Developments in the auditing profession

Mr Mangion is a senior partner at PKF, an audit and consultancy firm, and has over 25 years’ experience in accounting, taxation, financial and consultancy services. Mr Mangion can be contacted at gmm@pkfmalta.com or on +356 2148 4373

So it came as no surprise that a local paper reported that the Swedish Pensions Agency (SPA) had delivered a pejorative verdict on the way a pension fund (Falcon Funds) registered in Malta was being run. Emil Ingmanson, a Swedish entrepreneur with extensive business interests in Malta is now alleged to have had some sort of access to the money Swedish pensioners poured into Falcon Funds.

The fund, valued at €276 million, is to be audited and its administration tested as to how it has been managed. Officially, in Sweden, there has been serious criticism about its management and the fact that it is registered and regulated by the MFSA in Malta. A 15-page document lists suspicions about Falcon Funds involving misleading sales tactics, pointing to the role of director Mr Ingmanson accused of taking control of Falcon Funds’ investment decisions, and even the possible misuse of €31 million for his own ends. Observers may comment that the incidence of one fund that has turned sour does not mean the audit profession needs to sharpen its claws. Nevertheless, the market expects more quality from the auditing profession to safeguard investors and depositors, especially those saving to build up their pension nest egg.

Due to a number of accounting scandals in the past decades, one feels that close familiarity with clients may breed complacency at a time when auditors are constantly expected to be the whistleblowers.

One of the main criticisms levelled against the profession is the concentration of audit suppliers. This topic has been of concern to regulators as it limits global competition and choice which is characterized by the oligopoly of the so-called “Big Four” audit firms (KPMG, PwC, Deloitte and Ernst & Young). In turn, this entails that due to acute specialization of services available at the Big Four, the medium term small- and medium-sized companies may be forced out of the market.

The term “concentration” describes the agglomeration of economic power, which the Big Four dominate in many industrial sectors, causing distortion in the market (Moeller and Hoellbacher 2009). Critics of the present supply conglomeration argue that audit quality is under pressure due to industry expertise locked in a handful of firms, but also by rivalry from the incumbent auditor’s closest competitor. It stands to reason that the prescriptive obligation on the auditor to sound the alarm bells in cases of suspected irregularities may mean loss of the client which may then issue a tender for rotation.

In particular, studies show that the likelihood of issuing a going concern opinion to a financially distressed firm decreases as competitive pressure from the closest competitor increases. As the auditor contemplates the chances of losing the client this may in some cases lead to a sharp drop of earnings – particularly fees involving mega listed clients. Empirical studies have shown the myth that Big Four firms only wield industry expertise per se, which is not a guarantee for audit quality since mid-tier firms can, if need be, take remedial measures to secure comparable standards.

Definitely, the main driver of quality results from a high level of judgmental capability combined with impartiality and scrutiny which an audit firm needs to possess and not necessarily because it happens to rank as one of the Big Four. The drive for more transparency and impartiality seems to have gravitated in a revision of rotation rules of audit firms for all listed companies, which has also been promulgated in our laws.

A brief glance at the new Audit Regulation (EU/537/2014) shows that this will impose stricter requirements on Public Interest Entities (PIEs), i.e. listed companies, credit institutions (e.g. banks and building societies) and insurance undertakings. The time when audit firms let grass grow under their feet is over and a new mandatory audit tendering and rotation requirements is now in force. Simply put, the EU Regulation requires PIEs to rotate their auditors after 10 years, subject to certain options available to member states. Mandatory audit firm rotation is introduced as per new regulation (Articles 16 and 17), such that PIEs have to appoint a new firm of auditors every 10 years. However, member states have the option to extend this maximum period to 20 years (24 if there is a joint audit) provided the audit is subject to a public tendering carried out after 10 years.

Readers may ask why auditors should rotate after 10 years when there exists a harmonious relationship between the client and auditor. Surely mandatory rotation means musical chairs with only the Big Four able to play so there is limited choice in the market. In the past, even in Malta, companies changed their auditor relatively infrequently. Typically, one major bank retained the services of a Big Four auditor for an uninterrupted period of close to 40 years. It is very rare in Malta that PIEs or listed companies issue a tender when changing its auditors. Rarely does one read that auditors were changed due to lack of industry expertise. It is ironic that the EU has introduced such stringent rules of auditor rotation when choice is still limited or even reduced if one of the Big Four goes the Andersen way. In reality, all firms still have to compete hard to win work.

In the UK, it is not uncommon for audit mandates to last a lifetime – for example Barclays Bank used PwC for 120 years until it switched to KPMG recently. Certainly the advent of forced rotation is adding pressure on auditors to invest in more expert staff to retain or win new business. Such firms recruit actuaries, statisticians, advisory specialists in the fields of data analytics, long-form reporting and wider assurance services in order to gain an edge on their competitors.

To conclude, one of the basic requirements of an efficient market is an effective audit process. In achieving such a level, one essential condition is to be able to certify the existence of a true and fair view of the financial position and comment on future performance. For the financial statements to present fairly in all material aspects the financial position and performance, a methodological approach structured in successive, well-defined stages is necessary. Another condition is to take into account any changes that have occurred to these assertions during the financial year, but also consider the impact of these changes to the entity’s future.

At this stage, the auditor analyses the appropriateness of the entity’s use of the going concern basis of accounting. It is clear that a qualified audit report caused by going concern issues is a signal for investors that either the management of the company is unable to keep the company profitable, or that they have attempted to present an over optimistic view of the company’s share value. A cry for smarter auditors can be heard echoing over the distant horizon.