Master health check-up of the Big Four

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WHAT is the quality of audit conducted by the Big Four? On this, an important report by the Professional Oversight Board for Accountancy (POBA) was out on Monday. POBA is part of Financial Reporting Council (FRC), UK's `integrated independent regulator for financial reporting, auditing and corporate governance'.

The 32-page pdf that can be downloaded from details conclusions drawn by the Audit Inspection Unit (AIU) of the POBA based on inspection carried out between June 2004 and March 31, 2005 at Deloitte & Touche LLP, Ernst & Young LLP, KPMG Audit Plc and PricewaterhouseCoopers LLP.

This is the first public report and so the POBA has explained its monitoring approach and objectives. That could come in handy for Indian regulators.

"Our monitoring approach is intended to be more challenging than in the past, focusing on judgments as well as audit processes," states the report. "Our reviews of individual audit engagements indicated that the key audit judgments exercised in relation to financial reporting issues appeared, in the great majority of cases, to be both appropriate and soundly based."

"However, as a result of insufficient documentation, it was often necessary to form a view as to the appropriateness of such judgments on the basis of oral explanations provided to us," states the report, blotting the reputation of accountants as efficient book-keepers and record-maintainers.

"Our inspections identified no systemic weaknesses in the overall policies, procedures and systems of quality control operated by the firms and indicate that, when properly applied, those procedures and systems should provide reasonable assurance that appropriate audit opinions are issued by the firms," observes the report.

"However, we have identified certain areas in which we consider that improvements to these policies, procedures and systems, and/or the application thereof, should be made, either to achieve compliance with relevant standards or to enhance audit quality." That explains why the POBA's Chairman, Sir John Bourn, opined that Big Four auditors "do well overall, but they could do better still."

AIU's focus was on the quality of auditing, not merely compliance with regulatory requirements. The rationale is explained thus: "By monitoring and promoting improvements in audit quality, we contribute to the FRC's overall aim of promoting confidence in UK corporate reporting and governance." On what audit quality is, the report has this to say:

"An appropriate audit opinion to shareholders which is independent, supported by sufficient and appropriate audit evidence, and supported by objective judgments. A report to those charged with governance which is complete and appropriate to the circumstances." If that sounds quite simple, the para on how audit quality is assessed would remind you of what you studied in the 101 on auditing standards, the old SAP-1.

As the POBA puts it, "Audit quality inspections involve assessing the independence of the auditors, the sufficiency and appropriateness of the audit evidence obtained and the appropriateness of the key audit judgments made." Since a review cannot be expected to access client records, or re-perform audit, the Board assessed `key factors driving audit quality which are inputs to the audit process' such as leadership, HR, ethical policies, engagement performance, and monitoring.

A significant finding in the report is what we always knew that the documented goals and objectives established for partners, against which their performance is measured, focussed mainly on commercial considerations, such as revenue growth and profitability, with generally only limited visible focus on quality indicators. Again, in partner promotions, leadership skills and the ability to generate new business were important, not quality considerations.

One wished an exercise similar to POBA's were carried out in India too!

D. Murali

(This article was published in the Business Line print edition dated June 23, 2005)
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