Archives For Big Four

By John Davies, head of technical, ACCA

The House of Lords Economic Affairs Committee has published BIS’ response to their March audit market inquiry. There’s nothing particularly unexpected in BIS’ response as many of the positions have been outlined before. Overall, it’s a curate’s egg: we agree with BIS where we expected to (for example, on IFRS) and disagree in other expected areas (for example, on small business audit requirements). A couple of things jump out that are worth going through:

The Audit Commission (Para 178)

EAC: Recommended the Government encourage the development of a rival to the Big 4; Baroness Hogg from the FRC suggested that this could possibly be created out of the ashes of the Audit Commission

BIS say they are looking at a ‘range of options’ for the future of the Audit Commission’s in-house practice. ACCA is supportive of Baroness Hogg’s suggestion for the future of the Audit Commission’s audit practice. We believe that the Government should work to ensure that the Audit Commission’s audit practice is successful as it provides an opportunity to enhance competition and choice.

Restrictive bank covenants (Para 180)

EAC: Recommended the Office of Fair Trading should conduct a market study of restrictive bank covenants

BIS point out in their response that they’ve already asked the OFT to look into this, and we welcome the government’s acknowledgement that bank covenants can be anti-competitive and need looking into.

Audit liability (Para 181)

EAC: Recommended OFT investigate whether audit liability arrangements deter non-Big 4 auditors from taking on large listed clients

We’re looking forward to the OFT investigation, but it is disappointing that BIS seem to be pre-empting the outcome of that investigation by saying they have ‘no current plans’ to further limit liability. BIS note the 2006 Companies Act in their defence, but this hasn’t exactly been a roaring success. Audit liability needs to be reformed alongside the broader reform of audit, which is something we’ve looked into in more detail here (we’ll have a post about this report up soon).

Audit for small businesses (Para 185)

EAC: There is a case for some reduction in the audit requirement on smaller companies to reduce regulation, but this is unlikely to reduce audit market concentration

BIS unsurprisingly agree with this given their previous announcements on small business audit. We think BIS are wrong on this one, but it’s interesting to see they’ve not responded to the committee’s caveat that a change would not impact audit market concentration.

Non-audit services (Paras 187)

EAC: Recommended that a firm’s external auditors should be banned from providing internal audit, tax advisory, risk committee advice. OFT should investigate whether other services should be banned.

BIS take the position that there should be no fixed ban on the provision by auditors of non-audit services, which is to be welcomed. The ethical standards issued by APB (Auditing Practices Board) already contain extensive guidance on how auditors should react to threats to their independence and objectivity posed by such matters. We would however point to the points made by the AIU (Audit Inspection Unit) in its 2010 annual report about the need for the big firms to show more commitment to complying with the ethical standards in respect of independence issues.

IFRS (Paras 192-4)

EAC: International Financial Reporting Standards have resulted in a loss of prudence in accounting; IFRS is weak in relation to bank audits

We welcome BIS’ clear recognition that IFRS does not encourage or result in a loss of prudence in accounting. Professional scepticism also remains an integral element of the approach of the independent auditor and we support any efforts to ensure this element is present in the work that auditors do. There are widespread regulatory concerns though that auditors need to do more in this areas. Recent steps by the FRC, FSA, and other standard setters to ensure auditors focus on this issue are positive moves.

Mandatory dialogue (Paras 200-3)

EAC: Dialogue between bank auditors and supervisors is poor and a statutory obligation is required.

BIS say they aren’t persuaded by the need for additional legislation. We welcome the moves to institutionalise more frequent dialogue between auditors via the FSA's new code of practice and trust that this will result in an enhanced quality of communication between the two sides. But the conclusions of the committee report were especially damning on this matter and the Government must reserve the right to legislate further unless significant improvements are forthcoming. It seems very possible in any case that the current review of audit being undertaken by the EU will conclude that exchange of information needs to be put on a statutory footing.

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By Ian Welch, head of policy, ACCA

Amidst all the focus on tax changes and economic forecasts in the UK Budget yesterday, accountants could be forgiven for not noticing an interesting announcement sneaked into the fine print: that the Government has called upon the Office of Fair Trading to assess whether bank clauses in lending agreements unfairly restrict competition in the audit market.

The surprise announcement – mentioned on page 78 of the 126 page Budget document issued jointly by the Treasury and Department for Business, Innovation and Skills comes just before the report of the House of Lords inquiry into audit competition, expected to be published next week. It seems to have stolen some of the thunder from the Lords' conclusions.

The Government seems to have been influenced by the OECD, which suggested last year that banks sometimes make loans to business contingent on having audits carried out by the Big Four. Mid-tier firms such as BDO and Grant Thornton told the OECD of the existence of such restrictive covenants and have been very vocal on the subject ever since.

The Financial Reporting Council, which examined the issue and urged companies to disclose any such clauses (though admitting that few do) yesterday promptly welcomed the Government's move, which seems to have been inspired by Vince Cable, who has previously urged action on the issue.

ACCA, in its own submission to the Lords inquiry, supported greater audit competition and specifically focused on the restrictive covenants issue (along with liability) as being one area where action could be taken, so we welcome any move that the OFT might take to prevent banks including any such anti-competitive clauses into its lending agreements.

