Value of doing the splits
THE first port of call in seeking to better understand the Queen’s finances over this Jubilee pageant weekend is the audited accounts of the Sovereign Grant and other Crown entities.
The annual report is the best starting place in the quest to understand public institutions, listed and private firms.
There is no better source for spotting irregularities and nuances in financial results. These include inter-company transactions, dealings between executives and the company, finer points of remuneration as well as cash flow and debt levels.
If the auditors have failed to understand an issue they are technically obliged to say so in a ‘note’ and, in extremis, to ‘qualify’ the accounts. The work of audit is the antiseptic of capitalism and vital to the trust placed in the published accounts of stock market-quoted companies.
That is why the Government’s plans for audit reform are critical. Yet somewhere in government, proposals for fundamental reform have been watered down.
The view of the professionals, in a review conducted by the Competition & Markets Authority, came down firmly on the side of splitting the audit and consulting arms of the Big Four firms, on the grounds of conflict of interest. A further review by former London Stock Exchange boss Donald Brydon was sympathetic to this view, as is Business Secretary Kwasi Kwarteng.
EY jumped the gun by announcing separation. However, when the draft legislation appeared this fundamental reform requirement was quietly expunged.
Among the unfortunate aspects of accounting and consulting functions being combined in the Big Four professional firms – PwC, Deloitte, EY and KPMG – is the way in which it has devalued audit.
In the case of many public companies, audit fees, regarded as routine, are dwarfed by consulting income.
CONFLICTS are clear. Consultants from accounting firms should not be involved, for instance, in setting director pay because of the risk of capture by greedy executives. It places in jeopardy the independence of auditors who become regarded as secondclass citizens.
A son of a friend is a graduate trainee at Deloitte. As part of the programme, he has been assigned to audit. But, as he told me, this is just a necessary step before he can transfer into the sexier consulting arm of the enterprise. The pull of consulting is much more glamorous.
The loss of the best and brightest could partly explain why audit firms have found themselves snarled up in failure, from Carillion to Patisserie Valerie. But the answer to reinvigorating audit is not just better regulation but re-establishing its centrality to the hygiene of business.
The fact that audit fees are dwarfed by consulting income suggests serious mispricing, with accounting firms overcharging for fancier work because they have been unable to push up plain audit fees fast enough.
Separation in the manner of EY would help to restore the pride which has led to so many accounting failures.
That reform has finally made its way off the drawing board onto the legislative agenda must be a good thing. However, the Government has allowed its instincts to get the better of it. Big audit firms, the directors of public companies and private unquoted firms have been let off the hook.
Restoration of confidence in audit will never happen while it remains the poor relation of a more alluring consulting practice.