MANY COUNTRIES, including South Africa, are debating ways to improve audit quality and regain public trust in the profession. The recent auditing scandals have been highly visible and the intense media scrutiny has tainted all audits, even though the professional failure of one firm is not a failure of the profession itself. Still, it’s a good moment to step back and think about the kind of structural checks that are needed when internal governance processes fail.
Some think the answer lies in mandatory audit firm rotation (MAFR), which comes into effect on April 1, 2023. The idea behind MAFR is that the natural business imperative towards retention, and the familiarity that inevitably develops between clients and their auditors over time, is a risk to auditor independence and quality. Our regulator – the Independent Regulatory Board for Auditors –also believes MAFR will reduce audit concentration, creating a more competitive environment and accelerating transformation.
This naturally leads to conversations about dismantling the Big Four firms. Like most things, this issue is complicated by an intersection of interests: the public wants the Big Four to self-regulate better, the regulator wants to avoid future scandals, and shareholders wants the assurance that financial statements can be trusted. For their part, larger firms are also talking about splitting (or in some countries are being directed to split) their audit and consulting businesses, so a client’s adviser and auditor are not the same. One of the Big Four, for instance, announced it would cease doing non-audit work for JSE-listed companies from the end of March.
These solutions sound good in theory but come with inherent limitations in practice. For example, although MAFR can help to mitigate familiarity threats and dissolve audit concentration, practically we have seen that clients simply rotate horizontally within the Big Four businesses, which often makes sense because not all mid-size firms can offer the scale or deep specialisation that many clients require.
And on the question of strictly separating audit and advisory, we should not underestimate the extent to which advisory services can enhance audit efficiencies through developments in cybersecurity, biometrics, artificial intelligence and blockchain. Dismantling expertise could make collaboration, and therefore audit quality, more difficult and expensive to achieve.
Another solution: follow the public sector appointment model
In the private sector environment, new businesses is mostly generated by doing work for listed entities on the JSE at a fee determined by various forces of the market.
The process for auditing public institutions is different: private firms do not approach public institutions directly but apply to the Auditor-General, whose office sets out minimum entry criteria in terms of quality, cost and transformation commitments.
If a firm meets these criteria, it is accepted on to a panel of service providers, which the AG calls on as needed. The key point here is that the institution being audited is not the same as the institution that pays the auditor. And when you change this model of remuneration, you enhance objectivity.
A few years ago, I sat in on an audit committee meeting of a public institution and was amazed at how forthrightly the audit manager laid out his case to the audit committee chairperson. The audit manager was particularly effective because he was freed from some of the forced diplomacy that often defines the private sector’s relationship with its clients, where the value of relationships is paramount to securing future work.
I would suggest we apply the same model to the auditing of listed entities in the private sector. Let the JSE, for example, award audit work based on each firm’s availability of skills, capacity and transformation credentials.
The JSE will then compensate each audit firm directly, avoiding any of the fee and service conflicts inherit in our current working model. Put simply, we need to avoid being in situations where our diplomacy in front of clients makes us ineffective. Setting up a body of the JSE to assign work naturally requires funding to set up and would need regulatory support.
One could, for example, charge a small levy on the movement of shares to fund this body, because a founding principle here is to safeguard shareholder interests by auditing the auditors, so to speak. And, of course, there will be details to agree on – joint audits, sign-offs and split fee arrangements – but these can be worked out.
As a partner in a mid-size firm, I am conscious that this sort model benefits my working environment. But there is a larger, stress-tested principle here that says when you remove the complication of auditing a business you also want to retain, you help to keep the profession in check. And when you get that right, you lift up the reputation of us all.
Zak Sadekis a partner at BDO in South Africa.
* The views expressed here are not necessarily those of IOL or of title sites.
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