HOW MUCH can investors rely on the statements of accountancy firms in auditing company accounts or on the judgments of rating agencies when assessing the creditworthiness of borrowers, whether companies or sovereign governments?
The question has been raised in the wake of the global financial crisis when the accountancy profession and rating agencies have faced strong international criticism for their contribution to that crisis. The European Commission has decided major reform is overdue in both areas and has made some progress in achieving it. From next year, credit rating agencies operating within the EU will be closely supervised and tightly regulated. And the commission is now proposing to make changes in how auditors operate.
It published a Green Paper on the role and function of auditors last month and has opened the subject to wider public consultation and debate before it adopts specific proposals. Encouraging participation in this process, Minister of State for Trade and Commerce Billy Kelleher has called for a strong response by the public “on the role and function of the auditor” in “the broader context of financial stability in the euro zone”.
Certainly, the accountancy profession in Ireland has suffered considerable reputational damage in its handling of aspects of the financial crisis, notably its auditing role in the banking sector. And it has some major questions to answer about its performance.
On an international level, a major concern raised by EU internal market commissioner Michel Barnier, in the discussion paper, is the potential threat to global financial stability posed by the dominance of the four major audit companies – Deloitte, Ernst & Young, KPMG and PwC. These firms act as auditors to most of the world’s major companies. Mr Barnier has called for international talks on a contingency plan to deal with the possible – and not inconceivable – failure of one of the four major auditors. Enron’s failure also resulted in the collapse of its auditor, Arthur Andersen.
No less a concern is the conflict of interest that can exist for accountancy firms where income from audit fees may be much less than income from other services that are provided to the same company. That raises the question of how independence can be assured when non-audit income in the form of consultancy services greatly exceeds that earned from performing an auditor’s primary function – to provide a true and fair view of a company’s financial performance and position.