Select Committee on Treasury Appendices to the Minutes of Evidence


Memorandum submitted by Mazars Neville Russell

  We are sure that many commentators have made the point that the Enron collapse occurred in the United States and therefore took place under very different standards and regulations from the United Kingdom. Much comment in the public domain is of course ignorant of this fact. In the public interest however, it seems appropriate to be seen to examine the system of regulation here to ensure that we are taking all reasonable steps to "prevent another Enron".

The setting of accounting and auditing standards and their application

  We do not perceive substantial gaps in standards in place. There is a mature, authoritative standard setting process in this country and we believe that this process has earned the respect of those who are required to follow the standards. In setting standards, sight has not been lost of the importance of judgement and of "substance over form". We believe that this environment, as opposed to a detailed rules based approach, gives us a firm foundation for the preparation and auditing of financial information.

  The Financial Reporting Review Panel ("FRRP") examines apparent departures from the accounting requirements of the Companies Act 1985, including applicable accounting standards, and if necessary seeks an order from the court to remedy them. Preparers and auditors seek to learn from the decisions of the FRRP in exercising their professional judgement. However, this body is clear that it "does not make general statements or offer advice on the application of accounting standards or the accounting requirements of the Companies Act 1985". Maybe it, or a similar body, should provide this service in addition to threatening a rap on the knuckles retrospectively.

  We have seen little recognition by commentators of just how complex financial reporting standards have become in recent years. Company directors increasingly rely on their auditors to help them in applying new standards. It is worth exploring the merits of providing all concerned with an additional independent viewpoint prior to financial statement publication.

Competition in the audit market

  Shareholders should have a genuine choice of service providers. In any marketplace a limited number of dominant players is not good. It does not drive competition in standards, service levels or technical excellence and can engender complacency and create a set of audit standards that are not sufficiently challenged.

  As greater competition is good for the market, clients and investors alike, each of those groups should recognise that they need to take a long-term stance in order to encourage competition into the market. There have been various suggestions as to how the market can create more competition, for example:

    —  adding an Audit Commission-style layer of regulation into private sector audit;

    —  audit rotation.

  We do not believe that there is sufficient support for the forced regulatory approach of the first of these and we fear that the second suggestion is fundamentally flawed. Such a system could seriously affect an auditor's judgement in different ways depending on the point in the period of the audit appointment. In addition, research suggests that "audit failure" is more likely in the first year that an auditor is appointed when business knowledge is still being accumulated.

  At Mazars Neville Russell, we strongly believe that introducing a system of joint audit to the UK market would go a long way towards solving the epidemic problem of competition. Joint audit is a system in which each publicly listed company is compelled to have two professional firms audit its accounts. The firms audit different aspects of the company but both firms take joint responsibility for expressing the audit opinion. Having two sets of auditors means that one can support the other against a client in those unusual but high-risk situations where the client is taking an unnecessarily aggressive approach in its accounting policies.

  In the long-term, joint audit guarantees the standards of objectivity, independence and excellence that the capital markets need to maintain their credibility. In the short-term, joint audit enables new entrants into the marketplace because mid-tier firms are able to work alongside "Bigger Four" audit firms, as is the case in France. This may look like a way of putting more cost into the audit process for businesses, yet the benefits revolve around the protection of shareholder and stakeholder interests.

  Joint audits should be introduced and encouraged to demonstrate rigour, independence and encourage market competition with new entrants in to the listed company audits market. This is particularly relevant post Andersen.

Provision of other services

  The argument is that under the current system, an audit firm that derives a substantial amount of business from both the audit and the other services it provides may be less challenging in the audit process.

  We admit that the audit profession as a whole has done a great disservice to the value of audit by using it on too many occasions as a loss-leader to gain access to lucrative consulting contracts or other non-audit services. This approach has had an inevitable knock-on effect among clients, many of whom have been led to believe that the cost of an audit is a necessary, regulatory evil and that value-for-money equates to obtaining the cheapest credible service available on the market.

  We would like to share with you two actions that we have taken in our firm that we would commend to others:

    —  Taking away from the appraisal system judgements that reward audit partners for selling non-audit services. By switching audit partners' attention from generating fees for other service areas, they focus on the quality of audit work and the competencies and standards that go with producing a quality audit. Ultimately, how audit partners are appraised has got to tie in to how they are rewarded as individuals and this, in turn, has to be built around the kind of outputs audit firms want and that the investment community needs.

    —  Fostering lifelong audit training. The accountancy profession has moved away from specialising in audit as it has added new branches of consultancy to its service offering. We have reached a stage in many firms where auditors are not trained and valued as specialists and where those working in accountancy firms have seen their audit training as a means to an end, rather than as something that is preparing them for their chosen specialism over the long-term. We still believe that audit is our firm's core specialism and we expect people to maintain their specialist skills.

  The regulators of the profession need to make it clear that these sorts of actions are expected.

  Also with regard to ensuring the quality of audit, we support the initiative of the International Federation of Accountants (IFAC) and the Forum of Firms and their proposal to introduce an international peer review and establish consistent audit standards world-wide. We are playing our part in this initiative and we hope that the doubt cast on the peer review system as it works in the USA will not cause this international initiative to falter.

Corporate governance

  As part of an effort to encourage improved corporate governance, IFAC has set up a task force to make recommendations on the role and composition of audit committees and how they should report to shareholders. Although much has been written in the past about audit committees in terms of how they should be set up and what they might discuss, there has been little real practical help for committee members on how to assess the quality of the audit work performed. There is scope for a UK initiative to build on what IFAC produces if it does not itself meet this need.

  Risk reporting has had its profile well and truly raised by Turnbull and others but we would question whether the public reporting of risks has substantially improved. When financial statements have been prepared and audited directors and auditors should be satisfied that the investors have the information they need to make a realistic assessment of the risks attaching to their investment. Current regulation would allow much still to be hidden.

Company law review

  There is much that is to be welcomed proposed in this review and we would urge government to speed the process of this review as much as possible. We understand the complexity of the legislative process but suggest that increased resource needs to be applied to this project to modernise our company law.

  We hope that these few comments are of interest and assistance to the committee. If clarification of any point would help them please contact Kim Hurst, the firm's audit compliance partner, in the first instance.

21 June 2002

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