Shareholders don't like it, nor do the regulators. It's expressively forbidden to be included in appraisals. Unfortunately, evidence uncovered by the Financial Reporting Council's Audit Inspection Unit (AIU) shows that the controversial practice of selling non-audit services to audit clients is alive and well, threatening the independence of  audits.

At Deloitte audit directors and managers are highlighting their cross selling abilities when trying to secure promotions. According to the report “A number of audit directors and managers referred in their performance evaluations to cross selling non audit services to their audit clients.”  While at Ernst & Young, the AIU found some staff attached their personal sales data to their appraisal forms: “Contrary to the firm’s instructions some audit partners had retained certain raw sales data generated by the firm’s IT systems on their appraisal forms.”

Earlier this year the AIU reported that PricewaterhouseCoopers had changed its bonus criteria to emphasise business growth, which jumped from 25% to 40% as a proportion of its KPIs. At the sametime the audit quality portion dropped from 25% to 20%. At KPMG the AIU reported that audit quality was not significantly represented in the performance assessment.

Other notable highlights from the report include:

Communication with Audit Committees:

"On four of the audits reviewed the AIU identified shortcomings in reporting to audit committees or other governance bodies which were consistent with those identified in prior years. These included not communicating significant findings from the audit in writing, not confirming the firm’s independence and a lack of clarity as to whom the communications should be made. In the AIU’s view the quality of reporting to those charged with governance remains an area requiring improvement at other firms."

Audit Independence

"Issues relating to rotation policies and monitoring procedures were identified at most firms"

"Long association with an audit client continued to be an issue"

"inappropriate involvement by firms in the preparation of the taxation figures"

Audit Evidence

"The AIU identified issues in relation to the adequacy of audit evidence on file to support certain account balances and related audit judgments on most of the audits reviewed at other firms."

Shareholders at Risk?

In the absence of hard quantitative data about the quality of audits, shareholders are unlikely to draw much comfort from the POB's findings.

Audit firms are clearly not immune to the economic pressures of the day, but a focus on reduced audit hours and competing at the lowest possible cost could leave shareholderholders and companies without adequate protection. Unlike executive pay, audit issues rarely grab the headlines - until it's too late.

The current framework for audit appointments puts the directors in the driving seat and shareholders are at a disadvantage. Perhaps the only way to break the log-jam would be to consider the continental-European approach of shareholder-proposed Statutory Auditors?

Links

Professional Oversight Board Individual Reports >>

Professional Oversight Board Overall Report >>