INDEPENDENCE: BEDROCK OF THE AUDIT ENVIRONMENT

The European Commission’s Green Paper on Audit Policy has generated much debate. The paper hopes to address apparent cracks in the audit profession, revealed by the 2008 financial crisis. Matters highlighted include expectation and communication gaps between auditors and clients, matters of independence and conflict of interest, and the regulatory burden faced by SMEs.

The greatest interest lies in question 19 of the paper, which targets dual audit and consulting roles of the Big Four. In an article published in the Financial Times, KPMG Global Chairman Michael Andrews vows that the firm will never split its audit and consultancy businesses. Roger Acton, Director of ACCA Europe, describes any regulation meant to downsize the Big Four as inappropriate.

Lessons from the past…

The argument about audit firms venturing in and providing non audit services is not new. Following a previous split the consulting wing in audit firms reemerged in the second half of the last decade. Pundits argue that such a systematic arrangement shakes an auditor’s independence, which is described as the ‘unshakeable bedrock’ of the audit environment. Question is, does it?

Arthur Anderson is accused of ignoring SOS signs in Enron, largely because of the USD $27 million consultancy fees that came with the $25 million audit fees. Consulting does carry with it big numbers to audit firms, and from the management point of view, it would be a bad idea to separate audit from consultancy. From an employee’s point of view, the marriage of the two provides an avenue for exposure and experience. That way, the auditor gets to know how a client can solve her problems, after making recommendations in the management letters. What of the client’s point of view, which is most important. Does he get value when the two wings stay together or when they separate?

The client gets value through audit quality she receives. The audit quality is a function of many factors, including the auditors knowledge, experience and ethical qualities, among them independence. The expansion of services offered by audit firms is part of the natural intellectual progression of man. Auditing is about identifying issues, advisory acts on such issues. To curtail such progress would be inhibit knowledge generation in the profession. It is also logical that the auditor gets greater experience when the firm has both functions than when it has one. What awaits clarification is the independence bit.

Independence; the main issue…

What is an auditor without his independence? Independence is the cornerstone of profession, and auditors themselves appreciate this fact more than anyone else. If there is anything learnt from the Anderson saga, is the bigger one is, the harder one falls. Breach of independence can make giant audit firms fall hard!

For this reason, the audit profession has set for itself robust regulations to ensure that the auditor is not compromised. Among the rules is the categorization of non audit services that an auditor can provide to the audit client and those prohibited. These have been assimilated in national regulations and internal firm mechanisms.

At KPMG, independence is given priority in approving an engagement with a client. Before an audit team goes out to an assignment, the engagement must be run through a global independence database system called Sentinel, and an approval given. The approval procedure is detailed and intensive, taking into consideration the historical and emerging independence issues all around the world. The process is so serious that should the approval process fail, the firm declines to take up the engagement.

The firm also ensures that its people have independent frames of mind. Annually, employees have to take independence tests, to refresh the concept in their mind. Before every engagement, all auditors have to sign an independence declaration form to disclose any matters that could impede their judgment. The firm also has a standing risk management department, which ensures that independence and integrity are always the top agenda of the firm. The long and short is that auditors in the firm eat, drink and sleep independence.

The answer; not to separate…

The auditor therefore has many lines of defense before he loses his independence. Regulations prohibiting provision of advisory services by audit firms with an aim of assuring independence would have little effect on whatever safeguards have been built. On the contrary, the provision of both audit and advisory services by audit firms would ensure increased audit quality, which translates to heightened value delivered to the client. After all, that is what we are about!

Denis Nyanja
Appeared on Msafiri; a KQ publication; December 2011 issue