It’s been an insightful couple of weeks for me. I’ve had a very interesting three days delivering ICAEW’s ‘False Assurance’ video for the North West society. This shows how quickly apparently successful corporates can implode and how their auditors can be left between a rock and a hard place. Crucial viewing!

I also took the opportunity to read the joint letter from the Departments of Business Energy & Industrial Strategy and Work & Pensions dated 25 January to KPMG – auditor of Carillion. The letter asked for answers to some serious questions by 2 February.

http://www.parliament.uk/documents/commons-committees/work-and-pensions/Correspondence/Letter-from-the-Chairs-to-KPMG-Chairman-relating-to-Carillion-services-25-January-2018.pdf

Here are four of the questions from the joint letter that really grabbed me and that I feel are relevant for all auditors:

  1. ‘We are seeking to establish what services the Big Four accountancy firms have offered Carillion. We would request those details … and the fees charged’.

Amongst other things, the issue of ethics rears its ugly head here. Isn’t the auditor always going to be conflicted when carrying out a statutory audit of an entity it provides non-audit services for? The recent EU Audit Directive has addressed this issue (to an extent) for public interest entity audits but things carry on much as before for SME audits.

Regulatory bodies and file reviewers clamp down hard on firms that don’t properly embrace the FRC’s Ethical Standard and rightly so. Everything’s fine while audit clients prosper. But when things go pear shaped this perennial conflict comes sharply into focus.

  1. ‘In the light of Carillion’s collapse … do KPMG stand by their audit opinion that gave Carillion’s consolidated accounts a clean bill of health?’ 

The outcome of the going concern audit is easy to explain but very hard to grapple with at the sharp end. Auditing standards require a paragraph to be included in the audit report where there is a material uncertainty regarding going concern. Although this does not constitute a modification of the audit report, it feels to many (including clients and their bankers) as if it is. So the temptation is to leave it out – but at your peril!

This issue isn’t the reserve of large firms auditing listed PLCs. It’s one all auditors face and can be really tough when you’re focussed on getting the right outcome for the client.

  1. ‘Your 2016 audit opinion noted the risks relating to revenue recognition from contracts but concluded that there was no material misstatement in the accounts. Yet three months later a KPMG-led review resulted in an £845m provision in relation to these contracts. What changed?’ 

Regulatory bodies and file reviewers are tough on auditors that don’t demonstrate ‘professional scepticism’ when reviewing accounting estimates. Furthermore, auditing standards specifically require all auditors to assume a risk of fraud in revenue recognition – though this can be rebutted.

Because accounting estimates are, by their very nature, subjective, there can be a temptation for auditors to back off. After all there’s not a right and a wrong answer is there? And since the FD knows their business well, how could the auditor know better?

Professionally sceptical auditors are made of sterner stuff – but it’s not easy if it means putting the client’s nose out of joint! As the Carillion debacle may end up demonstrating, taking the easy option can come back to bite you when things go wrong.

  1. ‘Goodwill, at £1.57bn, is the single largest single item on the balance sheet. Did KPMG form a view as to whether this reliance on goodwill was sustainable in the long term?

Another conundrum for KPMG! IFRS accounting rules don’t allow the systematic amortisation of goodwill. This protects the balance sheet when things are going well – but when things take a turn for the worse an impairment review is required.

These reviews are fraught with complexity though and, in my experience, clients (and sometimes auditors!) will fight with tooth and nail to convince themselves that such a review isn’t required.

And if the company is in decline, the impact of any subsequent asset write-down on the balance sheet can be very severe.

In this moment, the position of the company auditor is a lonely place to be! Pushing for a major write-down might be the straw the breaks the camel’s back. And then the perennial conflict of interests comes back to bite – insist on the impairment and push the client to the brink? Or work for an outcome that keeps everyone happy?

Who’d be an auditor?!

Many of the issues here are brought brilliantly into focus by ICAEW’s False Assurance video.

For more information about how you can get access to the video for you and your staff, go to https://www.icaew.com/en/learning-and-development/icaew-educational-films/false-assurance

Peter Herbert (www.insight-training.biz)

February 2018