business with confidence icaew.com research with ftse100 audit committee chairs prepared by...

BUSINESS WITH CONFIDENCE icaew.com

Research with FTSE100 Audit Committee Chairs

Prepared by Brunswick Research

The Future of Audit


Copyright © ICAEW 2011. All rights reserved.

Audit in general



Audit in the UK is generally held in high regard

• Audit in the UK is “fit for purpose” – given the stated purpose of an external audit

– Remit is (necessarily) tight; limitations should be considered in this light

• Industry generally considered highly expert and professional

– UK audit and auditors are widely considered best in class

– Profession attracts top graduates; senior people are highly respected

• Some express concern (e.g. relating to AIU reports)

– Generally individual not systemic failings

• Concern that audit purpose is poorly understood beyond the worlds of business and finance



Areas for improvement

•Auditor-client relationships can appear too “cosy”

•In an ideal world, the majority would like to see more than just the Big Four

•More transparency around audit is generally considered desirable, but must be balanced with the requirement to protect commercial sensitivities

•Improve understanding of external audit’s function

Independence

Competition

Greater transparency

Communicating purpose



Perception that proposals are based on a flawed premise

• Case for reform has yet to be made convincingly

– Not felt to be any clear evidence that fundamental issues relating to audit either precipitated or accelerated financial crisis

– Proposals designed to solve a different problem (what happened in ‘08)

• Issues relating to audit are being misread as symptoms of a fundamental problem with audit quality

– Majority of ACCs strongly refute this

• Strong disagreement with the Commission’s line of argument means ACCs often struggle to see merit in proposals

– Other areas (e.g. accounting standards) more in need of reform



I think this Green Paper is trying to correct a

wrong that doesn't exist. I think that's the bottom

line here. We – certainly in the UK – have a

broadly sound system which occasionally

doesn’t perform quite as well as it should.

The credit crunch had nothing to do with the

auditors, it was not an audit issue.



Fear of adverse effects on audit quality • Widespread belief that proposals will not positively impact the

issues they are designed to address

– e.g. Will rotation genuinely increase competition?

• The law of unintended consequences

– Proposals may have a detrimental effect on audit quality

– e.g. Audit-only firms would struggle to retain best people

• A minority are supportive of significant change to system

– Serious issues which should be confronted – regardless of motivation



Remit of audit committees



Remit has changed and expanded

• General increase in committee activity

– Crisis has put financial reporting in the spotlight

• Outside FS, greater responsibility for (financial) risk management

– FS has seen formation of separate risk and audit committees

• Enhanced quality and “professionalism”

– Greater financial experience and expertise; more detailed reporting

• Increased demand on AC members’ time– Committees becoming less attractive



(Re)defining audit committee responsibility

• Consensus that the committee’s role must be clearly delineated

– Strategic risk, business model and signing off the annual report (are and should remain) the remit of the main board

– Financial reporting is still main responsibility

• AC must report effectively into main board, not oversee it

– Oversight of company processes – not implementation

– E.g. ensuring correct risk management processes are in place – not delivering risk management

• “Mission creep” risks muddying waters

– Off-putting in terms of extra time required



Increasing openness is a balancing act

• Transparency is important, but its utility must be clear

– Many ACCs feel they detail “discharge of responsibilities” already

• Additional reporting at risk of being boiler-plate

– More data/verbiage does not necessarily equal better understanding

– Danger of information overload (with 200 page annual reports)

• Reporting of internal discussions could reduce effectiveness

– Confidentiality enables frank debate; issues would be taken offline

• Additional reporting needs to add real value



I think a lot of the reporting we have today ends

up giving less information than it does giving

more information. There's a lot more pages, but

do people understand what they are reading?

If the dialogue between the auditor and the audit

committee was published it would naturally

reduce the openness and honesty of that

conversation.



Independence



Independence divides opinion

Minority view

•Fee structure creates doubts: paying for an independent opinion

•Different world post-Enron

•High margins on non-audit

•Reassurance always needed

•A long-standing concern

Majority view

•Huge incentives for firms to ensure independence

•Existing safeguards work well

•Audit/non-audit fee ratios are published

•Not big issue for investors

•Independence has improved

•Partner rotation reinforces independence

Serious concern

Nothing major



Non-audit services: a thorny issue?

