How are the big auditors audited?

The Audit Inspection Unit oversees the big four accountancy firms

The Audit Inspection Unit oversees the big four accountancy firms, but is it going about its job correctly? Peter Williams explains

Auditing is all about judgement, as is deciding whether an audit has been good enough. Until now there has been no mechanism to find out what sort of job auditors are doing. The only system was the blunt weapon of litigation. But the failure of Enron and others has put in motion a series of reforms, including a shiny new monitoring system for the audit of UK listed companies.

The Audit Inspection Unit (AIU) is part of the Professional Oversight Board for Accountancy (POBA). In reality, the unit focuses on the quality of auditing by the big four firms because they audit virtually all FTSE-350 companies and nearly 83 per cent of all listed companies. The AIU’s first verdict is a definite “could do better”.

All this must be a culture shock to partners in the big four firms, who are used to having to convince just the financial director and one or two partners that they made the right call.

A quality audit has two outputs. One is the right audit opinion to shareholders, which is independent and supported by sufficient audit evidence and objective judgements, and the other is a “complete and appropriate” report to those in charge of governance.

Auditors have always hated the idea of partner rotation and fought to keep the same audit partner on the job for as long as possible. They don’t see the dangers of the long-serving audit partner going native.

Firms are still not documenting their work properly. Auditors find it hard to commit to paper how and why they reached their conclusions.

The AIU was so concerned by two cases of non-documentation that it referred them to the Financial Reporting Council’s Financial Reporting Review Panel to ascertain whether they complied with UK Generally Accepted Accounting Principals. As only 27 audits were reviewed by the AIU, that’s a high doubt rate. In fact, so poor was the written evidence provided by the firms that the AIU frequently had to go and ask partners how they had come to their conclusions.

Assuming no sinister motive to this lack of written audit evidence, it is hard to see why firms record the reasons for their judgement so poorly.

There are two possible explanations. First, the decisions are made in meetings where it is hard to make full and accurate notes – a rather lame excuse. Second, and more likely, is that decisions are made when deadlines are looming and the audit team is running out of time. At some firms the sign-offs to evidence completion and clearance of review points were sometimes dated after the audit report was signed. That is not in the procedures manual.

Reporting to audit committees is ropey. On some audits, key accounting policies were not discussed in sufficient detail with the audit committee. In some cases not all unadjusted audit differences were notified to the audit committee.

The AIU is satisfied there are no systematic weaknesses in the overall policies, procedures and systems of quality control operated by the big four. But it is clear that there are serious issues of quality. The AIU is a typically British solution. Its approach contrasts sharply with the US Securities & Exchange Commission’s naming, shaming and fining of recalcitrant auditors.

As POBA chairman Sir John Bourn noted: “Where the firms do not follow their own procedures, they expose themselves to risk that future audit opinions may not be appropriate.” It is a judgement that the big four auditors would do well to heed.