Auditors: Market concentration and their role - Economic Affairs Committee Contents

Letter from the Institute of Chartered Accountants in Australia (ADT 23)

  The Institute of Chartered Accountants in Australia (Institute) is pleased to have the opportunity to respond to the above Call for Evidence. The Institute is Australia's premier accounting body, which represents over 50,000 professional accountants. Our members work in diverse roles across public practice, commerce, industry, government and academia through Australia and internationally.

  The Institute is a founding member of the international accounting coalition called the Global Accounting Alliance (GAA), which provides reciprocal arrangements with ten of the other leading accounting bodies in the world. The Institute is the only Australian accounting body within the alliance. The GAA represents more than 778,000 members world-wide and includes professional accounting organisations from America, Canada, Hong Kong, England/Wales, Ireland, Scotland, Japan, Germany, New Zealand and South Africa.

  We have limited our comments in this response to the issues and questions where we believe we can substantially add to the richness of the evidence and to provide a non-European perspective. We have not reflected on many of the questions relating directly to the banking crisis of 2008. Australia was at the periphery of the crisis but did feel the waves of impact primarily through fragmentation of the global funding markets. Our banking and financial systems served us well during the crisis.

  The scale of international financial market activities has grown substantially over the last 10 to 15 years. In particular the growth of cross-border financial activity is even more rapid—international capital flows have been increasing at over 10 per cent a year over the last 15 years. As business and the financial markets have grown and become more international there has been a strong desire from parts of the business community to have one audit firm—across many jurisdictions—meet their needs. This desire has been a strong incentive to some firms to continually build their global size.

  In setting a context for our response, we wish to outline three particular themes which we believe are important to consider:

    — Future of Audit—the global events of recent years have shown that there is more work to be done by all stakeholders to contribute to identifying, analysing and responding to "systemic risk". Systemic risks stem from the size and complexity of institutions and their relationships with other parts of the financial systems. Many and varied proposals about systemic risk have been brought forward. An auditor's current practice with its clients is to identify risk within the company. However it can be seen looking forward that there will be much greater emphasis at country level as well as industry and company level on business risks. Auditors are well placed to be involved with the reporting on risks to the business model and the potential for that model to fracture.

    — Continuous Assurance—enabling technology now permits business to be conducted 24 hours a day, every day of the year. While this dramatic change has occurred in the business environment, the financial reporting and assurance model continues to focus on the past, reporting in accordance with a historical financial reporting framework. In our view there is merit in exploring changes to this model to permit "closer to the event" assurance in order to align the assurance model more closely to the business model. The term "continuous assurance" is used to describe such a model. It may well be that this type of assurance is complementary to, but does not replace the current historical financial reporting framework. We attach a copy of our recent thought leadership paper on continuous assurance.

    — Audit Quality—Shareholders, company directors, audit committee members, auditors and regulators all agree that quality external auditing is fundamental to capital market confidence. In just a few years the concept of audit quality has evolved from being a relatively static concept, loosely discussed and poorly acknowledged to having "real" substance and understanding. The pace of evolution of Audit Quality is accelerating and there are great opportunities for the audit firms and professional bodies to influence the ongoing enhancement for the benefit of all. For example in recent years there has been significant work in clearly understanding the drivers of audit quality. That work is then used by participants and stakeholders with the common goal of continuing to improve audit quality. We produced The Benefit of Audit—A Guide to Audit Quality based upon the drivers to enhance communication (in plain English) between the audit committee and the external auditor—it has been well received. We attach a copy of our Guide.

  Australian Treasury noted earlier this year that our audit regime compares well with international best practice and that the audit regulatory framework appeared to be functioning effectively during the current uncertain economic conditions. We believe that the above three themes are of sufficient importance that we will be investing substantial resources in their further development.

  Finally, in presenting an Australian perspective, it is important to recognise the presence of Professional Standards Legislation in our regulatory framework that places limits on the liability of auditors. This is important in keeping audit attractive to providers, because of its impact on reducing the incentive or the need for auditors to exit public practice, as well as reducing the barriers to entry. It is also an essential driver of overall audit quality and in ensuring that the market continues to receive quality audit services.

