Value of Audit | Relationships | KPMG | BS

Value of Audit | Relationships & third-party perceptions

Value of Audit | Relationships

The main focus is on improving the understanding of clients and investors, but there was also agreement that the profession should do more to contribute to the transparency of public interest clients.


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In conversation with:

  • Charles Krieck Head of Audit, KPMG in Brazil 
  • Marc Hogeboom Head of Audit, KPMG in the Netherlands 
  • Joachim Schindler Former Global Head of Audit, KPMG International 
  • Sai Choy Tham Head of Audit, KPMG in Singapore 
  • John Gordon Head of Audit, KPMG in Canada

Introduction by Andrew Mills

Andrew Mills is a freelance analyst and writer, specializing in financial services. Before becoming a freelance he spent seven years as an equity analyst. He began his career as an auditor. He is a member of the Institute of Chartered Accountants in England & Wales and the Chartered Institute for Securities & Investment.

Q. Can auditors ask the truly tough questions? Aren’t they simply too beholden to management?

Charles Krieck (CK): Auditing is a human science. We should admit that close client relationships, combined with the wrong mind set, can make asking tough questions a problem. But a good relationship is essential – is a bad one supposed to make asking tough questions easier? In 28 years as an auditor, I have never seen a critical situation where an auditor failed to ask the necessary questions of management.

Marc Hogeboom (MH): I completely agree that auditing is a people profession. So standards will never be completely uniform. Independence has been high on our agenda for years, but we have failed to engage in the public debate. As a result in the Netherlands we now have mandatory auditor rotation. Rotation certainly brings a fresh perspective, but I’m not sure it actually improves independence or audit quality.

Joachim Schindler (JS): I think there is a tension between the need for a critical perspective and for positive relationships. We should not shy away from this difficulty. A lot depends on the audit committee or supervisory board; if it is as independent as it should be, the tension goes away. In reality this is not always the case. But a lot of regulatory and professional safeguards have been built up over the last 10 to 20 years.

Sai Choy Tham (SCT): I don’t see independence as today’s most pressing issue. Does independence still need to be monitored, and if possible improved? Absolutely. And safeguards continue to be strengthened. But to me this is a bit of a red herring. It should not be the profession’s greatest priority.

John Gordon (JG): My perspective comes from watching and talking to more than 200 working audit partners. In my experience, they believe their lot in life is to help clients get to the right answers. To do that they need relationships that are professional, but allow them to ask tough questions. Management and audit committees have front row seats, and they absolutely believe that auditors are independent.


Q. Is it fair that the audit profession has been blamed for failing to predict the financial crisis?

SCT: It is unfair to blame auditors for failing to prevent the financial crisis. But I think we deserve to be criticized in other areas. One is that we have not challenged the view that we should only talk about historic information. Another is that we don’t use fully the vast amount of information we gather in the audit. Auditors are capable of communicating much more information than simply an audit opinion over historic financial data -- we know a lot about the companies we audit and can use this information to help other stakeholders fulfil their roles.

CK: If governments, regulators, the IMF and the World Bank failed to prevent the crisis, it is unfair to blame auditors. But the profession has been shy – maybe even afraid – to discuss what an audit can and cannot do. If we had communicated better in the past, skepticism towards the profession would be less than it is today.

JG: Financial statements are like looking in the rear view mirror of a car. It can be interesting to learn about a place you’re never going to see again. But it’s not so relevant to where you’re going. So yes, I think a lot of the criticism is understandable. The challenge is to move away from the historic focus, but without blanket protection from liability. I don’t think society is quite ready to provide that yet.

MH: If auditors had the ability to predict financial markets, then we would not be auditors at all – we would be making a fortune as investors! Still, I think that most of the criticism the profession has received is an understandable reaction to our failures of communication. There are a number of expectation gaps that we need to bridge in order to rebuild our reputation.


Q. If audits were not required, would we have them anyway? Do they create real value?

JS: The value of an audit is something that never gets talked about. The profession should take the blame for this. We are always on the defensive. An audit helps to identify icebergs – potential hazards that otherwise wouldn’t be seen. And who would buy an unaudited company? The world may be changing, but audits are still needed, not least because of their preventative role. But the changing world also means that the audit profession needs to develop existing and new services that clients want and require.

JG: In Canada, there is no statutory requirement for unlisted firms to have an audit. But banks considering a loan, private equity firms and other potential investors demand them. So there are lots of very smart stakeholders who insist on audits. That shows they attach a lot of value to the product. But is some of it negative value? Maybe – the feeling is that if something goes wrong you would wish you had demanded an audit.

SCT: If audits did not already exist, we would certainly need to invent them. Management, shareholders, banks and capital market participants would want them. But would we invent the audit product in its current form? I doubt it. We would report not just on results but also on risks, not just on numbers but also on narratives, not just once a year but continuously. The output would change, and as a result so would the process.

CK: In Brazil, the number of companies required to have an audit is far smaller than the number that choose to have one. So I do think the audit is seen as having inherent value. Whatever the failures of our communication, investors think a third party attestation is vital. But are audits seen as having as much value as they should? I’m not so sure.


Q. In that case, how can the profession enhance the value of the audit?

CK: We need to do more to explain our ability to detect fraud to the marketplace and to society. We need to be clear that when we issue a report on a particular piece of information, we are not giving an assurance on the whole business. And I think we could make our overall approach more predictive. This could never be insurance against the future – unless someone is willing to pay for it. But it could happen.

JS: I think we should concede that an expectation gap has developed, particularly over fraud and going concern. A lot of people believe that an auditor’s signature means that no fraud has taken place. This is not possible. But if society expects us to do more on fraud, I’m sure we could find a way to say more without issuing a guarantee. And on the going concern side, I agree that we need to become more future-oriented in our work.

