It was one of the toe-curling moments of a turbulent year in business. When the chief executive of one of Britain’s biggest accountants told MPs it was not the auditors' job to look out for fraud, outsiders could hardly believe what they were reading.
David Dunckley’s evidence to a parliamentary committee came during questions about the collapse of Patisserie Valerie after a £40 million hole was found in its accounts. It was one of a string of company collapses in which auditing has been called into question this year.
Grant Thornton is being probed over its scrutiny of Interserve’s books before the outsourcing giant went into administration in March. KPMG was the auditor of East Kilbride firm Goals Soccer Centres at the time of the alleged VAT fraud which led to the company’s collapse. Grant Thornton also resigned as Sports Direct’s auditor after it emerged that a £674 million tax was owed in Belgium.
This month, KPMG was in the spotlight again after its audit client Halfords was forced to write down its inventory by £12 million. It was also the auditor for Ted Baker, which this week admitted it may have overstated its stock levels by up to £25 million. KPMG had already been given a ticking off and fined £2.1 million for its auditing of the fashion brand. The lead auditor at Halfords was Peter Meehan, the same KPMG partner responsible for scrutinising outsourcer Carillon, which collapsed last year.
But how much should we expect from auditors and should they be expected to look any further than the figures presented to them by their clients?
The audit industry is currently the subject of an independent review by Sir Donald Brydon, the Sage chairman and former chair of Royal Mail and London Stock Exchange. The Scot's remit is to explore whether audit should have a broader scope than just checking the numbers add up - including whether it should be expected to detect fraud, whether auditors should be held liable for omissions. His findings could result in the Companies Act 2006 being amended to include a new definition of audit.
Simon Dingemans, the new chair of the Financial Reporting Council, is on record as saying he believes auditors should be responsible for blowing the whistle on illegality.
However, James Pirrie, partner and head of audit at Anderson Anderson & Brown (AAB), believes it is unrealistic to expect auditors to act as a kind of financial fraud squad, which could make the process punitively expensive.
"It’s difficult to see how it would work if the audit scope was extended to encompass fraud detection," he said. "There would have to be a materiality consideration within this, auditors could not be expected to identify fraud on a minor scale within an organisation.
"An extension to scope would undoubtedly mean additional time having to be spent on assignments, resulting in higher fees and putting further strain on a profession which is already suffering from a lack of experienced resource. A further consideration would be the impact this scope extension would have on professional indemnity insurance availability and premiums for auditing firms."
But Graham Marjoribanks, head of audit and assurance at Johnston Carmichael, agrees with some critics that auditors should look beyond mere box ticking.
He said: “Businesses are approaching the audit process in a different way. More and more businesses are recognising that a strong and comprehensive audit can add so much value beyond simply ensuring compliance.
“With a number of high-profile insolvency events hitting the headlines over the last 12 months, the spotlight is on the audit profession more than ever before. Ahead of the publication of the Brydon Report it is encouraging that businesses are looking to engage in a more holistic approach to the process.
"Rather than just jumping through the regulatory hoop, we aim to provide advice that will fully support the company and see them in a stronger position 12 months down the line. If more companies had taken a broader approach to the audit process in recent years, it is conceivable that some of the headline grabbing insolvency cases may not have happened.”
Dingemans has also stated he would like to see the so-called Big Four firms Deloitte EY, KPMG, PwC broken up to separate their audit and non-audit functions.
The dominance of those firms can result in auditors effectively checking their own colleagues’ work, a potential conflict of interest. Dingemans wants to see a strengthening of the second tier of auditors - Mazars, BDO and Grant Thornton - and has insisted that such firms are indeed responsible for spotting fraud.
Scott Henderson, chief executive of tax incentive and innovation advisers ABGI UK, has a limited amount of sympathy for auditors.
He said: “It is easy to blame auditors for company failures, therefore I tend to agree with Sir Donald Brydon. He said recently, 'It is not auditors that cause companies to fail, that’s the result of the actions of directors'."
But breaking up the Big Four is not necessarily the answer, says Henderson. The firms should be capable of stepping back themselves when there is a conflict of interest. “Simon Dingemans has said that an enforced separation of audit and consulting at the Big Four, if not the bigger six firms, was a critical measure to improve the quality of audits," says Henderson.
“Meanwhile, the Competition and Markets Authority (CMA) has made wide-ranging recommendations such as forcing big firms to hive off their audit practices or requiring companies to conduct mandatory joint audits.
“Some of these recommendations have merit but they may not prove effective or could be burdensome for the businesses being audited. The principle of reform should be simple: to ensure auditors produce the most challenging and objective audits, accountancy firms should remove all conflicts of interest by not providing other services to the same companies that they audit.”
The Big Four have all raised auditing fees this year and EY chair Steve Varley says that is good news for second-tier firms. Grant Thornton has complained that lower fees made it difficult for firms of smaller scale to pitch competitively for business against the Big Four.
AAB's Pirie said: "I’m not sure that it’s necessary to break up the Big Four’s audit and advisory functions. Stricter regulation preventing the provision of non-audit services to listed audit clients feels like a simpler solution to the perception that conflicts of interest exist.
"If that results in some Big Four firms deciding to focus on providing more lucrative advisory services to these clients then it might open the door for second tier firms to pick up more listed client audit work. There has been a huge focus on the conflict of interest issue and while this does require consideration, it is equally important to consider how we improve audit quality through better training and investment in technology."
