Call for reform of audit system that lets failing lenders slip through net

The financial crisis has exposed a flawed auditing model which allows banks to be given a clean bill of health just days before collapse.

Prem Sikka, professor of accounting at the University of Essex, says the model whereby one bunch of commercial entrepreneurs effectively regulates another bunch of commercial entrepreneurs is bro-ken, has not worked in the past and cannot work in the future.

Giving evidence to the Treasury Select Committee last week, Sikka says: “We need to see a fundamental change in accounting and auditing methods. Auditors are too close to companies – they get their fees from them and can’t bite the hand that feeds them.

“Auditors are paid a lot of money to make judgements and if they find something they have to disclose it – simple as that. Auditors are simply hiding behind the fact that they don’t want to upset their clients.”

Other witnesses at the inquiry into the banking crisis claimed that auditors could not shoulder the responsibility for guaranteeing the financial strength of banks or firms.

Michael Power, professor of accounting at the London School of Economics, says: “Auditors rely on firms’ management. If the manage-ment is not doing its job, misleads the auditors or doesn’t know what is going on in the bowels of the organi-sation it is difficult to expect the auditors to do better.”

And Paul Boyle, chief executive of the Financial Reporting Council, argues that it is not auditors’ job to investigate firms’ attitude to risk.

He says: “It’s not the role of audi-tors to report to shareholders on the quality of risk management practices in firms. It’s not clear to me that auditors are well placed or competent to do that.”

Boyle adds that although this approach is adopted in the US it would have a significant impact if the same responsibility were to be imposed on UK audit firms.

John Hitchins, UK banking lea-der at PricewaterhouseCoopers, agrees that the expectation that auditors can guarantee companies’ financial strength needs to be addressed, and says there should be no hesitation when it comes to bringing firms to book when they see holes in their accounts.

He adds: “If there appear to be problems the first step should be to tell the Financial Services Authority and the tripartite authority what’s going on rather than publish accounts and see what happens.”

Witnesses also voiced concerns that only a handful of firms possess the skills needed to carry out audits for the biggest firms.

Boyle adds: “We are exposed to risk because only four companies are capable of auditing the largest global organisations.

“It is important that legislators review the rules that prevent new firms entering the field – this is an issue we must not lose sight of.”