Firms should have to demonstrate that they are the best-placed to carry out audit work – it should not be assumed and they certainly should not be given artificial 'help' in this way. Action in this area could genuinely increase competition by persuading 2nd tier firms that it is worth undertaking expensive and time-consuming tenders. At the moment they are understandably reluctant to do so in certain cases, believing they will not be given a fair crack of the whip. 

It will be interesting to see what concrete evidence the OFT unearths, but the very fact it has been asked to examine this issue by the Government increases the political pressure on the Big Four. You can be sure it will have been noted in Brussels, where EC Financial Services Commissioner Michel Barnier continues to deliberate on fundamental changes to the audit profession. He will also have noted in the Budget document yesterday that the UK intends to "press the European Commission to remove the audit requirement for most medium-sized companies in the lead up to the publication of a revised audit directive, expected in November 2011." This, it is understood, would mean companies of up to £25m turnover, a dramatic hike from the current level.

This is where ACCA parts company from the Government. You can make a fair case for SMEs not to have to undertake a full audit. But if you believe that good audit adds value to business – as we strongly do – then where should that line be drawn? The Budget document once again makes reference only to the 'savings' made by such plans – this time a conveniently eye-catching £200m – and not the downside of a dramatic increase in the number of businesses having no external check on their finances. Other EU member states do not even use the maximum threshold allowed under current rules, fearing that, in the current global economic uncertainty, doing away with audits may not be wise. Can the Government be so sure they are wrong without carrying out any impact assessment?

By Ian Welch, head of policy, ACCA

If anyone was wondering where more than 500 senior figures of the profession had disappeared to on 9 and 10 February, I can reveal they were all in Brussels. A two-day conference on financial reporting and auditing would not normally have got such a huge response but this was no ordinary event.

This was the event arranged by the European Commission last October when it unveiled its landmark Green Paper on the future of audit, post-financial crisis. Last week the Commission issued a summary of the 700 responses it had received, and on the second day of the conference, EC Financial Services Commissioner Michel Barnier gave the assembled auditors, business leaders and regulators the first indication of his thinking. It proved to be far from everyone's cup of tea.   

Barnier, hot-footing it across town, where he had just told another high-powered audience that he was keeping up the pressure on bank bonuses, got straight to it: 'The status quo is not an option' for auditors, he declared. There would be proposals for legislation by November, and his five areas of concern were:  

  • Enhancing independence
  • Clarifying the role of audit
  • Market structure
  • SMEs
  • International convergence

While stressing that nothing had been decided and that all the responses were being considered, it soon became clear that three issues – all concerned with independence – were at the forefront of probable action. Firstly the provision of non-audit services by auditors to clients. Secondly, mandatory audit rotation and thirdly, joint audits.

Barnier said that he had been looking on the websites of the big firms. Nothing sinister in that, you might think. But the firms' promotion of non-audit services and positioning themselves as internal business advisers clearly concerned him: 'we cannot just assume audit independence – how can you be sure the audit will not be watered-down?'

To be fair, Barnier's reaction is typical of many politicians – witness the UK Treasury Select Committee in 2009 and the Commons report on Northern Rock both of which seized on the issue of non-audit services even though it had little to do with the problems being addressed.

ACCA's view is that there is no evidence that non-audit services affect the audit adversely – on the contrary, there is a considerable body of business opinion that prefers the knowledge of the company built up by the auditor not to be dissipated by the recruitment of a different firm to do the tax work, for instance (see a previous blog of mine).

But it has always been a difficult case to make to a sceptical audience – and the financial crisis has stripped away any inclination the EC had to give auditors the benefit of the doubt. Sometimes realpolitik is too strong and it may be that the profession has to give ground on this issue; but the outcome must not be the nuclear option of 'audit-only' firms, which would lead only to a serious tailing-off of talent coming into the profession. That simply has to be avoided.   

Mandatory audit rotation also seems likely to be brought in. Once again, it is hard to justify to critics how a firm can be auditor to a company for 30 years without becoming part of one speaker called the 'organagram' of the company. Speakers including FRC chief executive Stephen Haddrill who followed Barnier, made the case eloquently that this could be overkill and rather than increasing competition and independence would simply add costs and lead to one Big Four firm replacing another. But again, the odds must now be on this happening.   

Finally, having repeated his view that Big Four dominance posed a systemic risk ('prevention is better than cure') and that the EC had to find ways to increase competition, the Commissioner turned to joint audits.

This was an area where national differences were stark. Barnier's compatriots at Mazars and the French regulator praised the use of two firms as being a success in France – 'two pairs of eyes are better than one" – but UK and German speakers condemned them as costly and ineffective. But given the lack of any other effective ideas to help the second-tier firms challenge the Big Four, joint audits must also be a good bet for action.

Turning to accounting standards, Barnier warned the US that the EU's patience would run out on convergence if they did not act reasonably soon. Luckily Arthur Lindo, the US Federal Reserve's chief accountant had already responded to this blogger's question in the Q&A session, to say that he was confident the US would accept IFRS 'quite soon'.

