Why auditors are under scrutiny from regulators and investors, globally
It is not just India—auditors across the world find themselves under scrutiny from the governments, regulators and investors. Enhanced disclosures, lower conflict of interest and regulations to improve the quality of audit are in the works. How effective these are could also offer lessons to India.
The International Forum of Independent Audit Regulators conducts an annual survey on the quality of audits. Its 2017 survey that covered 120 firms and 918 audits showed that 40% of the audits had at least one ‘finding’. A finding here refers to a fault that may affect the quality of the audit. That’s a fairly large number.
One of the main issues concerns the separation of the audit and consulting work that the top firms offer to the same companies. These fees form a substantial part of the revenue of the top four auditing and advisory firms globally. For long, there have been concerns that this creates a conflict of interest. Audit firms claim they ensure that this conflict is managed without compromising the quality of audit.
In the UK, the collapse of Carillion Plc was investigated by a joint committee of the UK Parliament. The company entered liquidation in January, with nearly £7 billion of liabilities and with £29 million in cash. Its 2016 accounts were certified by KPMG as true and fair; but in September 2017, the company announced a reduction in the value of its contracts by £1.05 billion—which equalled the combined value of six years of profits.
The committee report mentions that KPMG audited the company for 29 years, but did not qualify their audit opinions.
It says the warning signs were visible in the form of questionable assumptions about contract revenue and accounting of goodwill. It failed to exercise professional scepticism in the face of aggressive accounting practices, says the report.
The committee has recommended to the government to refer the statutory audit market to the Competition and Markets Authority, to break the Big Four (Deloitte, Ernst & Young, KPMG and PriceWaterhouseCoopers) into smaller audit firms and the separation of audit arms from those providing other professional services.
In South Africa, KPMG has lost 20 audit clients since the start of 2017, reported the Financial Times, partly due to new rules on mandatory auditor rotation and also to issues over KPMG’s work for South Africa’s controversial Gupta family.
In another case, in the US, General Electric’s (GE’s) auditor for 109 years—KPMG—came under pressure, after GE disclosed a $6.2 billion charge to increase insurance reserves and also a $15 billion provision for insurance policies. These disclosures disappointed investors, who then called for the auditors to be replaced.
It was in 2001 that Enron Corp.’s accounting scandal broke and affected its auditors—Arthur Andersen. That cut down the Big Five to Big Four.
Even so many years after that incident, the audit function is found wanting.