What is the point of an audit?

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KPMG is in the news again for the competency of its audit standards over the collapse of Carillion. KPMG has previously been criticised over its audit of HBOS, Co-op and Rolls Royce. Arthur Anderson collapsed after its audit of Enron.

There are clearly issues around auditing standards but let’s be absolutely clear on one thing. It is the responsibility of company directors to ensure the accuracy and relevance of the published financial statements of their companies and to give an informed opinion of the future prospects of the business. For too long directors have hidden behind the role of auditors and sought to gloss over the short comings of their businesses. Directors who exaggerate the strength of their businesses in the Directors Report whilst being in possession of management forecasts which should fully show the future risks the business faces should be the ones that incur the ire of shareholders and not the auditors who will never be fully informed of all aspects of the business. It is entirely the responsibility of the directors to keep informed their shareholders and other stakeholders of the sustainability of the business and what actions they intend to take to maintain the business and its profitability. An audit shows a degree of compliance within the law of the preparation of the company financial statements. It contains an outsiders opinion on the short term sustainability of the business based on the numbers prepared by the Directors and the comments and opinions of those Directors. Beyond that the audit does not claim much else. If shareholders wish to elevate auditors to watch dogs then big changes would be needed.

Firstly, auditors would need to be independent of the company. Currently businesses appoint auditors and pay their fees. Much as Credit Ratings agents were paid by those seeking to get a rating this conflict of interest gives rise to a risk that auditors will err on the side of Directors opinion when it comes to explanations of the accounting data. Would the state take over the cost of company audits? Would companies need to be charged an audit levy to cover the cost? Who would set the price of audit services for each company?

Secondly, auditors would need to be safe from prosecution by companies where an audit opinion is given which damages the audited shareholder value of a company. Since business failure risk can never be 100% certain auditors would be required to give some subjective view of a company’s future potential performance. In nearly all cases this view would be wrong due to circumstances changing with time. An opinion given in January would almost certainly have changed by March if not sooner. Only company Directors and managers can fully be aware of the day to day changes in a Company’s fortunes. Many complete basket cases are rescued by either private or state intervention and it would be impossible for an auditor to comment with any certainty on the likelihood of such a future event or any other crystal ball type occurrence. How for example would an auditor rate the possibility of banks continuing or not continuing to support a business.

Audit opinion would become a major factor in market valuations which could cause big falls in share prices based on unsubstantiated views and those shareholders would be even more irate at the inadequacy of audit opinion then they are now.

It is clear even on just these two factors that it is almost impossible to create a foolproof audit system which captures the potential for business failure within the audit process. It is possible to criticise an audit opinion as being of limited value in evaluating the viability of a business. This criticism is perfectly valid and less emphasis should be paid to audit opinion. Auditors are not watchdogs and cannot be held responsible for not spotting failure any more than racing tipsters can be held responsible for not picking winners.

My view is that shareholders only ever consider the Audit Report when a business fails and largely ignore it up until that point. Shareholders put their faith in the statements of management and Directors when it comes to investment decisions and it is the management and Directors who should take responsibility when businesses fail.

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When is discrimination not discrimination

