exclusively to audit work, making the assignation of costs far more complex than it is for the Big Four firms.
Finally, the proposal raises the interesting question that, if auditors are compelled to show the profits they make from audit work, then who will audit the profits calculated by auditors?
Robert Kerr is Managing Partner of French Duncan, Chartered Accountants
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