The Joint Committee on Corporations and Financial Services says it has expressed concerns about audit quality in Australia for “some years” now, noting that the issue is an international problem with some “deep-rooted problems” in the audit market.
It believes a serious review is in order, with particular reference to market dominance and conflicts of interest arising from the range of other activities also conducted by the major firms in the industry.
The committee has also called for ASIC to devise and conduct a study which will generate results which are comparable over time to reflect changes in audit quality. This is separate to the regulator’s current audit inspection program which the committee notes is “risk-based”.
The committee believes the structure of the audit industry gives rise to two issues – that the concentration of major company auditing lies in the hands of the big four, and the potential conflicts of interest arising from the diversified nature of operations of the big four.
“The traditional view of the audit firms is that they operate as independent outsiders scrutinising the accounts of major corporations. In effect, however, the big four audit firms have become corporate insiders embedded within the business world,” the report said.
“The risk here, of course, is that the big four audit firms now fail to fearlessly scrutinise the accounts and risks of the corporations that they audit because it may be detrimental to the pursuit of their wider business interests.
“It is precisely this diversification into a whole raft of other professional services, and the attendant conflicts of interest, that calls into question the view that a lack of competition in the audit industry is the root cause of poor audit quality.”
ASIC’s latest audit file review found that one in five audits did not receive reasonable assurance that the company’s financial report was free from material misstatement, down from 23 per cent in the previous 18-month period.
However, the Financial Reporting Council (FRC), disputes that the audit quality in Australia is “unacceptably poor”.
“The FRC is confident that the leadership of the accounting firms in Australia are displaying appropriate seriousness about concerns over audit quality and are continually implementing initiatives to address the issue,” said FRC chair Bill Edge in January.
As such, the committee believes ASIC and the FRC should consult to determine an appropriate study that will measure and compare audit quality over time.
As part of potential solutions, the committee noted the UK’s Competitions and Market Authority proposed structural break up between the audit and non-audit businesses into separate operating entities.
The UK’s competition watchdog has also called for the UK’s largest companies to be audited by at least two firms, with at least one outside the big four, to give mid-tier firms access to larger clients, to develop their experience and credibility while ensuring a cross-check on quality.
“It appears to the committee that the fundamental question at this juncture is whether the deep-rooted problems in the audit market can be resolved by more robust practices aimed at managing conflicts of interest, or whether action is required to remove those conflicts of interest,” said the report.
“The committee reserves its judgment on the view expressed by ASIC that the big accounting firms are now sending strong messages from senior management about the importance of audit quality, and are also bringing in coaching, review processes and internal accountability measures.”