A year on from the meltdown at Carillion, quite apart from the immense fallout in practical terms, one consequence is that serious questions have been raised about the role of that company’s auditors. The same questions have arisen after almost every subsequent corporate failure the latest being at Patisserie Valerie, where the company’s owners discovered a large hole in their balance sheet just months after the annual accounts were signed off by their auditors. The powers that be have taken notice: the Financial Reporting Council (FRC), which is responsible for regulating auditors, is currently investigating several of the large audit firms involved in recent corporate failures; the Competitions and Markets Authority (CMA) is looking at the dominance of the ’Big 4’ accountancy firms in the UK; and there have been suggestions that the FRC itself may face a shake up.
Clearly auditing has had bad press in recent times; and on the face of it perhaps auditors shouldn’t complain too much that their performance is being scrutinised more closely.
Unfortunately in the public mind all auditors and accountants can be tarred with the same brush. It’s quite common to see people questioning the value of all audits and the reliability of any set of financial statements. That isn’t a new situation and one of the reasons for this is that there’s something of a misunderstanding regarding the actual role of ’auditors’. There’s been an ongoing debate as to how much suspicion an auditor should approach any audit with and indeed the whole purpose of the audit in the first place.
For a long time that purpose was accepted as being to allow the auditor to express an opinion as to whether the financial statements showed a ’true and fair’ view of the activities of the business during the period they covered. Those statements were expected to be used not only by the owners of the business but by third parties to allow them to see the health (or not) of the business before engaging with it. Of course, the auditor was supposed to be an outsider independent of the business or its managers and work according to recognised standards. Over time, however, both the owners and the senior management of those businesses found that audits brought other benefits. In simple terms, the owners came to rely on the auditors checking that the management was acting correctly, and the managers to rely on the auditors to discover whether any more junior employees were doing anything wrong.
And so it came to be that for many years the annual visit of these outsiders with supposed powers to ask any questions and look at any records inspired trepidation among staff. In reality audits did uncover many instances of financial malpractice within businesses. But an important benefit of the audit was that having outsiders looking at the business processes often led to the discovery of glaring inefficiencies or potential risks which were either invisible to ’insiders’ or which were left because "that’s how things have always been done, and we don’t know how to change them". In other words, what later grew to become ’management consultancy’. Some believe that’s where the current problems with auditors started. Those independent outsiders and company management realised that there were lucrative benefits to each from this ’systems analysis’ and resulting ’change-management’. The outsiders spent more time inside each business and could suggest radical improvements which they then offered to help implement for the managers. And the managers could always blame the consultants for unpopular or disruptive changes.
This happened at a time when technological change offered never-ending opportunities for more ’consultancy’ and so the distinction between independent auditors and management consultants became blurred to the point of invisibility. It was also a time when auditors, who used to face unlimited personal liability for any failures in their work, were allowed to hide behind limited-liability arrangements.
It’s easy to be over-cynical about the state of ’auditing’. Certainly the role does need to be reviewed but nobody in any business should forget the genuine benefits of having experienced, impartial professionals come into their business with an outsider’s eye once a year.
A good audit isn’t just about approving the accounts, it can highlight issues that owners and managers need to address and then pay for itself very quickly.