New Audit Order: Take 2. Remodeling audit services

The audit profession is very conservative by its nature but to survive any organism must be flexible, open for changes and new trends.

How can we modify meaning of “audit services” terminology? How could it influence audit firms market and multinational companies (MNC)?

New services – more analysis

Let’s be clear about it. Society demands from auditor to give the opinion about financial soundness and performance of listed companies, given that auditors have extensive access to information. Green Paper of  European Commission suggests that ‘forward looking analysis’ of ‘large listed companies’ might be ‘real value added to the stakeholders’.

So auditors are going to move to the business of credit rating agencies and financial/equity analysts. And I would suggest this is very good news! Auditors are extremely fit for this job: auditors have enough expertise, knowledge and analytical skills to provide sound analysis of companies, moreover they know degree of reliability and relevance of each line of financial statements.

Format of product: three-fold report

We have already had reports with two types of opinions: financial statements opinion and effectiveness of internal control (over financial reporting) opinion. Under SEC requirement Companies listed in US need to be audited in accordance with Public Company Accounting Oversight Board (PCAOB) standards (after enacted SOX legislation). See, for instance, extracts from Hershey’s financial statements audit report:

Source: http://www.thehersheycompany.com/investors.aspx?ICID=HCOMP1005        

Obviously, the third part could be added to this report. Brief paragraph about financial viability of company (going concern analysis) which must be accompanied by detailed analysis of company’s previous financial year performance and financial perspectives based on evidences  gathered as at  audit report date. The brief paragraph in the body of report together with detailed analysis should give unambiguous understanding of auditor’s opinion about the company financial and business perspectives.  

How to do – technique

Some words about audit team management. In my opinion, in the above case scenario the audit team should split at least in 2 parts: financial statements audit team and business audit team. The first one would be concerned with internal controls and financial statements. The business audit team would have to spend time on analysis. These split in two roles is necessary to avoid any eye-soaping of members of audit team and would encourage fresh look on business activity and company’s reports by business team.  Definitely, both team must work together and question each other on their findings, inconsistencies and misunderstanding. For example, such procedures like overall analytical review supposed to be carried out in cooperation.

Responsibility of auditor: less regulated more active and open?

Responsibility of auditors is very complicated issue to discuss. There are similar kind of services provided by other companies, but their responsibility is not as much auditors’. What does hold our profession from development? How does responsibility influence on competition?

I suggest responsibility should be limited to quality of services provided. In any case, dissatisfaction by work of auditors whether they failed to predict bankruptcy of Lehman brothers or failed to reveal fraud in Enron is caused by bad quality of audit work; non-compliance with audit standards or weak audit standards itself. If society is not satisfied by quality audit standards then it is time to change them, but there is no use to blame auditors, because they complied with wrong standards.

On the hand we have market, which is supposed to regulate audit business. If shareholders are not satisfied with quality of audit services they hire another auditor and bad reputation would not let providers’ of bad services to succeed.

Some considerations about other industries…

Let us look on credit rating agencies. There are no much regulations about them. They do not have such comprehensive quality standards as accountants do. But it is also quite oligopoly market (Big three:  Standard & Poor's, Moody's Investor Service and Fitch Ratings). The agencies also has faced severe criticism after financial crunch for not being accurate in their assessment of companies’ rating. This reminds me something…

There is another interesting industry which is worth mentioning: the higher education institutions. Suppose, I hired MBA graduated from Yale University with GPA = A+. After we signed one year labour contract it have been appeared that my new hire has had idea neither  about efficient market hypothesis nor net present value analysis. What should I do? Should I sue Yale University for that? Does it mean that there is unsatisfactory education quality control and attesting system at University? Or is there anything wrong with my  recruitment system?

Anyway I think it is time to make Porter’s five force analysis and PESTEL for regulators and audit professionals to assess:

1)      if legal, social and political barriers have been already rather high and suppress competition in industry;

2)      if lowering of those barriers might increase competition level;

3)      if increased completion level might positively impact quality of audit services and provide additional value for society.

There are lots of work to be done and long journey to be made.