The financial crisis that rocked the world in 2008 resulted in most companies declaring huge losses on their financial statements between 2008 and 2009 and this has generated a lot of debate on how to stabilise the financial systems. While the role played by banks, hedge funds, rating agencies, supervisors or central banks has been questioned and analysed in depth in many instances, the role played by the audit profession has not been left behind.
In the wake of the financial crisis, The European Commission's Green Paper on Audit Policy, questions whether the role of auditors can be enhanced to mitigate any future financial risk. The commission recognises that audit, alongside supervision and corporate governance, should be a key contributor to financial stability as it provides assurance on the veracity of the financial health of all companies. This assurance should reduce the risks of misstatement, and in doing so, reduce the costs of failure that would otherwise be suffered by the company's stakeholders as well as by the broader society. Robust audit is therefore key to re-establishing trust and market confidence by offering an opinion on whether the financial statements of an entity give a true and fair view. Given this societal role, the independence of auditors should be “the bedrock of the audit environment”.
The Commission through the paper hopes to address apparent loopholes in the audit profession, revealed by the 2008 financial crisis. Matters highlighted include whether an audit provide the right information to all "financial actors'' matters of independence and conflict of interest, and how best the specific needs of small and medium-sized businesses might be met.
Greater interest lies in the question whether or not audit firms should engage in advisory services. 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.
The argument about audit firms venturing in and providing consulting 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 receiving more revenue from consultancy fees than 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 their problems, after making recommendations through management reports. What of the client's point of view, which is most important? Does the client get value when the two wings stay together or when they separate?
The clients get value through audit quality they receive. 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. To curtail such progress would 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.
What is an auditor without his independence? Independence is the cornerstone of the auditing profession, and auditors themselves appreciate this fact more than anyone else. If there is anything learnt from the Anderson saga, is that, 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 that are prohibited. These have been assimilated in both the national and global regulations implemented by the firms.
At KPMG, independence is given priority in approving an engagement with a client. Before we accept an engagement the team must go through comprehensive global approval processes. The approval procedure is robust, and takes into account 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 compromise their independence. 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 KPMG eat, drink and sleep independence.
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 do at KPMG!
Wiennis Nyanja (firstname.lastname@example.org) is an auditor at KPMG Kenya.
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