Russian Corporate Governance Roundtable Meeting
(OECD / Tacis)
• Statutory Audit of Financial Statements;
• Who audits the auditor?
Geoffrey Townsend; Team Leader
Moscow, 11th November 2004
Introductory Comments
Professional Bodies
External Quality Assurance
Public Oversight
Summary
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Introductory Comments
Caveat:
- all views expressed are personal views.
They are not:
- the views of the European Commission,
- the views of the consortium partners.
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Introductory Comments
Who are the users of financial statements?
Views differ
broader definitions talk about
stakeholders.
In this presentation, I shall use a narrower
definition.
- Investors, by which I mean:
current and future –
Minority Shareholders
Lenders.
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Introductory Comments
What Users want:
• A flow of useful, current and accurate information from the
management.
• Most of that information is unaudited; i.e. will be taken on the
trust of management.
• A part of that information is annual final statements.
• Audit is an external, independent verification of those financial
statements.
• Audited financial statements are usually too late for many
investment decisions.
• If there are no surprises, they reinforce trust in management.
• If there are surprises, they reduce trust in management
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Introductory Comments
History of Audit:
Audit has been a response to the possible problems arising from the
division of management from ownership.
Originally, auditors were a committee of shareholders independent of
management.
Increasingly, this task was transferred to outside experts; later this
became a legal requirement.
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Introductory Comments
History of the Audit profession:
•
•
•
•
•
Auditors began to form professional organisations, modelling
themselves on medieval guilds.
These guilds represented the interest of their members, and
simultaneously protected public interest.
Later, these guilds received legal privileges
1. Restriction of use of name
2. Exclusive right to certain types of business – e.g.
statutory audits.
On the whole, the guilds worked well; but there were
scandals.
Guilds have an inherent conflict of interest
– members interest vs. public interest.
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Specific Problem of Audit Control - 1
“Normal” Contract Structure
Customer
Goods/services
Contract
Payment
Supplier
General
– Normally subject to mutual agreement,
i.e. freedom of contract
– Normally, assume parties are equal and
knowledgeable; each knows what he is
doing; each protects himself
Role of state
• Contract law framework
• Court system (last step in dispute
resolution)
• Protect “weak” customers
• Standards (simplification of contract)
• Protect third parties
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Specific Problem of Audit Control - 2
Auditing
Enterprise
Service
Delivery
Financial
Statement
Contract
Fee Payment
Election of
Auditors
User
Auditor’s Report
Lawsuit (??)
Auditor
Triangular Problem
– User not enterprise, but 3rd party
– User not interested in audit technique, only in
result
– Appointment of auditor
• De jure – shareholder
• De facto – management
• Also users such as banks, not involved at all
Role of state and SRAAs
SRAAs are “experts”; detail is very technical
– Represent users’ interests
– Set legal framework
– Ethical guidelines
– Legalize standards (codification of service)
– Minimum quality
– Set barrier to entry
– Ensure auditors “up-to-date”
– Force enterprise to appoint auditors
– Police quality
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Professional Bodies
Membership
Accountants?
Auditors?
Audit firms?
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Professional Bodies
Activities
Members’ interest:
– Lobbying
– Training
– Conferences
– Publications
Public Interest:
– Examinations (?)
– CPE Monitoring
– Compliance + Disciplinary
– Inspection
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Regulation and Discipline
Traditional “triggers”
• Complaints
• Scandals
• Professional investigations
• Government investigations
• Legal Actions:
- civil,
- criminal.
Problem
Shutting the stable door after the horse has bolted.
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Regulation and Discipline
Pre-emptive measures
• Standards
• Ethical code
• Curriculum
• Pre-qualification training
- theoretical
- practical
• CPE monitoring
and – increasingly
• inspections
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External Quality Assurance
Two triangles or one rhombus?
Audit firm
Professional
Organisation
Audit Assignment
Auditor
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External Quality Assurance
Inspect what?
• Procedures
• Independence
• Specific audit assignments.
Inspect whom?
• Firms
• Auditors
Inspect how often?
What to do with results of inspection?
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Public Oversight
“Auditing too important to be left to auditors”.
“Chaps controlling chaps”.
Professional Organisations have a conflict of interest; they
must represent interests of
• Members (who pay their subscriptions and
complain)
• The Public (who only complain)
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Public Oversight
Intrinsic problems
The topics are very technical
Meaningful inspection only possible by someone with at least the skills of
the person being inspected.
Boredom risk
• Intrinsic boringness of subject
• Night-watchman syndrome
• Are results being taken seriously?
Source and remuneration of inspectors.
Parallel Problem (analogy)
How can independent director monitor management?
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Public Oversight
Oversight
How it fits together
Standard
Setting etc.
yardstick
Professional
Organizations
Audit firms
Users
yardstick
Audit
Audit
Engagements
Board
Chief Accountant
Accountants
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Public oversight of Professional Bodies
Members
Public
Representative
Professional
Organisation
Oversight
Public Interest
Activities
Member Interest
Activities
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Who should be the focus
of quality assurance?
The problem:
There are very many small firms and only a few big
ones.
This is not purely a Russian problem:
Germany (WP only)
UK (ICAEW only)
But:
Auditors
Audit firms
12.194
29.947
2.178
16.010
the focus of POBA in the UK is FTSE 350.
Big 4 – 97%!
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Summary
Audit too important for auditors
Public oversight essential to improve perception of auditors.
Inspection of audit firms and audit engagements is an essential element.
Done well, inspection can help improve standards; focus on
recommendations and follow-up rather then disqualification.
Thought must be given to the quality and training of inspectors
Inspectors’ remuneration will be an issue.
Prioritisation is important.
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Prioritization
Who is to be inspected:
• Important to cover auditors of public interest companies.
• But for smaller audit firms, inspection could be a real
help.
What is to be inspected:
Personal view:
• In addition to a general programme tailored to the size
of company inspected and complexity of clients.
• I would suggest that MinFin publishes a lot of special
concerns on which there should be focus.
e.g. Related Parties
Pocket auditors.
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Presenter’s contact details
Geoffrey Townsend
tel: 937 – 29 – 51
e-mail: gtownsend@kpmg.ru