After damaging reports from inspections of external audits that found several instances of shoddy work over the last few years, audit firms are working hard to regain public trust and prove the value of the service they provide.
Last week, at the Compliance Week 2013 conference in Washington D.C., top executives at two of those firms explained the steps their firms and the entire industry are taking to improve the quality of public company audits. Meanwhile, Jeanette Franzel, a member of the Public Company Accounting Oversight Board which conducted the investigations, called on the audit industry step up its game.
Greg Weaver, chairman and CEO of Deloitte & Touche in the United States, said Deloitte is doing just that. He says the firm has invested $400 million over the past two years in training, audit methodology, and audit tools to improve the quality and reliability of its audit services. The firm has also expanded its audit personnel by 20 percent, he said, all while audit revenues have remained relatively flat. “Regaining that trust that we as a firm and a profession have lost over a period of time is paramount,” he said in a keynote panel discussion at the event. “Our business is a trust business. Investors in capital markets need to be able to trust that what we are doing is high-quality work.”
As recent financial frauds and meltdowns that were not detected or forewarned by auditors have cost investors billions—from the financial crisis of 2008 to frauds at several Chinese companies with listings on U.S. stock exchanges more recently—some critics are asking whether there's any point to requiring public companies to have their financial statements audited.
There is indeed, said Trent Gazzaway, national managing partner of audit services for Grant Thornton, who also spoke as part of the panel. “If all auditors put down their pens and pencils and walked out the door, the cost of capital would skyrocket,” he said. “There might be a level of financial information, but there wouldn't be a level of trust. We help provide that objective trust that keeps the cost of capital low. But doing that is very difficult, and it's more difficult as the complexity of financial reporting has advanced.”
Gazzaway said the profession needs to work harder to assure capital markets appreciate what an audit provides, but it also needs to work harder at demonstrating greater skepticism and objectivity. That's been a big focus of the Public Company Accounting Oversight Board the past few years, which has called on auditors to get tougher on management, especially in areas where financial statement assertions are heavily pinned to management judgments and estimates.
It's tricky, though, because auditors are paid by the companies they are auditing, which builds in an inherent conflict of interest, some of the panelists agreed. Auditors have not been shy in the past about serving not only as auditors but also advocates for their clients, they said, because the firms have viewed themselves as paid professional servants.
Who Should Pay for Audits?
The framers of the Sarbanes-Oxley Act contemplated whether there was a way to break that relationship, but couldn't come up with another payment model that was feasible. Instead, it directed auditors to sever other client service ties from the companies they audit to help them become more objective, and it established some rotation requirements for the lead or engagement partner on the audit.
The PCAOB has revisited the objectivity problem more recently by fostering a protracted debate over whether it could create more of an arm's length relationship between auditors and the companies they audit by setting term limits on how long audit firms could audit the same company. That debate has stalled in recent months as the PCAOB has failed to generate any meaningful support for the idea or demonstrate it would be effective. Still, the payment model remains an obstacle to objectivity, says Gazzaway. “It's difficult to provide an objective risk assessment unless you have that healthy skepticism, and that's a difficult thing because of the issuer pay model,” he said.
Deloitte & Touche's Greg Weaver, above left, spoke about big change happening on the global scene. At right is Jeannette Franzel, a member of the PCAOB.
According to Franzel, the pay-model issue has been debated for decades, but the alternatives would likely involve some kind of government involvement. “I don't think to date anyone is really willing to go there,” she said. Instead, the PCAOB and the firms are focusing on what other steps they could take to increase objectivity and skepticism, including looking at the role of the audit committee, in attempts to make the current model work.
“I really think the key is an active, involved audit committee,” said Weaver. As one who sits in on dozens of meetings between auditors and audit committees each year, he believes audit committees have stepped up their oversight of the process in the past decade but could still be much more proactive.
Many audit committees could be more involved in assuring the quality of the audit work, digging into the key issues auditors address, and assuring the fees are fair and the amount of work is appropriate. Weaver said he would like to see audit committees that are involved enough to make their own judgments, without deferring to management on such issues. “The audit committee is the one that determines whether to hire or fire the auditor,” he said. “They have that responsibility, not management.”
Auditors also acknowledge they could do more to help investors understand the audit by putting more information into their audit reports. The PCAOB is considering a new requirement for auditors to include more in their audit reports, although they are getting different views on what should be required, said Franzel. “The feedback is to keep the pass-fail model, but also add more,” she said. The question is what else to add, and the board is exploring that now, she said. It might include requirements for auditors to include information on the difficult areas of the audit or areas that involved significant estimates or uncertainty. “However we come out on this, not everyone is going to be happy,” she warned.
Gazzaway said he would be very concerned about any proposal that would require auditors to give opinions on whether investors would be wise to invest in a given company. The analyst community already serves that role, he said, although he sees some wisdom in perhaps analysts and auditors teaming up to give investors a better view of risks, especially in reflecting on the events that led to the financial crisis. “When you step back with perfect hindsight, if the audit and analyst community had gotten together and maybe produced some risk reports, that might have been helpful,” he said.
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