Whilst the Big Four accountancy firms presumably do some good work, when it comes to auditing clearly something’s gone awry. Over the last couple of years, there’s been a flurry of instances of high-profile companies that have either gone belly up, come very close, or become embroiled in a financially-charged scandal of some kind, despite having not long since been given clean audit reports. In the case of Patisserie Valerie, which fell into administration in January (though was subsequently rescued) amidst reports of fraudulent activity, Grant Thornton, the firm that carried out the preceding audits, said it was not the role of auditors to uncover fraud. This seems a tad disingenuous given the scale of the fraud (£30m missing, subsequently upped to £94m by KPMG who took over as auditors). This comment did not go down well with Labour MP Rachel Reeves, who said: “In a shop that sells tea and cakes, you’d sort of think that might be spotted. It’s not a multinational complex organisation.” Fair point. Construction giant Carillion was another recent corporate casualty which blindsided investors and was caused by what’s been described variously as ‘fantastical’ or ‘aggressive’ accounting. Surprising, given the fact that KPMG had been carrying out regular unqualified audits prior to the company’s collapse. But was this ignorance or wilful ignorance? Well, KPMG reportedly suspended the lead partner involved in the auditing of Carillion and the firm remains the subject of a second UK investigation over its handling of the Carillion audits so we’ll let you be the judge of that for fear of a libel lawsuit…
All this begs the question: to what extent should auditors be held accountable for the ‘unqualified’ reports they produce? If, as Grant Thornton CEO David Dunkley’s attitude suggests, auditors feel it’s not their job to detect fraudulent activity then do audits provide an accurate portrayal of a company’s financial well-being? In other words, can audit reports be trusted? And, if not, then what purpose do they serve, if any? The way we see it, there are two things that need to be addressed here. The first is what can only be described as bad, unreliable auditing. The reasons for this presumably vary from firm to firm and can hopefully be rectified by making accountancy firms more accountable for the clean reports they publish.
However, the second and in our opinion more pressing issue is the problem with conflicts of interest within the audit industry. For example, when an accountancy firm that does considerable consultancy work for a company also does the same company’s audits, one can’t help but have doubts about the efficacy of the resulting reports. It’s a tricky one this, because here at OC we’re usually pretty anti-regulation, as a rule, because most of the time regulation, aside from being largely ineffective, actively encourages further dishonesty, creates more bureaucratic red-tape, and ends up hurting SMEs the most. And, in many ways, the problems with auditing reinforce this opinion of ours. How so? Well, the government passes a law that businesses over a certain size must be audited regularly to protect employees and shareholders from potential dishonesty amongst those in charge of a company’s finances. That’s great, in theory. Problem is, in reality, judging by many of these recent scandals at least, many businesses have actually become less transparent and more dishonest thanks to ‘creative’ accounting and auditors who are all too willing to turn a blind eye to what’s really going on. So, what often happens? The auditors falsely publish an unqualified report which, if you think about it, is actually worse than producing nothing at all because it lulls employees, shareholders, along with anyone else invested in or reliant on a company’s success, into a false sense of security.
This is likely especially true of larger firms that spend a lot of money on consultancy services from the same accountancy firm that’s auditing them because there’s a definite conflict of interest there. It’s in auditors’ interests to reassure shareholders that a company is in shipshape because they are a big-spending client. Indeed, with regard to Carillion, MPs accused the firms in question of “feasting on what was soon to become a dead carcass”. It’s pretty gross that any accountancy firm would have that level of contempt and apathy toward their own clients. Having said all that, if regular audits are to remain a legal requirement, there does seem to be a genuine need for more accountability on the part of the auditors, given these recent high-profile cases…
“If we don’t work with them, they will go to our competitors”
When we were discussing this in the office, a scene (video below) from The Big Short, the movie about the 2008 financial crisis and the crafty few who benefited from it, came to mind. The scene depicts the film’s protagonists interrogating a credit rating agency worker about the regulator’s rather cavalier (to say the least) approach to dishing out Triple-A ratings. To begin with, the guys asking the questions reckon the rating agencies have just been lazy or otherwise bad at their jobs, i.e., not looking into the individual loans that form the bonds that they are being asked to rate; however, as the scene progresses, the agency worker reveals the true reason behind the less-than-accurate ratings…
Here are five recent examples of companies that either fell upon hard times or found themselves at the centre of a scandal that audits failed to expose. Aside from Patisserie Valerie which, as mentioned, was audited by Grant Thornton, all of these companies are audited by Big Four accountancy firms. These stories are not unique and the problem is thankfully being addressed. Indeed, just a couple of weeks ago (18 April) a comprehensive report was released by the Competition and Markets Authority (CMA) entitled the “Statutory audit services market study”, which delves into many of the issues currently plaguing the audit industry. The report recommends a fairly radical shakeup of the audit industry, though falls short of the “full structural split” called for by the Business, Energy and Industrial Strategy committee in its Future of Audit report. Instead the CMA report calls for an “operation split” wherein separate management, accounts and remuneration” for the two arms, i.e., consulting and audit, including “a separate CEO and board” and “separate financial statements for the audit practice”, become mandatory. The proposal would also end profit-sharing between audit and consultancy. Hopefully something will change soon because it is frankly insane that the same firm can invoice a client for both consultancy work and auditing work. However, the sad truth is things will probably stay the same. Following these sorts of high-profile scandals, the fallout process generally goes something like this:
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