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Who is the customer of the audit?

Guy Strafford
Mar 5, 2013 4:35:00 PM

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Guy-New

There are some strict rules about the scope and execution of statutory audit. Things undoubtedly got tougher for the profession in the wake of the Enron scandal that brought down its auditor, Andersen. But interestingly, while there are now stricter rules around auditor independence from management and limits on non-audit services an auditor can provide, many of the issues that scarred audit then still linger.

Take this quote from the Economist’'s summary of Enron'’s audit failings in 2002. The problem, it said, was "rooted in “a set of business relationships that are bedeviled by perverse incentives and conflicts of interest. In theory, a company's auditors are appointed independently by its shareholders, to whom they report. In practice, they are chosen by the company's bosses, to whom they all too often become beholden…... it is far too easy to play on an individual audit partner's fear of losing a lucrative audit assignment. Against such a background, it is little wonder that the quality of the audit often suffers.”"

It’s true that in the vast majority of corporates, the board’'s audit committee (and its chairman) are nominally responsible for the relationship. But on a practical, day-to-day basis? It’s often the CFO who'’s engaged with the audit partner and their team. Many CFOs take on audit committee roles when they develop a non-exec portfolio. And in the case of the Big Four –- which audits almost the entire FTSE350 -– the CFO will usually have existing non-audit relationships with many of the firms tendering for their audit.

This is why Standard Life, LGIM, USS and others are still vexed –- 11 years after Enron - –on the issue of ensuring that auditors do not get too close to management. They want someone to independently represent their interests.

So who-s the customer? The word can be used either to describe the economic buyer; the person interacting with the service; or the end consumer. In this situation, the economic buyer is the CFO (it often comes from his or her budget) or the audit committee; the interface is the CFO; but the end consumer is unambiguously the shareholder.

Some of this issue is being resolved in quoted businesses by putting still more onus on the audit committee to dictate auditor selection. The best – in pure governance terms – are putting the budget under this committee in some shape or form.  In these businesses, the auditor feels more comfortable challenging management.  

There are pros and cons to this approach. For example, if there’-s a fundamental breakdown in the relationship between the audit lead and the CFO, should the audit committee always side with the outsider? And how well does such a set-up address judgments about accounting treatments or internal process decided within the committee itself?

But it has the advantage of moving the economic buyer firmly outside the executive. For audit to provide compelling reassurance to the shareholders, boards must behave like Caesar’s wife -– to be above suspicion, not merely innocent.

I would welcome your thoughts.

Click here if you would like to read more thought pieces around our audit commentary as well as our submission to the Competition Commission

Guy Strafford

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