September 2010


1.   Why did auditing become so concentrated on four global firms? For example, do economies of scale make it too difficult for smaller firms to compete?

  The emergence of four major audit firms over the last 10 years is due to a number of factors. Firstly the increasing globalisation of business and clients' preference for engaging one firm of auditors in all the jurisdictions in which they operate. Clients do value all of their operations being subjected to independent external audit using the same approach and methodology. The globalisation of business has also led to dominance of certain providers of other types of commercial activities—outside of auditing—such as investment banks.

  Secondly the rapid demise of Arthur Andersen in 2002 left a considerable limit on audit firm options.

  Thirdly the ascent of significant engagement and public commentary by audit regulators has led to some rationalisation of audit providers. Some practitioners in Australia have considered it more beneficial to change their business models to move away from auditing services to the delivery of other types of accounting services. We have seen a contraction in the Australian market of audit firms and registered company auditors.

  However, the first question being asked could infer that only the four major audit firms are capable of servicing multinational clients. The Institute's experience is that this is not the case, and many firms other than the four majors can, and do, provide quality auditing services to multinational clients.

2.   Does a lack of competition mean clients are charged excessive fees?

  Whilst the Australian listed market's audits are dominated (by market capitalisation) by the four major firms there are approximately 100 different audit firms currently engaged with a listed client. There is not a lack of competition amongst audit firms in Australia. There is strong contest around audit and current evidence showing aggressive fee reductions to encourage clients to change auditors or incumbent auditors to retain clients.

  This strength of fee competition has recently led our audit regulator to take certain actions to preserve the delivery of quality auditing. The Institute has warned our members that audit files of entities which have changed auditors and where a substantial fee reduction is evident, will attract closer scrutiny under our quality review program to ensure fee reductions do not lead to a reduction in audit quality.

5.   What is the role of auditors and should it be changed?

  Notwithstanding many years of work on the clarity of communication, the role of external auditors in general is not well understood by many stakeholders—even by groups who have regular on-going contact with their auditors. The "expectation gap" ie the differences between what auditors do and what stakeholders perceive they do is very much alive—and potentially growing wider. The statutory audit report—a primary output of an audit—is important to stakeholders in terms of the fundamental assurance it provides, enhancing the credibility of information reported on. However the current model of audit needs to change and expand. Part of this change lies in the general annoyance that audit is seen to be only focused on the past and "why didn't the auditor see this beforehand?"

  The role of the auditor has been, and continues to be, to provide an independent professional opinion on whether the financial statements of the entity present fairly the entity's state of affairs and financial results for the period. The financial position and operating results directly reflect the results of the decision of management and the Board of Directors of the entity.

  We believe that the role of the auditor should be expanded to focus on:

    (i) the reporting of risks to the business model and

    (ii) "closer to the event" assurance.

  We have outlined these themes in more detail in our opening comments to this response.

7.   What, if anything, could auditors have done to mitigate the banking crisis? How can auditors contribute to better supervision of banks?

  As mentioned above, it is not currently the responsibility of auditors to assess and report on risks to the business model. That area has clearly been the responsibility of the entity's Board of Directors and management. However if that role of the auditor could be expanded we believe that it would assist with the identification of systemic risk and the supervision of the banking sector.

10.   Do conflicts of interest arise between audit and consultancy roles? If so, how should they be avoided or mitigated?

  Conflicts of interest can arise between audit and consultancy roles being performed by the same audit firm. The conflicts could be real or perceived. However the main issue here is how the firm and individual practitioner identify and responds to those conflicts.

  Our members of the Institute are obliged to comply with the IFAC Code of Ethics for Professional Accountants. The Code is principles based and adopts a "threats and safeguards" approach to potential conflicts of interest. There are a range of responses that a firm may use with different circumstances including not accepting work or terminating an engagement if a conflict arises. Furthermore, some jurisdictions have prohibited specific activities or relationships which are considered to impair auditor independence.

  In Australia the Corporations Act 2001 prohibits audits being undertaken where certain conditions are present.

