Accountancy and Management: 'Make the audit an inside job': The Scots propose downgrading the role of external auditors. Roger Trapp reports

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The Independent Online
EVER since the collapse of the Bank of Credit and Commerce International and the empires built up by Asil Nadir, the late Robert Maxwell and the rest, those concerned with issues of corporate governance have been battling to find ways to stop it happening again, or at least make it less likely.

At the centre of the debate has been the search for an answer to the familiar cry: 'Where were the auditors?'

Carried along by talk of the 'expectations gap' and the general disillusionment with the role of the large accountancy firms, City bodies, from the Cadbury committee on the financial aspects of corporate governance to the MacFarlane working party on the future development of auditing, have talked of strengthening the role of the external auditors. But uppermost in their minds has been the problem of how to square this with the liability issue that is causing such headaches for the big practices.

In such circumstances it seems odd for anybody to suggest a reduction in the role of the auditor. But then the Institute of Chartered Accountants of Scotland has never been afraid of breaking away from the crowd.

Its 1988 paper, Making Corporate Reports Valuable, has had a marked effect on company reporting, and the institute's research committee sees its latest effort as similarly epoch-making.

The content of Auditing Into the Twenty-First Century is not always as sci-fi as the title might suggest, but there is plenty there to challenge the conventional wisdom.

Most notably, the document, published last week, proposes that the internal auditors do much of the detailed work currently done by outside accountants, or external auditors, and that the latter be relegated to a checking role designated by a change of name to assessors.

Not surprisingly, the notion has been endorsed by the Institute of Internal Auditors-UK. Having criticised Cadbury for failing to give enough attention to the internal audit function, the organisation is pleased to see some recognition for a role that it sees as fundamentally different to that of external auditors.

'The role of internal auditing envisaged by the ICAS report is that constantly advocated by the IIA- UK,' it said. 'The knowledge of the internal auditor of its organisation's culture and aims assists in providing continuity of work and greater assurance of organisational control in line with management requirements.'

Whether it will attract the same degree of support within the accounting firms is another matter. With those in the lower ranks already preparing for the loss of the small-company audit, the big players could soon be facing a similar situation. This time it is not so much a matter of lost fees - which are said to be artificially low - as a lost role for the thousands of accountancy students enrolled every year as cannon fodder for auditing.

Then there is the spectre of individual partners having to put their names to accounts they have assessed rather than hiding behind a firm signature. Professor Ian Percy, the Grant Thornton partner who is convenor of the institute's research committee, said although this would put pressure on individuals it would avoid the compromise view. A partner - who would have to be highly experienced - would put his or her name to a set of listed company accounts only if genuinely satisfied that all was well.

Arguing that the public deserves greater reassurance from auditors, the paper asserts that directors of listed companies - and not the auditors - are directly responsible for ensuring that there are reliable systems of management information and internal control.

With increasing signs of a move towards quarterly reporting, this is likely to become more important, Professor Percy believes.

The authors of the paper - mostly working practitioners but including Steve Zeff, the noted US accountancy academic who is the institute's international adviser - also feel that directors have a clear responsibility to provide greater information on such matters as whether there are sufficient financial resources to enable the company to continue in business and whether the chances of fraud and other illegal acts have been minimised.

To enable such onerous responsibilities to be carried out properly the document calls for all listed companies to have 'significantly stronger' internal audit departments.

In particular, it recommends the establishment of the post of chief internal auditor to take charge of this activity. Such a person would be greatly experienced - possibly a former chief executive - and would report directly to the board on a regular basis. He or she could only be appointed or removed with the approval of a financial reporting and audit committee made up entirely of non- executive directors.

This is seen as an important victory by the IIA-UK's president, Neil Cowan, who said: 'Internal auditing operates from the top down, and focuses on the achievement of management's objectives at all levels and the adequacy of internal control in all areas.'

He said his organisation had always argued that internal control had a wider role to play, and had been disappointed that the Cadbury committee did not fully acknowledge this.

However, the Scots' report has other jobs for outsiders - a plan that many may feel will stretch the resources of appropriate personnel. In an effort to reassert the principle that auditors are appointed by and answerable to shareholders rather than the board, the document also proposes that each listed company set up an audit review panel, recruited from experienced business people with no other connection with the company, to appoint and decide on the fees for the external assessors, as the auditors would be renamed.

The panel would be responsible to the shareholders but would also take note of the needs of other interested parties, such as creditors, employees and the local community.

Professor Percy recognises that the proposals are far-reaching and novel. The starting point for discussion was a blank a sheet of paper rather than the status quo, he says. He also acknowledges that such changes will require legislation.

But a government with other matters on its mind might be open to lobbying from those who are likely to suffer from the planned reforms. And not only the big accounting firms will be counting the costs. Companies - especially those that do not already have audit committees - will incur additional running costs.

If, as is expected, an economic recovery produces a slackening of interest in corporate governance, this could be enough to kill off the proposals. But Professor Percy sees attractive operational benefits. 'If it's done properly it will have a good effect on the bottom line.'

(Photograph omitted)

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