Accounting: Examining the role of statutory audit

Statutory audit has become such a natural part of the corporate governance furniture that many have forgotten what it is for. Why not scrap and swap it instead for assurance work, to be led by the demands of the market, not by governments?

Of course, after the financial crisis it may be hard to persuade politicians and regulators that an auditor’s visit should be a matter of choice for companies and their investors.

But audit has lost much of its grip on corporate life – and does not appear to have been missed that much. In the UK, with only one or two caveats, businesses only need to appoint an auditor if turnover reaches £6.5m or balance sheet values exceed £2.26m. The threshold varies across the European Union (EU) but the net result is that, according to figures from the Association of Chartered Certified Accountants (ACCA), 98.7 percent of European companies are excused a statutory audit. But at the same time, those companies collectively employ almost half of Europe’s workforce. They matter.

If audit has been scrapped for small business, why keep it for large entities? According to Stephen Haddrill, the Financial Reporting Council’s still-new broom, auditors are needed because the shareholders of large companies have become more fragmented, so investors have less power to challenge management. He claims the era of insurance companies and pension funds wielding power is waning. They now own less than 15 percent of the shares on the London market, preferring bonds to equities. Overseas investors are taking a larger equity share and concentrated influence is lost. Auditors are sometimes accused of acting like management, forgetting they are meant to report to shareholders: in this scenario of disappearing investor influence, they are more like surrogate shareholders.

If auditors were forced out from behind the skirts of legal privilege, they would stand on their own two feet, proving their worth and delivering better value. That might lead to a more transparent audit process, and more robust audit reports. Such a move towards privatisation would also help auditors with their long-standing campaign to improve the liability arrangements that are just not working.

Most importantly, such a bold move would reverse the growing impression – pointed out by Haddrill – that just when audit is needed more, it is delivering less. He raises two examples of falling value. First, accounting standards have allowed management more discretion in the valuation of assets. This has resulted in a wide range of valuations of the same asset, which makes the audit process look pointless. Second, as was highlighted by the parliamentary investigations of the financial crisis, the role of the auditor has become confined to an oversight role. The wider thinking – and contact with others in the regulatory framework – no longer happens.

The EU and its member states are due to re-examine the role of audit with an overhaul of the fourth and seventh accounting directives, due to start at the end of this year or early 2011. The most likely outcome is that member states will be allowed to raise audit thresholds, gradually nibbling away at the hold of statutory audit. But there is little appetite for scrapping the audit law outright: it is seen as a minimum, a lowest common denominator safety net. Keep the statutory minimum, however, and there seems no way to raise quality and aspiration.

One final fact from ACCA’s audit briefing. While under EU law, only 0.3 million audits are required, and 1.4 million are actually performed. There is a host of reasons why non-statutory audits happen, but happen they do. Scrapping the statutory audit may be just the step required to deliver the value from audit that all stakeholders need.

To read more thinking on the future of statutory audit, see Robert Bruce’s column, Corporate Governance: Does governance exist in a world of short-term investment? Peter’s column returns in September