UK Treasury Committee Says Auditors of Company's Financials Should Neither Perform Non-Audit Work Nor Give Assurances on Risk Management

Concerned about auditor independence, the UK Treasury Committee recommended that the firm that audits a company’s financial statements should be prohibited from doing non-audit work for the company. The Committee has asked the UK’s audit oversight regulator, the Financial Reporting Council, to consult on this proposal at the earliest opportunity. While independence is just one of several determinants of audit quality, noted the Committee, audit firms face strong incentives to temper critical opinions of financial accounts prepared by executive boards if they perceive such opinions could put non-audit work in jeopardy. Even more important, emphasized the Committee, investors are skeptical that audit independence could be maintained under such circumstances. The problem is exacerbated by the concentration of audit work in so few major firms.

The Committee is particularly concerned about auditors earning fees from non-audit work arising from securitizations, especially where assets are held off-balance sheet. The Committee heard testimony that financial audit is the only kind of audit in the world which permits an auditor to also act as a consultant or advisor to the same firm.

Noting that complexity of financial reports caused a missed opportunity to improve the understanding that users had of a firm’s financial health, the Committee asked the FRC to consult on ways in which financial reporting can be improved to provide information in a more accessible way. At the moment, financial reports can be used for finding specific bits of information, said the Committee, but they do not tell the reader much of a story.

The Committee said that financial statements should read less like dictionaries and more like histories. A useful approach would be to require firms to set out their business model in a short business review, in clear jargon-free English, to detail how the firm has made or lost its money, and what the main future risks are judged to be.

More broadly, the Committee said that, while there is very little evidence that auditors failed to fulfill their duties, the fact that firms failed soon after receiving unqualified audits raises questions about exactly how useful the audit currently is. The Committee is concerned that the process results in tunnel vision, where the big picture that shareholders want to see is lost in a sea of detail and regulatory disclosures.

The Committee also criticized the FSA's piecemeal approach to garnering auditor knowledge about individual firms as a wasted opportunity to improve the effectiveness of regulation. The Committee urged the FSA to make far more use of audit knowledge, on a confidential basis.
The Committee rejected the idea that the role of the auditor should be redefined to include risk management duties. The Committee noted that auditors are not particularly well placed or even competent to provide additional assurance regarding the risk management practices of financial institutions.

In addition to increased liability risk, noted FRC CEO Paul Boyle, extending the remit of audit to incorporate assurance regarding risk management could be harmful at a national level without corresponding international agreement. In the Committee’s view, a better way to ensure that firms manage their risks would be to concentrate on a firm’s own internal risk management functions, complemented by more invasive regulation of risk by the FSA.