Pure Audit

There were lots of fuss last month over audit business separation from the rest of consultancy. Indeed, The Economist, Accountancy Age and other business media decided to pay attention to this hot topic.

Actually, I can not say I was much surprised by this news. The idea emerged in European Commission (EC) at the end of 2010, when so called Green Paper was issued. In my overview of this discussion paper in February this year I emphasised, that EC used in their report categories like “pure audit firms” and “inspection units”.

In this post I am going to contemplate some aspects of pure audit.

No problems?

There is no problem for existence of pure audit firms except for initial stages of industry restructuring. I am sorry for Big 4 and other audit firms, but restructuring should cause painful changes in their business model.

There are some other issues of interest. For example, are brands for audit and consultancy going to have same name? What it if consultancy business would collapse or in other way would be able to damage the auditors’ reputation? Would the business be allowed mutual investment, e.g. Deloitte consultancy owns audit and audit owns consultancy? So at this point we reach the level of problems which usually attributed to banking business. The idea of banks ring-fencing has been discussed rather massively in UK this autumn and Glass-Steagall act recalled as well.

Would accounting ethical codes change accordingly I wonder? I suggest that previous projects of employee who used to work for consultancy should be checked to avoid independence problems.

Refocusing reforms

Would this reform change anything in current governance structure? Frankly saying I am in a huge doubt. This is because connection between consulting and audit segments should be totally cut to make changes relatively effective. The questions I set above should be answered by US and European policy makers.

Why not refocus our attention on shareholders? Let me speculate a bit on this subject. Shareholders are major users of auditors’ work, audit reports are addressed to them. It is obvious that shareholders (principals) hire one type of agents (auditors) to check quality of work and truthfulness of other agents (managers). The idea should be simple: shareholders should win or lose from the decision of hiring good or bad auditor. In more broad view this would include stakeholders for public interest entity.

Thus, I would propose idea of introduction mechanism according to which shareholders would be able to participate more actively in the process of selection and approving annual auditor. First, it might include creation of separate audit (governance) expenses reserve/fund, which would be used by shareholders for audits without consent of managers. Second, introduction of information systems in the process of auditor selection and dealing with audit reserve money by shareholders. Third, opportunity of minority shareholders to use resources of audit reserve and appoint additional auditors in case of any need. Yes, I honestly think that possibility of the second opinion is appropriate tool to discipline first auditors and fully appropriate if shareholder wants to have alternative view of professional. Fourth, the arrangements for other stakeholders’ participation should be made. For example, banks might want the opinion to be issued by PwC, government wants to appoint local audit firm, shareholders have more belief in KPMG’s report. You are welcome! If all of these interested (and powerful enough) parties have money to pay different auditors for their independent audit projects (not joined audit) then why not let them embark for this journey. Again, the idea is that stakeholders should bear risks of doing nothing and doing something.      

In Denial? I told you so! J

Here is small anecdote in the end. On 13^th of September UK PwC Twitter account posted following: “Best question about our performance last year wins an iPad. First read our Annual Report?”. Being cautious auditor and willing to get free iPad (probably to do iAudit J ) I read their annual report. As I did not find even a word in their strategy on how PwC UK is going to tackle coming audit regulations I twitted in response:

PwC guys ignored my question… and plans to impose regulations on audit firm rotation revealed at the end of September. I told you so! J