• Recognition this can be cause for concern

– Committees exercise tight grip on commissioning non-audit services

– Set percentage of audit fees; key aspect of oversight role

• Non-audit often broken down: audit-related and pure non-audit

– Non-audit consultancy work often out of question

– Audit-related activities can be a grey area

– E.g. “treasury-related” areas, regulated financial returns, due diligence around M&A, tax compliance, stock exchange confirmations

– Auditor can be preferable: more efficient and minimal risk of conflict

• Majority against complete prohibition, but backed by minority



We don't give work to our auditor unless there

is a very clear-cut reason why the auditor, as

auditor, would be able to do a cheaper, more

efficient, higher quality job.



Audit-only firms would drive down quality

• Multi-disciplinary firms have number of benefits

– Range of experience and expertise; exchange of ideas

– Importance of firm’s reputation helps “guarantee” audit quality

• Concerns that audit-only firms would fail to attract the best talent

– Multi-disciplinary firms offer variety of training and opportunities

– Staff retention could suffer

• Fears that top firms would exit audit market altogether

– Non-audit is considerably more lucrative

• ACCs do not see any real reason to implement the proposal



You will not get the brightest joining those

firms, and you won’t get quality as a result.



The audit market



Size of market has reached lower limit

• Majority feel there is a choice within Big Four – but not beyond

– Few would argue against more competition; delivering it is the issue

• Ideal is for Group A to become more competitive at FTSE100 level

– Perceived to lack necessary size and scale – and perhaps the desire

• Concentration is not ideal, but understandable

– Big multinational businesses need big multinational auditors

– In any particular sector, businesses want sector expertise

• A Big Three would create serious difficulties and lack of choice

– Potential conflicts arise around M&A already



Experience of tendering (as chairs) is low

• Cost, complexity and satisfaction explain low tendering rates

– Businesses need a compelling reason to go out to tender

– A last resort when quality is in question

• Confidence in ACs’ annual review of external audit

– Benchmarking vs. peer group

– Audit Inspection Unit reports widely used; scope could be increased

• Mixed experiences of tendering process– Some highly positive: rigorous and effective

– Others comment on lack of choice, if any of the Big Four don’t contend



I think there is just enough choice…If a major

firm fell out, went bust or something like that, it

would be a significant problem.

I'm a proponent of tendering, but I haven’t

done it for any of my companies recently,

instead [we’ve] gone through processes to

look at the incumbent, and whether or not

they’re up to scratch.



Mandatory rotation divides opinion

• Many vehemently reject the proposal

– Downsides: costly, time-consuming, loss of institutional knowledge

– Concern firms would “ease up” towards end of appointment period

– Reduces role of tender as “last resort”

– Query whether it would open up the market or increase choice

• Others recognised challenges, but were much less sceptical

– Sends out the right message

– Help to break up “cosy” relationships; would sharpen industry up

• Some improvements suggested

– A mandatory rotation period, rather than a fixed time limit



Mandatory tendering least objectionable

• More openness than to other proposals

– Leaves selection decision to the client

– Increase competition between firms

– Potentially less disruptive

• Also attracted criticisms

– Risk of being a “charade”, but with added expense all round

– Costly and time-consuming

– No guarantee it will increase competition

• Most comfortable with “comply or explain” basis



I am not quite clear whether, when they talk

about independence and rotation, they're

trying to move this audit between the Big

Four, or they want to bring other players into

it.

I personally would think that mandatory

tendering as opposed to rotation is adequate,

but would I throw up my hands in horror at

mandatory rotation? No.



Serious concerns relating to joint audits

• Costs generally perceived to far outweigh the benefits

– Quality concerns: logistical issues and risk of error are major fears

– Concern auditors would struggle to work effectively

– Lead to increased cost and work-load

• Few positive exceptions

– Increased exposure and opportunities for smaller firms

– Works in other countries (though some dispute this)

– Many remain uncertain about the benefits



There's a massive chance of miscommunication.

There's probably one and a half times the

amount of work for a finance department to deal

with because it's dealing with two companies. I

can see no upside in it at all.



Future directions



Considering change

• Majority feel the system works well, and question rationale behind the reforms

– However, ACCs would adapt to the change

– But major fears around the knock-on effects of the proposals

• ACCs feel it is important for regulators to…

– Recognise inevitable limits and limitations of external audit

– Understand the AC’s role must be clearly delineated

– Investigate potential negative effects on quality

– Look at accounting standards rather than audit quality



Implementing change

• Openness for incremental change

– ACCs most open to rotation or re-tendering

– Consider increasing third party/peer review of audit practices (e.g. AIU)

– Support for greater transparency and communication on process

– Emphasise role and importance of partner rotation

– Very little perceived upside in joint audits

– Strong opposition to audit-only firms

– Priority is to increase competition from Group A firms

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