Overcoming Conflict of Interest Concerns with Audits

Article by Managing Director, Steven Watson, as published by For Accountants.

Audit firms provide an essential service to capital markets. By building a basis for trust and confidence in financial reporting, auditors help firms manage financial risk, reduce financing costs and contribute to the effective allocation of capital for economic growth.

Despite these benefits, there have been significant challenges in the way audit services are perceived by businesses and markets, including

1. Commoditisation of external audit services resulting from technology advances
2. The perceived value and relevance of the traditional external audit
3. Growth in demand and value of internal audit and consulting services
4. Impact on independence of increased focus by audit firms on consulting services

There’s no doubt that an integrated exertnal and internal audit service potentially provides significant benefits to both client and firm in relation to sharing of information and strategy. Unfortunately, conflict of interest issues have led to deterioration in the perceived independence and value of audits.

In the UK, three of the Big Four accounting firms (PwC, EY and KPMG) have recently announced that they will stop offering consulting services to audit clients in a bid to end a perception of conflict between providing external audit and consulting work to the same client. In practice, this is likely to hasten the exit of traditional accounting firms from audit as they move towards higher value consulting services.

In this environment, who will be left to provide specialist audit services?

Within Australia, The Institute of Internal Auditors has recently announced the creation of the Financial Services Committee, which will develop best practice guidelines modelled on existing standards for internal auditors.

At the same time, the Parliamentary Joint Committee on Corporations and Financial Services have commenced an enquiry into the regulation of auditing in Australia, with particular reference to:

1. the relationship between auditing and consulting services and potential conflicts of interests;
2. other potential conflicts of interests;
3. the level and effectiveness of competition in audit and related consulting services;
4. audit quality, including valuations of intangible assets;
5. matters arising from Australian and international reviews of auditing;
6. changes in the role of audit and the scope of audit products;
7. the role and effectiveness of audit in detecting and reporting fraud and misconduct;
8. the effectiveness and appropriateness of legislation, regulation and licensing;
9. the extent of regulatory relief provided by the Australian Securities and Investments Commission through instruments and waivers;
10. the adequacy and performance of regulatory, standards, disciplinary and other bodies;
11. the effectiveness of enforcement by regulators; and
12. any related matter.

Practitioners are encouraged to make submissions to the committee, with a report expected in early 2020.

Further anticipated reviews of APES 110 in relation to independence will no doubt address these issues in more detail.

There’s also increasing focus on the value of internal audits in relation to corporate governance, risk management and internal management. The central government of Vietnam, a stong emerging economy, has recently issued a decree requiring listed companies and those that are owned at least 50% by the state to carry out an internal audit.

At the present time, the ASX Corporate Governance Principles and Recommendations state that if a listed entity does not have an internal audit function, they need to explain the reason for this.  Additionally, they should explain how risk management and internal control processes are managed, evaluated and continually improved in the absence of an internal audit function.  It’s likely that internal audits will become an increasingly important part of the regulatory framework for both public and larger private companies.

What does this mean for accounting and audit firms in Australia?

1. Increasing competition for external audit services may result in auditors attempting to scope the audit work to match the fee for service as opposed to the audit risk.
2. Reduced profitability of external audit may result in increased focus on consulting services which have a higher perceived value for the client
3. Conflicts of interest created by expanding consulting services may reduce the choices of external auditors available to both publically listed and private companies.

Until these issues are addressed by regulatory bodies, it’s appropriate that accounting firms make a clear decision to separate audit and advisory services provided to clients.

Specialist audit firms with sophisticated internal processes are increasingly taking audit services from traditional accounting firms. This should free up accounting and advisory firms to provide consulting services around the development and management of financial systems and processes.  However, there’s no doubt that most smaller accounting firms currently lack the specialist capabilities to provide internal services beyond payroll, FBT and GST audits.  There’s opportunity for firms who can do it right.

The team at National Audits Group is intently focused on separation of external audit and consulting services.  We recognise, for example, that most accounting firms don’t have the skills to prepare statutory financial statements. We’ll work together with client firms to provide relevant documents which can then be used in relation to tax and accounting matters. We can help firms develop a map of their audit universe, including a project timeline for implementation of financial management systems, policies and processes. By providing both management and governance letters to audit clients, we’ll clearly explain the steps required for improved internal processes and corporate governance.

In an auditing climate where trust and independent are the core governing principles of behaviour, the role of the company auditor has never been more important.  The team at National Audits Group is committed to engaging with the profession to ensure that client needs are always addressed in a professional manner.

In the next article, we’ll discuss in more detail the implications of current trends on the role that auditors will play in the years ahead.