Discrimination is now to all intents and purposes legally proscribed in most areas of employment law although probably not in practise. No employer can eliminate candidates based on their ethnicity, religion, sexual orientation or disability.
The one area it is seems that it is still possible to discriminate is in education. Employers and recruiters still issue job specifications which demand that the potential candidate has a minimum educational requirement. This could be a minimum of a Bachelors Degree, a minimum grade of say a 2:1 or as in the case of many professions the need to have a professional qualification. Certainly in the field of finance it is prevalent and increasingly so that anyone wishing to work in any form of senior finance position must have a professional qualification from one of the self appointed finance bodies providing such education. In effect a system of licencing evolves in order for any individual to trade in one of these areas.
Is that a good thing? Well maybe. There is nothing inherently wrong with having people with good educations practising certain skills and improving those skills by acquiring targeted training. However is it ever right to exclude someone who can demonstrably show an ability in a certain area simply because they do not have the right certificate? Would it be reasonable to exclude an athlete say who can run the 100 metres in under 10 secs from competing simply because they hadn’t been to running school and been taught how to run properly? Should it be a requirement that all CEO’s should also be MBA’s in order that we can have confidence that they have the ability required to manage the company. After all if anyone should be “qualified” it is the person with whom the buck stops. I am not sure many would necessarily agree. What counts is their ability to organise and run a business and the thing that shows that is previous experience not a certificate.
You might say “you wouldn’t allow a surgeon to operate unless they were a qualified surgeon” but I personally would be more comfortable knowing that they had performed 100+ of the operations rather than none but had been to school. Experience trumps education every time.
The purpose of education should be to ensure that people have better skills and to an extent it does but education should not become the sole criteria for assessing suitability for one role or another. Education ensures only a minimum standard of attainment. What education does not do is guarantee a high standard of skill and ability. The highly qualified people, legal, financial and managerial, who ran Enron, WorldCom, Lehman Brothers, Royal Bank of Scotland, Lloyds TSB, Barclays, Arthur Anderson, Guinness, Polly Peck, Long Term Capital Management, Bear Stearns, Northern Rock, AIG, Anglo Irish and many, many more both large and small failed to avoid difficulties which many people would presume by virtue of their training and education would be avoided. I am not attaching any blame to those “qualified” workers who were working for such companies at the time of any corporate difficulty but stating that education is not something that gives any guarantees that such failures will not arise and that to be base employment practises solely on a level of educational ability can in itself have drawbacks.
In my area of expertise, production accountancy, it is now increasingly common that anyone applying for a job has to be a member of one of the three accountancy training organisations (ACA, CIMA or ACCA). But production accountancy is not about numbers it is about understanding the process and unless you understand how the physical process works and can explain that process to others both in terms of numbers and words you cannot do the job properly. Knowledge of that process only comes from the experience gained from doing the job and being around the production process and cannot be taught from a manual. If the work becomes just a number crunching exercise without the understanding of what those numbers mean then the role is diminished and the employer is buying less skill not more because of the exclusion of “non-qualified” applicants. If there is no presumption on the part of the employer that the Production Accountant understands how the process works then you might as well do without the accountant entirely and save on some cost as the value added apart from just “adding up” is negligible.
There is an element of “occupational capture” by organisations providing financial training that does not necessarily add to the skills of those who do the work but excludes from those occupations anyone who hasn’t received the “correct” training provided by those organisations.
The ICAEW itself in its ‘Directors’ Briefing’ on ‘Human Resources Management’ states in line one that “Discrimination on any other grounds other than an employees’ ability to do the job is illegal.” But the absence of a qualification however worthy and arduous should not be seen as an absolute sign that an employee does not have the ability to do a job. Whilst it is possible to discriminate on the grounds that there is “an occupational requirement”, and I suspect that many who do discriminate on educational grounds, especially in financial occupations, see this as the legitimate reason behind the requirement for a formal accountancy qualification, this requirement has to be “a genuine and crucial requirement” and “the application of the requirement must be a ‘good proportionate means of achieving a legitimate aim’.” In many recruitment specifications I think these criteria have not been met and that in numerous instances the employer does not have a full understanding of what skills the qualification imparts that are applicable to the role and therefore cannot apply the test criteria properly.
In short exclusion from occupations solely on the grounds of educational qualifications is in most instances illegal and acts solely as a lazy means of filtering applicants.
I have no issue with accountancy firms whose staff or partners are all members of a recognised accountancy body and who trade exclusively on the basis that this is the case as part of their USP although they are probably missing out on some good people by applying that criteria. In this case the firm is an accountancy firm and trading as such. Where it does become an issue is where there is occupational “mission creep” such that all finance jobs in any industry are seen to need membership of these organisations irrespective of whether the training provided is appropriate and exhaustive.
Of course the organisations that do benefit from the capture of occupations requiring “professionally recognised” qualifications are the professional bodies and education providers tasked with ensuring that a key sector of the business world are wholly members of and trained by them. That gives rise to a whole new question on competition, diversity and homogeneity of skills but we will save that for another day.