Around the world, more questions than ever are being asked about audit and auditors. For example, scandals in South Africa and Brazil in recent times have raised questions about the independence and effectiveness of auditors. But it is perhaps in the UK that the greatest attention is being paid.
This attention follows a series of corporate collapses where failure has in part been laid at the door of auditors who were slow to highlight problems — the roll-call of shame includes Carillion, BHS, Patisserie Valerie and Conviviality. It also reflects situations where the companies survived but with the reputations of both management and auditor significantly damaged — think BT, Sports Direct and Mitie.
The concerns about audit have led to no less than three regulatory reviews in the UK. The Kingman Review considered whether the audit regulator, the Financial Reporting Council, was fit for purpose. The Competition and Markets Authority has ruled on the lack of competition in the audit market, and introduced changes that it believes will over time deliver greater audit quality as well as more competition. And the Brydon Review is looking at the audit product itself. Legislation is expected, and many expect that where the UK leads other countries may follow (in this regard at least).
Fundamental questions are being asked: is audit fit for purpose, is it effective in responding to the needs of shareholders and other users of corporate reporting, is it well understood? There is much talk of a so-called expectations gap.
Shareholders lean on audit committees to be their representatives in discussions with the auditors, making sure that the audit delves as deeply as it needs to and that the auditors properly challenge the judgements of management. But perhaps in part the gaps in shareholder understanding arise because audit committees and auditors talk a language few others understand. Accounting standards have become more complex over time, and clarity about audit has only been assisted a little by attempts in recent years to lift the lid on the audit with enhanced auditor reports. There’s a risk of a closed group of individuals talking to each other; given that audit, and corporate reporting generally, is a public good, this is not a good thing.
To test how closed this clique is, we looked at the audit committees of the UK’s leading companies:
- 18 audit committees at FTSE 100 companies are chaired by former audit partners at Big 4 firms and a further 6 were CFOs or FDs between their Big 4 partnership and their audit committee positions.
- 61% of audit committee Chairs are or were CFOs and FDs, with their position at audit firms having been further back in their history and probably more junior.
- Only 15% are from a different background and a vast majority of these were bankers, insurers and investors.
Figure 1. Background of FTSE 100 Audit Committee Chairs
Given the unprecedented attention on audit and auditors, perhaps more consideration needs to be given to whether audit committees are fit for purpose. Unless their Chairs are drawn from a broader pool, will they provide the challenge to auditors that will assist them to deliver the effective audits that shareholders and others need?