Is the time right to reform the auditors?

The world’s largest audit companies are the external auditors for the majority of higher education providers in the UK. Governing bodies rely upon their work but is this reliance justified? Our governance editor David Williams says a new, hard-hitting book, Bean Counters: the triumph of the accountants and how they broke capitalism, argues it may not be.

A former tax inspector, who writes for Private Eye magazine, Richard Brooks traces the roots of auditing back to the nineteenth century and the fraudulent practices associated with the development of the railways. The auditor was an independent and trusted agent exposing cases of fraud and false accounting. Their independence and actions checked the excesses of capitalism. The roots of today’s Big Four accountancy firms can be traced back to the early audit companies.

In a tough assessment of their power and influence, Brooks offers multiple examples where the auditors failed in their primary task of finding or exposing false accounting.

Brooks believes the independence and actions of the large audit companies no longer align with those of their predecessors. He says today’s auditors are compromised by conflicts of interests. An audit offers the opportunity to sell a client non-audit services (eg. tax advice, management consultancy) and boost their fees. The latter, rather than the former, is their primary objective.

He notes that when auditing financial statements, too often auditors fail to challenge management. False accounting is either not identified, or only identified at a late date by the auditor. If junior members of an audit team raise concerns about an organisation’s business practices, they are often over-ruled by their seniors. He says that too often organisations ‘fall over’ shortly after gaining a clean audit opinion. Regulators are in most cases ineffective, current or past senior members of the Big Four often serving on their governing bodies.

Brooks sees the process as circular, with the influence and lobbying of the auditors limiting reform and allowing existing business practices to continue. He suggests “…most accountancy failings are less about dishonesty and more of tales of insufficient courage, curiosity and independence of thought in the face of huge commercial incentives.”

The collapse of Carillion, including the application of accounting standards which were signed-off by the auditors, suggests criticism about the rules and their application (see, for example, the Financial Times, 18 June 2018) has substance. Further, the recent parliamentary select committee’s report into Carillion’s collapse laments the weakness in the checks and balances on the company shown by three regulators. Criticisms of one, the Financial Reporting Council (FRC), as “chronically passive” and “timid” and requiring cultural change, are requoted in the call for evidence as part of the current review of the FRC.

Cynics might suggest the FRC’s recent findings that the audit quality of the ‘Big Four’ has declined, comes late in the day. The FRC finds a significant number of audits require improvement, not least in the challenge to management and the exercise of professional scepticism. Is the same true of audits in higher education?

What needs to change then – the rules, the auditors or the regulators? Brooks believes the system of setting accounting standards (the rules), the functioning of the auditors and their regulation (the checks) are fundamentally broken. Tinkering will not result in an effective system of audit. The Big Four should be broken-up and their accounting and consultancy services separated – a fundamental flaw is that the auditee pays the auditor. For this to be addressed, auditing should become a public regulatory function funded by taxation/levies. Auditing should be conducted in the public and not the private interest. To create an effective multi-level approach, independent regulation is also required.

How far might some of the issues about audit influence the current revision of the Committee of University Chairs (CUC) handbook for HEI audit committees? Equally, in future, will the competent authority for audit (the FRC) expect more of auditors? Will the regulatory bodies for higher education in the different nations of the UK, require enhanced assurance from the auditors?

Future standards and regulation do not detract from the current need for all institutions to have an effective audit committee. Effectiveness includes ensuring that the external auditors are indeed challenging management, testing key assumptions behind financial forecasts and exercising appropriate professional scepticism.

Auditors are a vital part of the governance system and any suggestion that their work is not effective has to be taken seriously.

Further information for governors about audit can be found via this linkDavid Williams edits Advance HE’s governance pages.

Dates for our governor development programme 2018/19 are now available