A global coalition of accounting groups is urging regulators to consider evidence before proposing rules to split audit firms into two camps — those that provide audit services and those that provide advisory services.
Research prepared by the coalition suggests firms that provide both audit and non-audit advisory services have a track record of performing higher quality audits, and do so more efficiently, than audit-only firms because they’re able to leverage in-house multidisciplinary talent.
“The increasing complexity of business and reliance on technology has strengthened the importance of committed and qualified audit professionals and resulted in a greater demand for specialists,” the coalition said in the report it released last week. “Superior audit quality can only be delivered if firms have the best people, services and knowledge at hand, and the multidisciplinary model is one of the best mechanisms to develop the skills, expertise and consistency needed for quality audits.”
Whether audit firms should be allowed to continue providing both audit and non-audit services is an issue that’s coming to a head as regulators consider stepping in with rules to improve audit quality and reduce the potential for conflicts by splitting firms up.
“While splitting firms up sounds appealing, there are some downstream operational aspects that actually could work in exactly the other direction,” Russell Guthrie, executive director of external affairs and CFO of the International Federation of Accountants (IFAC), told CFO Dive. “The evidence says the multidisciplinary firm probably supports audit quality, so taking the counter position could actually lead to an unintended consequence."
Firms can work better and faster if they maintain an in-house pool of multidisciplinary talent because auditors can share in the expertise of specialists, the report found. Services can be expedited, too, because the work doesn’t have to be delayed while outside specialists are vetted for conflicts of interest.
“If it’s in-house, they would already be subject to the independence rules that the auditors are,” Guthrie said. “So, they couldn’t hold shares in audit clients and that sort of thing and all of that would have already been vetted. Any time you reach outside of your firm to bring in a specialist, you have to run that full independent screen. It’s not that it can’t be done, but it’s a bit cumbersome.”
Services included in 'black list'
Audit firms are already subject to restrictions on the type of non-audit services they can provide clients and subject to disclosure rules as well.
In general, any service that puts the auditor in a management role or provides a service that will itself be subject to audit — accounting, payroll, bookkeeping, preparing financial statements, having a say in recruiting senior management, among other things — are prohibited under the profession’s “black list.”
Disclosure rules vary by jurisdiction, but in general, auditors are expected to get buy-in from the company’s audit committee and any fees received for non-audit work are to be included on the company’s financial statement.
Rules already having impact
In part because of the actions regulators have been taking over the years to reduce the potential for conflicts, most firms already split much of their audit work from their advisory work.
Among the Big-4 accounting firms — KPMG, Ernst & Young, Deloitte and PricewaterhouseCoopers — 70% of advisory work is limited to non-audit clients. Only about 10% is done for clients also receiving audit work. The remaining 20% is just audit clients receiving only audit work. The numbers are roughly similar for smaller firms.
Anecdotally, Guthrie said, investors and other stakeholders aren’t clamoring for more regulation in this area.
“At least in my discussions with most business leaders and investors, they don’t perceive this to be a major problem,” he said. “It’s primarily regulators who perceive that these potential conflicts can lead to compromises in audit quality.”
Their argument against splitting up firms isn’t helped by high-profile cases in which the audit firm violates existing safeguards against conflicts.
In September, the Securities and Exchange Commission (SEC) fined PricewaterhouseCoopers almost $8 million for violating auditor independence rules by providing prohibited advisory services to some of its audit clients.
"PwC repeatedly provided non-audit services without having effective quality controls in place for monitoring whether the services impaired its independence on audit engagements and were properly disclosed to audit committees," Anita Bandy, associate director of the SEC's Division of Enforcement, said in announcing the fine.
But in cases like this, the issue isn’t about the adequacy of existing rules; it's about the audit firms adhering to the rules that are already in place. "In one sense, we’re saying the status quo might be adequate," said Guthrie.
In its report, the coalition said the impact of existing rules are already being felt in the drop in advisory work firms are doing for their audit clients. “The non-audit services provided to audit clients is relatively small and is not on the rise,” the coalition said. “In part, this is due to the increasing rules in place that limit the non-audit services that can be provided to audit clients.”
Bottom line, the coalition said, “evidence cited in this paper calls into question the need for sweeping regulatory changes that could have unintended consequences on audit quality.”
The report, Audit Quality In a Multidisciplinary Firm, was released by IFAC, the Association of Chartered Certified Accountants, and Chartered Accountants Australia and New Zealand.