MH: It is not enough to say that we should communicate better. We must communicate better. But in the long run, we need to be more innovative and increase the quality of our audit services. This is not only the best way to create value for our clients. It will also allow us to address fee pressure and ensure the long term future of the profession.

SCT: I don’t think we can add much value just by changing how we audit. We need to focus on what we audit. Some of my clients issue so many reports that I can hardly keep track, and they would like to see them all audited. But again and again I see firms running away from assignments because they don’t have cover from a specific auditing standard. It is up to us as a profession to adapt. We need to maximize the potential value we can provide to our clients.


Q. So how much of this is about investor perceptions and the demands of capital markets?

JG: Wholesale investors see the information auditors hold as largely irrelevant. They would like us to opine on management’s forward looking statements. But boy, that’s hard to do. Even so, I think auditors could share more of the insights we get from our access to management. In the long term, we need to focus on all the information that investors value. Companies regularly disclose lots of valuable information – like airlines’ load factors or natural resource companies’ production volumes. I believe auditors should focus on validating all this financially relevant information.

SCT: I look at the financial information that capital markets need, and I see very little overlap with what we audit. If an audit is useful, why is it only useful every fourth quarter? Ideally, auditors would be able to state that all financial information is accurate. Doing this in real time is probably impossible. But the first step could be to retrospectively check all financial information released to the markets. People have traded on this data – was it accurate? That would put more scrutiny on how data is compiled and released. And over time the process would become quicker and quicker.

JS: I’m not sure that asking what professional investors want will lead us down the right road. For example, auditors can’t discuss alternative accounting treatments – as I often hear investors ask. But we could certainly make our work less backward looking. If clients want us to we could analyze risks, budgets and business plans and discuss them with audit committees. But this is difficult to imagine in today’s litigious environment. We also need to think about how this could be communicated to the public.

MH: In the Netherlands we are working with shareholder groups to understand their needs. We have already taken a small but significant step by talking about our role as auditors at annual meetings. But the real goal should be to move beyond our traditional focus on the financial statements. This means auditing other statements and metrics that our clients publish, and perhaps doing more work on sustainability. It might also involve auditing soft controls, such as the influence of individuals or organizational culture. But for now that remains something for the future.


Q. How about public perceptions and the needs of the wider community?

JG: Poor public perceptions of auditors carry a real risk – the risk of intervention in the industry. Talking more with the users of our reports is one way to address this. After all, if you’re buying a house, you would welcome the chance to talk to the surveyor. Regulators could easily gain some insight from talking more with auditors, but communicating with large groups like retail investors could be harder to manage.

JS: I agree there should be a wider debate over the availability of auditors to shareholders and analysts. Perhaps all auditors should be required to take questions at an AGM, as they already are in the US and the Netherlands. However, a fair number of issues would need to be resolved, especially confidentiality and other legal questions that differ from country to country.

MH: Public communication is vital. As well as saying more about our own work, we would like to discuss management statements and board reports at shareholders meetings. But as a profession we have to balance the needs of external stakeholders with our duty of client confidentiality. So these improvements will only be achieved with the consent and support of management and supervisory boards.

CK: I certainly believe auditors should be more available for informal discussions with external groups. A forum connecting auditors with economists and regulators could help to stabilize capital markets, if a working group could identify the key indicators to monitor before they turn red. If the profession could diminish the impact of future crises, it would create great value for the economy at large.


Q. What about audit opinions and public reports? Should they move beyond the current pass/fail format?

MH: In my view, introducing extended audit opinions that say more about going concern, materiality and risk assessment is one of the most important steps the profession needs to take. There is no question that this is a difficult road to go down. The more that we disclose, the more likely we are to trigger claims and legal proceedings. But taking an entirely legalistic approach is not an option.

JS: There is no doubt in my mind that we as auditors should communicate more. The way we currently issue pass/fail opinions is certainly not sufficient. One thing we could do is to talk more about critical areas of the audit – if it could be done without giving away too much commercially sensitive information.

JG: The key question is whether the profession is willing to be open minded about the product of an audit. The public are skeptical about the value of binary audit reports. If we provided the kind of conclusions and explanations that investment advisers do, our reports might carry greater value. I think much more could be said, including some sort of judgment on solvency. Auditors, with our access and expertise, must be able to do better than something which is little more personalized than a stamp.

CK: I would be very supportive of longer, non-standardized audit opinions. Something closer to a true report that spells out what we have – and have not – done. Perhaps in future we could also look at issuing graded opinions. But users would need to understand that they could not rely purely on an auditor’s report when making investment decisions.

SCT: There is a place for pass/fail opinions, but they don’t meet all needs. For investment professionals, they are a useful sign that the numbers have been validated. But if we expand the information that we audit, we will also need to expand the range of reports we provide. This means we need to get past a USbased view of legal risks that is counter-productive in many markets. The profession needs to recognize that we are living in a changing, multi-polar world.


Q. Do you have any final thoughts?

SCT: We need to stand up and be willing to try to meet clients’ needs in the ways they want, as unrestricted by legal risks or auditing standards as possible.

JG: We should focus on all data that companies put out. And we should communicate better with investors, regulators and other audiences. We need to broaden our communication and our deliverables.

CO’H: We must recognise that there is a wider societal role in what we do and focus our efforts in rebuilding the public’s trust in us as a profession.

MH: Greater openness – in a range of areas is the single most important improvement the profession can make. But openness is not the whole story. In the long term, we need to up-scale our abilities.

JS: At the end of the day, we need to be clear that auditors are running a business. We can’t rely on regulation or legal requirements to sustain us. If the profession doesn’t evolve, it risks repeating the fate of other industries that failed to realize the world had changed.

© 2017 KPMG, an Irish partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

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