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When hand-in-glove the audit and consultancy assignments need governance

Should the Big 4 audit firms that provide audit services to a client, be legally prohibited from providing any supplementary consulting services to the same client? Is there a need for more independence, accountability and transparency for the audit firms? Are there major conflict of interest issues within the big 4 audit firms?

Porbunderwalla Kersi
Porbunderwalla Kersi
Let there be no doubt that auditing is a tough profession, requiring strong core analytic skills, good judgment and years of training and soft issues like ethics and objectivity to be able to perform a quality audit in the current complex business world, recession and intricate accounting and audit standards.

In a way it is rather strange that the major accounting firms rely on the exercise of robust governance by independent directors in the companies they audit, while some claim that similar governance components are a problem within the accounting firms.

The European Commission’s draft Regulation provides for the creation of audit-only firms in the European Union. This seems to imply that the way the accounting firms currently operate is deeply flawed or, at the very least, inappropriate in the context of protecting the public interest and that there is a need to rethink this whole business arrangement and the resulting possibility of conflict of interest issues post the financial crisis (1).

But it appears that the Legal Affairs Committee of the European Parliament does not support the Commissions’ idea. The slow and complex EU’s legislative machinery will probably take several years to determine the final outcome. Based on previous experience the question is how long will any new legislation, designed to segregate audit and consultancy work, last before a new definition of consulting services is created?

In 2002 the Sarbanes-Oxley act (SOX) limited the kind of non-audit services an American accounting firm can offer to an US listed audit client. However it did not forbid all consultancy services an audit company can provide to their client. SOX specifically restricted certain specified non-audit services for external audit clients. The intent was to protect large accounting firms from the same greed that auditors are supposed to protect investors and lenders from. Another result of the SOX enforcement was that all major audit companies in the early 2000 had to sell their consultancy business creating new companies like Bearing Point, Cap Gemini and IBM. However the consultancy component of the major audit companies is now bigger than ever.

Too big to audit
The “Big Four” accounting firms get bigger nearly every year not only in their core business which is auditing and the provision of independent assurance, but also in providing auxiliary and supplementary services to this work. This is the major issue that worries some regulators and lawmakers. Deloitte reported revenues for its 2012 fiscal year, growing 8.6% to $31.3 billion. Similar growth figures are expected from Ernst & Young, PwC and KPMG. As private firms the Big Four choose not to report their profits, segregated by major service segments. This clearly raises multiple issues of transparency and ultimately, governance.

Another issue is that in all four firms, consulting revenue is growing much faster than the audit business In 2012 Deloitte’s consulting revenues was 13.5% and from financial advisory by 15%—compared with just 6.1% for audit and 3.9% for tax and legal services. Consulting will continue to grow by double digits, whereas growth in the audit market is stable. The audit companies are also adding consulting staff at twice the rate as for audit staff and, at this rate, are set to do more consulting than auditing by 2017.

The question that remains whether the audit firms are an extended arm of oversight authorities and perceived as a “public utility” and do the audit companies share this assumption?

In order to ensure European or international uniformity in auxiliary audit services the following issues should be addressed;

1. The audit firms should undergo the same oversight scrutiny as the pharmaceutical industry when they wine and dine their clients to keep them happy, keep the account, or win new consulting services? Entertainment is probably more valid lower down the corporate hierarchy e.g. accounting staff rather than the independent directors and client Board members.
2. If an audit firm threatens to expose an accounting inconsistency, the client could switch audit firm and the manager/partner has to answer why he lost that account. If that is the reason why audit firms rarely catch any major accounting inconsistencies, we have a major problem at hand.
3. Even if an audit firm strictly sticks to audit service, can they really be independent from any of their large-bill-paying customers and be tempted to turn a blind eye to avoid reporting peculiarities in how the client applies accounting principles
4. All consultancy assignments are subject to an internal due diligence to make certain there is no threat of a conflict of interest or independence issue with appropriate firewalls and processes in place to protect the Client and Firm and deliver quality work in both instances. The Big 4 audit companies have rules and regulations to that effect without transparency on the exercise.
5. Audit companies should only be allowed to accept consulting engagements from clients for which they do not provide any audit or other independent assurance services
6. When the audit companies get too large, perhaps they should be publicly quoted, and be more transparent regarding their reported results and their dealings.
7. Will a ban on non-audit services to audit clients (e.g. taxation) effectively reduce audit quality and effectiveness by curtailing auditor verification of information necessary to understand and evaluate a company’s activities and to limit the utility and applications of technical expertise?
8. All non audit services be identified in advance and approved in advance by the audit committee.

Could the solution be that, since the largest audit companies are global networks, they should pay a tax or fee, based on their total global revenues, to provide finances to fund an International “ESMA/PCAOB” who in turn could be in charge of providing international guidance, a Code of Ethics and a set of global auditing standards to be used by all audit companies.

The future of the Big Four’s business model may depend on whether lawmakers in Europe and America are convinced that it is possible for the audit companies to conduct independent audits both professionally and responsibly when some of the advice, processes and documentation come from the same source.

Source. and The Economist.

(1) Before being bought by JPMorgan, Bear Stearns reported paying Deloitte in 2006 $20.8m for audit, and $6.3m for other services. Shareholders of Bear Stearns sued Deloitte along with the defunct bank. (JPMorgan and Deloitte settled in June. Deloitte paid out $20m, denying any wrongdoing.)

Kersi Porbunderwalla is the founder and CEO of Riskability®, Copenhagen Compliance® and Copenhagen Charter®.
After his early retirement from ExxonMobil, Kersi has been involved in several Global Good Governance, Risk Management and Compliance (GRC) Projects for multinationals like IBM, Shell, BP, Volvo and others.
He continues to implement GRC journeys for a variety of clients to develop custom tailored GRC folder that includes methodologies, roadmaps, and specific solutions to assignments, training and certification.
Kersi conducts workshops, seminars and conferences that focus on developing and implementing GRC applications & frameworks into operational environments.
He is a consultant, instructor, researcher, commentator and practitioner on 4 continents.

Vendredi 7 Décembre 2012