White noise and static is the bane of the radio listener - the hissing sound that distorts and blocks that actual message from getting through. There has been too much white noise surrounding the issue of auditor independence over the past six months and it is probably time for some straight talk.
Debate over the independence of those that sign off a company's books tends to follow corporate collapses because questions are asked about the rigor of the audit process and how an auditor was able to sign off on a set of accounts as being in compliance with the Corporations Law, accounting standards and other professional requirements. This does not mean an auditor is responsible for everything that goes wrong, or that the audit product is infallible. Audit reports tell users that audits are done on a sample-testing basis and in that environment errors can occur. That is a fact seldom mentioned in the general analysis of what auditors do for a living because it is assumed in some circles that an audit is a definitive seal of approval.
Very little is mentioned in the press about the nature of audit and some of the niceties that emerge during the audit process. That side of it might undermine the story some scribes and aggrieved parties seeking some kind of redress appear to be willing to construct. It must be said, however, that audit failures can occur and those would only be weeded out following an in-depth investigation by parties in a position to make a dispassionate and thorough study of circumstances. An early rush to judgment on a complicated maze of events and personalities such as those involved in the collapse of HIH would be imprudent, particularly since a royal commission will sift through the rubble and report comprehensively on the chief reasons for that entity's failure. The circumstances surrounding HIH and the other headline-grabbing corporate calamities remind the business community that certain things are inevitable in environments that are market driven. Business failures are a fact of life. Bad things happen and companies collapse. Auditors are not there primarily to stop bad things from happening although they must assess whether a company is still going to be in business during the next financial year on the basis of the financial result the company intends to report to the marketplace.
Though a necessary part of their role it can be tough for some auditors to question whether a client will be a going concern. Some auditors see it as creating a situation where corporate decline is a self-fulfilling prophecy because they have deemed it necessary to raise doubts about a company's prospects. A little-understood fact is that an auditor audits what he knows from what he is told exists. It is difficult for an auditor to audit things to which they have no access or if the numbers presented to the auditor and they've been the subject of fraud by management. Auditors with a better understanding of the industry in which a specific audit client operates are in a stronger position to ask more probing questions of a client that might uncover problems a less than frank client has tried to conceal. Experts - such as actuaries in the case of general and life insurers - produce reports auditors must consider and question before accepting the conclusions as being reasonable for the purposes of assessing whether a company's financial statements represent a true and fair view as it demanded by the Corporations Law.
These factors might make the auditor's job challenging, but they do not change the core duty of an auditor, which is to ensure the accounts reflect a true and fair view of the entity and to tell shareholders and others when things might not look quite right. The Companies Auditors and Liquidators Disciplinary Board can suspend or reprimand an auditors' registration if the auditor is found to have breached his or her duty under the Corporations Law. It has done so in several cases over the past 12 months - most notably in the case of the 1992 audit of Southern Cross where Andersen partner Stuart Gooley was reprimanded for not following audit procedures set out in professional standards. Professional accounting bodies also have disciplinary measures that kick in when actions of an individual member are breaches of their ethical rules.
Political imperatives?
A real danger of politicians introducing unnecessary regulation in an area that is little understood by the general community exists when the issues of audit integrity and corporate governance become a part of a very public autopsy of a corporate cadaver. Politicians can add to the white noise, the static, that already exists in the community by tackling issues in the public arena and perhaps not stating their case clearly. The Labor Party has already flagged its intention to make auditor independence an election issue. It is a part of their corporate governance policy and it's believed Senator Stephen Conroy, the shadow minister for financial services and regulation, has met with various players within the accounting profession to talk about independence matters. His stance on the SEC rules appears to be more flexible than it initially appeared and feedback from those who have met with Senator Conroy appear confident there is significant scope for a constructive dialogue on the issues.
The Senator's approach to consulting on the issue is decidedly different to that being adopted by the Minister for Financial Services and Regulation, Joe Hockey. Hockey has commissioned Professor Ian Ramsay from Melbourne University to consult with various parties with an interest in the issues surrounding audit integrity. A report is due for completion by the end of this month and the Government will announce any action it intends to take soon afterwards. In a statement to Company Director, the Minister said the role an audit committee should ensure auditors are paid sufficiently to conduct a proper audit of a business. "The audit committee should ensure that the auditors are fairly paid for performing an effective audit," he said. "I don't accept that it is the public interest for the audit fee to be structured as a 'loss leader' being used to leverage the audit into other consulting engagements.
"I also believe the audit committee ought to understand details like the compensation arrangements for their audit partner and decide if they are happy with her independence or whether she is primarily remunerated by cross-selling consulting services."
Minister Hockey said the audit committee had the task of serving investors not management and that the questions surrounding audit independence must be considered both as matters of perception and appearance. "That said the Government is not in favour putting ASIC in charge of audit appointments," he said. "Such a step would unnecessarily confuse the role of ASIC in law enforcement, policy development and interpreting accounting standards." While the major parties appear willing to talk about issues there is another stakeholder that must do more to ensure the community understands the function of financial statements and the limitations on audit reports. The accounting profession has more to do in explaining its stance on matters relating to financial reporting and audit. Little is done in the way of general community awareness other than media appearances by spokespeople. There is probably also a role for the ASIC in any education initiative as well. A lesson from the recent corporate calamities is that all organisations with members involved in any semblance of corporate governance should be prepared to cooperate to enhance investor education in the area of corporate reporting. Only a consistent program of community awareness will help the community better understand what they are reading in annual reports and how much or how little reliance they can place on the documents at hand.
The AICD view
The AICD's policy on auditor independence in summary is that members would prefer to have choice as to how they allocate audit and non-audit work, rather than see it determined by a regulator. How they manage the process should be a matter for individual companies to decide. Directors need to be able to take steps to avoid conflicts of interest in this area. Further:
provided there is a mandatory requirement to adhere to the independence requirements of current ethical rulings and auditing standards, the law should not place any restrictions on an auditor performing non-audit services for a client;
there should be an expansion of current disclosure requirements relating to non-audit services to cover a breakdown of those services and any services provided by entities with substantially the same beneficial ownership of the auditor's firm; and
a company's audit committee should review annually non-audit services provided by its auditor to ensure that the non-audit services do not compromise the independence of the auditor.
For further details e-mail relliott@companydirectors.com.au or see the AICD's revised Audit Committees - Best Practice Guide. For your copy contact your AICD state office.
Disclaimer
The purpose of this database is to provide a full-text record of all articles that have appeared in the CDJ since February 1997. It is aimed to assist in the research and reference process. The database has a full-text index and will enable articles to be easily retrieved.It should be noted that information contained in this database is in pre-publication format only - IT IS NOT THE FINAL PRINTED VERSION OF THE CDJ - therefore there might be slight discrepancies between the contents of this database and the printed CDJ.
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