It is just as well that peace seems likely on the convergence front, because there will be more than enough lobbying and politicking going on in Europe on audit over the next few months on this evidence. The European Parliament will have its say in May which should give more clues as to the likely outcome. But it is clear that Barnier has already decided on the essential direction of travel. And the profession is going to have to give ground on some areas it would rather not.

Narrative reporting

accawebmaster —  27 September 2010 — 3 Comments

By Helen Brand, chief executive, ACCA

Read a company's annual report (here's a selection from McDonalds, AstraZeneca, Vodafone, and us as random examples) and you'll notice its front and back halves are almost entirely different documents; the back full of figures and accounts, the front narrative.

The back half presents the bald financial facts and figures, while the front half – the narrative report – is a business's opportunity to tell its own story in its own words, to provide extra non-financial information that will help stakeholders take decisions regarding the business.

At least this is what should happen. Yes, the financial statements spell out the financial facts, but there are growing problems with the usefulness of narrative reports: increasingly, voluminous and complex regulatory requirements are seeing the story of business performance drowned out by a mountain of detail.

We've been working with Deloitte to look at some of the problems experienced by report-preparers, and we've carried out a survey of some 230 chief financial officers and other preparers in listed companies in nine countries (Australia, China, Kenya, Malaysia, Singapore, Switzerland, the UAE, the UK, and the US).

The survey found:

  • meeting legal and regulatory requirements was the most popular driver (83%) for narrative disclosures. Shareholders' needs came marginally behind this (82%). When asked to identify audiences of high importance, regulators were picked by 67% of interviewees while shareholders were picked by 88%
  • 71% of respondents consider the top critical challenges in producing a narrative report to be the number of requirements placed on preparers, and the cost and time involved in preparing the report
  • the interviewees see the five most important disclosures for shareholders to be: explanation of financial results and financial position (identified as of high importance by 87%); identifying the most important risks and their management (67%); an outline of future plans and prospects (64%); a description of the business model (60%); and a description of Key Performance Indicators (KPIs) (58%)
  • in the aftermath of the global financial crisis, 78% of preparers consider that the discussion of risks and their management is of greater interest. (The failure of conventional reporting prior to the financial crisis to explain the risks inherent to business models of complex organisations is an area of concern for me)
  • looking at improving future narrative reporting, 65% of interviewees say that they would like a reporting environment with more discretion and less regulation, 58% cite the inclusion of external auditor opinion, 57% believe there should be more emphasis on forward-looking information and 51% ask for IASB guidance.

Narrative reports certainly throw plenty of information at us to satisfy both regulators and report users but this is risking turning reports into tree-obscuring woods. There needs to be more flexibility for preparers to tell their business's story in a way they think would be useful to stakeholders. Regulation should underpin this, not get in the way.

The IASB is due to issue guidance on narrative reporting at the end of October. Greater clarity and simplicity would be welcomed by CFOs – not least because they believe it would benefit the report-users they serve.

Update: The full ACCA/Deloitte report

Playing catch-up

accawebmaster —  6 August 2010 — Leave a comment

by Helen Brand, chief executive, ACCA

If you missed the Global Virtual Conference at the end of last month, then you missed a couple of gems. Don’t worry though – the sessions are still available to view on demand.

One of my personal highlights was the interview with Professor Mervyn King. Professor King has a rather intimidating CV (Judge, South African Supreme Court Counsel, holder of numerous professorships, chairs, and directorships) and has had an almost unparalleled impact on corporate governance. He is the eponymous King of Kings I, II, and III. I thoroughly recommend you give his interview a look when you have the time.

One of Professor King’s current passions is the area of sustainability reporting (King is the chair of the Global Reporting Initiative), which is an area that ACCA takes a keen interest in too.

Sustainability matters, whether we like it or not. Even when the ramifications of the financial crisis die down, we’ll be left with the climate change crisis. According to the Global Footprint Network, 1.4 planet earths are needed to sustain the current population.

Everyone has responsibilities when it comes to combating climate change, and businesses are no different. In fact, given that enterprise is such a vast consumer of the world’s resources, you could argue that businesses had a bigger responsibility than others – many multinationals have bigger economies than some countries.

The key thing with responsibility is accountability. Businesses have long been required to report their financial activity to stakeholders in their annual reviews, but now sustainability reporting has to catch up.

There needs to be a universal standard that requires businesses to report in clear language the impact their activity has on the environment. Stakeholders need to be able to use the information to compare and contrast the sustainability performance of companies, just as they do with financial information.

As Professor King said in his interview, companies know their stakeholders and shareholders want this information and they want to give it to them, but the lack of clarity in the sustainability reporting requirements leads to caution and confusion.

Moving towards a clear and consistent method for businesses to report their sustainability impacts is the goal of the newly formed International Integrated Reporting Committee (IIRC), set up by the GRI and the Prince of Wales’ Accounting for Sustainability project (A4S). It’s a personal honour for me that I’ve been asked to sit on the steering committee of the IIRC, alongside representatives from (among others) the Big Four, IFAC, FASB, the IASB, and several multinational businesses.

United and focused action on sustainability is the answer. I’ll keep you posted.