  With the increasing focus on conflicts of interest, audit firms have invested heavily in developing systems, policies and processes to record and identify any potential conflicts of interest. They also have well developed approaches to responding once a conflict is identified. Also with the ascent of audit regulators in recent years, a considerable amount of their work has been focused on understanding how the independence of audit services is delivered and the focus on conflicts of interest. All of these initiatives have added greatly to managing conflicts of interest.

  Also we would bring focus onto the important role that the Audit Committee has to play in monitoring any non audit services that may be provided by the auditor's firm and determining whether there any threats to the independence of the auditor. The Audit Committee must work with their external auditor to ensure that conflicts of interest—real or perceived—are managed appropriately.

12.   Should the role of internal auditors be enhanced and how should they interact with external auditors?

  The role of internal audit is an essential contribution to the accountability and governance arrangements of a company. It plays an essential function of being "the eyes and ears" for the audit committee. Our analysis shows that there are a number of areas of better practice in the way internal audit operate and those should be further developed and adopted. For example the reporting lines for internal audit should be appropriate and there should be clear alignment and integration with risk management practices.

  Also the role of the internal auditor could become even more effective if the current reporting and assurance model is supplemented by closer to the event assurance. Our thought leadership paper Continuous Assurance for the Now Economy, suggests that:

    ". . . the emerging field of Continuous Assurance attempts to better match internal and external auditing practices to the reality of the IT-enabled entity in order to provide stakeholders with more timely assurance." The paper further suggests that most large organisations have several audits (internal, fraud, compliance, quality assurance, Basel II) which often have different structures and platforms and do not share findings. "Rationalisation of these audit-like functions, closer coordination and technology integration with external audit, and common platforms for audit/compliance, etc would create efficiencies and substantial improvement in the handling of risk."

  As more experience is gained in closer co-operation it is likely that the audit model will evolve to extend reliance on the work of internal auditors in certain circumstances.

  We believe there is great benefit in exploring this thinking for the role of internal audit further.

13.   Should the role of audit committees be enhanced?

  An independent audit committee is a fundamental component of a sound corporate governance structure. Importantly it brings together in one place non-executive directors, management, external audit, internal audit and advisors. The role of the audit committee has evolved significantly in the last 10 years and will continue to evolve. It has moved from being a fairly limited function primarily focused on the completion of the audited financial statements to a much broader and integrated focus of responsibilities. Drivers of this evolution include regulatory expectations, market expectations and better practice initiatives members and auditors gain in closer working relationships.

  We believe that further enhancements can and should be made to the role of the audit committee. An essential element of the audit committee's role is to interact effectively with the external auditor towards obtaining a quality audit. In order for this to happen the audit committee needs to be equipped to understand what a quality audit entails and to engage with their auditor meaningfully. We are assisting with this goal and have a range of initiatives underway to assist the director and audit committee community. To support these initiatives we have used The Benefit of Audit: A Guide to Audit Quality.

  We also believe some further analysis needs to be undertaken about potential "barriers" to effective audit committees and how those barriers may be overcome. This could include what potential changes could be made to the law (if any) to allow auditors to provide more meaningful reports for the better performance of the audit committee.

  Communication between auditors and the audit committee is important, as is communication between the audit committee and the company's stakeholders. In our view there is merit in exploring an enhanced role for the audit committee in external communication and contributing to an improved understanding of what auditors do.

14.   Is the auditing profession well placed to promote improvement in corporate governance?

  Yes. In short, the training and experience auditors receive make them invaluable in promoting improvements in corporate governance. In addition it is the auditor who is able to engage with a client in a close and meaningful way but still retain that view of independence—that is a rich and unique perspective.

  The IFAC Code of Ethics for Professional Accountants is the foundation on which the work of professional accountants and auditors is constructed. More particularly, the Code embodies the fundamental principles of integrity, objectivity, professional competence and due care, confidentiality and professional behaviour, which are integral in all the professional work undertaken by auditors.

  The auditing profession in Australia already makes a substantial and broad contribution to improving corporate governance practice and that contribution should be developed further for the benefit of all.

September 2010

  Mr White: I can, thank you. Good morning, or should I say good afternoon?

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