Reputation of auditors takes further blow

Following the sharp criticism of three of the "Big Five" accountancy practises - PricewaterhouseCoopers, Ernst & Young and KPMG - by the Public Accounts Committee (PAC), the reputation of auditors has been further sullied. That unfairly tarnishes the whole profession as the majority of auditors are vigilant and carry out their duties to high standards.

But auditors are meant to be watch dogs. And when they end up having a cosy relationship with their clients, they can quickly turn into puppies eager to please their masters.

This cosy relationship can exist if the audit firm remains unchanged for a long time, or if the audit firm is placed in a potential conflict of interest by having a dual role of auditor and provider of accounting services. The PAC was right to try and address these potential problems. It has done this by making ten recommendations to be addressed by a review group to be set up by the Department of Enterprise, Trade, and Employment.

These are directed at financial institutions but most of them could equally be applied to publicly quoted industrial groups. Four of these would involve fundamental changes and should be seriously considered. The first two address the one broad issue and are also the most contentious. The PAC asks if accountancy firms appointed to undertake an external audit should also provide other services. And it further asks if the provision of services such as tax and consultancy compromises the auditing function. Those in favour of retaining the status quo could argue that the audit firm has an intimate knowledge of the company, so it knows what to look for. This would also be helpful if the audit firm does outside work such as due diligence when a takeover is involved. However, if the audit firm puts in an accounting system, how can it question that system? Accountants should not place themselves in that position of self-review.

The provision of services other than auditing can be substantial. But this regrettably is rarely quantified by publicly quoted companies which tend to only reveal audit fees.

The Bank of Ireland does give a breakdown which demonstrates the importance of non-audit fees to accountancy practices. Its payment of audit fees amounted to £1.3 million last year which was dwarfed by non-audit work of £3 million. Some European countries, such as France, Belgium and Greece, consider the separation of the two roles an important issue, and prohibit an audit firm from doing the two jobs. Prohibition, however, could lead to higher audit fees as some accountancy firms may be tempted to tender at a lower rate for the audit in the hope they would get the non-audit work.

The third recommendation involving fundamental change is the proposal to have joint auditors to financial institutions, one of which would be appointed by the Central Bank. It is mandatory in Denmark and in Sweden (if 10 per cent of the shareholders want it) and is in practice in the UK. This makes a lot of sense as it would be an added protection for bank customers and shareholders but audit costs would be higher.

The last recommendation requiring fundamental change is the proposal that an auditor can only serve for a maximum of five years and after that a new audit firm has to be appointed. The Institute of Chartered Accountants in Ireland (ICAI) has a ceiling of seven years for an audit partner but that does not rule out a continuation of the audit by the same audit firm. It is a desirable proposal but audit fees are likely to be higher as the new auditors familiarise themselves with the new client.

The recommendations were made because PAC found there were a number of serious defects and weaknesses in connection to the statutory external audit function "which contributed to the continuance of the bogus non-resident problem". Following the secret hearings held in connection with the Beef Tribunal which noted the auditors obligation should be extended to informing the Revenue Commissioner in cases of tax evasion, the ICAI has been moving towards greater transparency.

This is demonstrated by the Blayney inquiry into possible breaches of the institute's rules, and the inquiry, headed by Mr Laurence Shields, a former president of the Law Society of Ireland, into the financial debacle at Powerscreen International. However, the very valid issues raised by the PAC should be addressed with urgency.

Bill Murdoch can be contacted at bmurdoch@irish-times.ie