How to audit the auditors still unclear

Ten years after the banking crisis, Kyran Fitzgerald explains why the collapse of the UK-based Carillion Group has once again resulted in external auditors facing increased scrutiny

How to audit the auditors still unclear

Ten years after the banking crisis, Kyran Fitzgerald explains why the collapse of the UK-based Carillion Group has once again resulted in external auditors facing increased scrutiny

This weekend, several hundred people employed on building sites operated by the Longford-based Sammon Group are facing into an uncertain future after the contractor was put into liquidation as a direct result of the collapse earlier this year of the UK-based Carillion Group.

Sub-contractors are also pondering their situation as the ripple wave effects spread out.

Meanwhile, the lawyers sharpen their pens and ready their tongues.

Many more people in the education sector — parents, students, and teachers, woke to discover that brand new schools they thought would open in the autumn will instead be out of bounds for an indefinite period, while the mess is sorted out.

The words Carillion and fiasco are now joined closely at the hip as commentators and politicians survey the wreckage left behind them by a management team which flew liked the fabled Icarus far too close to the sun.

By mid-2017, it was clear that the wings were melting and the group would be soon falling back down to earth with a bang.

Just months earlier, Carillion had reported profits of £150m (€171m) and everything appeared in apple-pie order.

The accounts, after all, had been signed off by KPMG, one of the Big Four firms of accountants.

KPMG was paid £1.5m a year for its auditing work by Carillion.

Another of the Big Four, PwC, acted as pensions consultant.

It emerged eventually that the deficit in the Carillion pension fund had grown massively.

As we approach the 10th anniversary of the collapse of Lehman Brothers and the point at which the true extent of the global financial crash was clear, we were treated to a sharp reminder in the form of a jury verdict in the trial involving former Anglo Irish Bancorp chief executive David Drumm.

Mr Drumm was found guilty of conspiracy to defraud and false accounting. He now awaits sentencing.

The Anglo Irish collapse will end up costing the Irish taxpayer at least €28bn.

Questions naturally have been raised about the firm, Ernst & Young, which signed off on its accounts.

The Irish Bank Resolution Corporation, or IRBC, which took over the failed lenders Anglo Irish and Irish Nationwide Building Society, initiated a lawsuit against Ernst & Young in 2012, not long before IBRC was put into liquidation.

The global crash certainly shone searchlights on the large accounting firms across the globe. Reform of the practices of auditors remains high on the agenda.

Yet the reality is that we had been here before.

Robert Maxwell was left free to plunder the Mirror Group pension fund to the tune of £400m back in 1991. Improvements in corporate governance resulted, but these were clearly not enough.

The collapse of the US energy group Enron, in 2002, created further shock waves.

Closer to home, before the crash, AIB’s financial housekeeping proved repeatedly to be flawed.

Management’s treatment of internal auditor whistleblowers attracted much criticism.

After the crash, further scandals have come to light.

In the UK, shoddy accounting practices at Tesco were highlighted in 2014.

Profits there were overstated by £263m.

The problems persist and new remedies are touted.

Campaigners have favoured mandatory auditor rotation, aimed at tackling overly-cosy relationships between auditor and client, and a break up of the Big Four accountancy stranglehold: The Big Four control 97% of the audit business of UK listed companies.

Other suggested remedies include the overhaul of outside regulation and the introduction of new accounting standards aimed at ensuring more realistic provisions for future losses on loan books.

Auditors are expected to ensure that the accounts of their client are “free of material misstatement”.

They are expected to be on the lookout for signs of fraud.

But some critics insist that unless clients are prepared to cough up more in fees, they should not be expected to engage in forensic accounting which requires much greater resources and expertise.

However, shareholders and creditors beg to differ.

Critics argue that relations between client and auditor are often too long lasting and costly.

The EU has introduced a requirement – which applies from 2020- for companies to change their auditor after 10 years (though there is room for extensions in limited cases).

However, some US experts are highly critical of the idea of auditor rotation, arguing that far from promoting greater objectivity through a refreshing of audit personnel, it will produce the opposite effect.

These critics point out that by forcing audit firms to enter into contests to secure audit business under the rotation, the weakness of the auditor relative to the client will be exacerbated and even more emphasis placed on sales considerations.

Moreover, a new auditor can take years to gain a real grasp of what are often complex client businesses.

Studies indicate that rotation results in increases in audit costs ranging from 20% to 40%, not including the initial cost of tendering for the new business.

Audit reform arguably should go hand in hand with more emphasis on better internal audit controls and improved corporate governance.

Yale University academic Shyam Sunder has, ironically, blamed the upsurge in audit failure on a post-1980 slump in audit prices.

He has proposed an integration of the corporate insurance and audit functions while arguing that taxation and financial reporting should also be integrated.

Others favour stronger public regulation with improved vetting of senior appointments.

Institutional shareholders need to demand much greater financial transparency from stockmarket-listed companies.

Private companies, however, cannot be allowed away scot-free, given the havoc and competitive distortions that can result where work is not properly priced due to sheer incompetence and overaggressive management-led expansionism, as was the case in Carillion.

At the end of the day, one thing is clear: The financial policeman’s lot is not always a happy one.

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