Technical
9 Aug 2012

When audit doesn't add up

As scrutiny of audit grows outside the profession and audit exemption levels increase, will small practices step away from an increasingly unreliable income stream? Liz Loxton reports

A parliamentary probe into the audit profession, European Commission scrutiny and a banking sector in a fragile state of repair – all these are telling reminders that auditing large public interest companies can be risky.

But business risk for auditors doesn’t dissipate when you look at smaller-scale audits. Small firms of accountants, from sole practitioners to firms with a handful of partners, are increasingly finding the balance of risk and reward for audit work to be adrift.

Some 3,800 firms of chartered accountants are registered with ICAEW to carry out audit. Registration is not mandatory, says Paul Simkins, director of quality assurance at ICAEW, but is required for firms that want to conduct audit or related work. Registration, he believes, goes a long way to signalling a firm’s commitment to quality. “If they don’t have the right client base or a range of clients who together make it worthwhile to be in audit they may choose not to retain their registered auditor status. Our firms will have a pretty clear idea of when it is worthwhile and when it’s not,” he says.

While the decision to hold registered auditor status is a business one, Simkins says firms should recognise that not only would deregistering rule them out of audit as a line of business, it could also rule them out of other activities. Firms of solicitors that hold client money require an accountant’s report carried out by a registered auditor, as do some travel agents, employment agencies holding client money and government bodies. “We would say to firms that they do need to be careful about whether their clients need the services of a registered auditor,” he says.

Practice adviser Phil Shohet, director of KATO Consultancy, says the firms he sees tend to fall into two camps. “One type of firm will say: ‘We are in this to make money. If someone comes to us and says they require an audit we can make a commercial decision on maintaining our registration’. The other perspective is to do with the fact that there is still a degree of cachet around audit. Whether they make money at it or not, dispensing with audit is unthinkable to some firms.”

For firms that would like to become registered auditors, the ins and outs of registration don’t appear contentious from ICAEW’s perspective, Simkins says. But it does acknowledge dissatisfaction among members over issues such as the tough demands of the International Standards of Auditing (ISAs) that must be applied to small and large clients alike.

A common concern coming through on ICAEW’s helplines is keeping up to date with ISAs and how they should be applied. But working in a highly regulated and public-interest field such as audit necessarily involves a degree of squaring up to the realities of compliance, Simkins points out.

“We tend to say an audit is an audit. If you are going to provide a service within a regulated area then you need to comply with the requirements as they stand,” he says.

For some, audit exemption levels, which have been increasing over the past decade, are the issue. As clients fall out of the audit net firms see less of a need to register. And an audit can still appear demanding to those smaller businesses that qualify.

“The government should look at alternatives to a full ISA audit,” says Simkins. “The UK has some of the highest thresholds in Europe, but an audit needs to mean something very specific and needs to be carefully regulated.”

Stephen McAlpine, whose firm SBM provides assurance services to small audit firms, says audit exemption increases mean firms are often prompted to decide whether audit registration is worthwhile.

If a firm has clients that would require an audit regardless of exemption levels, then registration is a no-brainer, he says. But others will start asking themselves whether it’s time to move out of the audit market. “All of them recognise that this is a one-way street,” he says. “Once they close the door to audit they are unlikely to open it again.”

Some practices may find their need for audit services fluctuating – if their clients experience peaks and troughs in turnover for instance. In such cases should the practising certificate, which all practising members must hold, cover small-scale audit? Simkins points out that practising certificate holders are also subject to monitoring by QAD and are expected to maintain high standards of CPD and experience.

So what are the requirements and how do smaller practices decide whether they stack up? Small firms – a sole practitioner with one office, for instance – would pay an annual registration fee of £405, which includes inspections by ICAEW’s quality assurance division. There are other costs, too, such as CPD, adequate systems and technical update services. Audit faculty membership costs £200 and is something ICAEW recommends. Checks on audit conduct and activity by a specialist firm – known as cold file reviews – are recommended. The cost can vary a lot, about £200 per review to £1,000 for a day’s coaching, but the QAD finds fewer problems with firms that commission external reviews, Simkins says.

The flipside of audit, meanwhile, is risk. Many small firms are well set up for tax computations and business advice, but don’t have the critical mass within audit to make it worth their while keeping up with CPD, systems and training, reviews and annual fees.

Firms’ decisions about maintaining an audit function will be driven by clients. And clients buy one of two things, believes McAlpine – solutions to problems or good feelings. If there is no problem to solve in the form of a regulatory requirement and clients don’t derive added assurance from the notion of having an audit, why would they buy it?

Given that backdrop, maintaining and staffing a viable audit function is seen as increasingly onerous. “It’s not that easy to get good audit staff,” says Shohet. “Non-audit staff are easier to find.”

 

Case Study: Peter Mitchell & Co

Peter Mitchell, a co-partner in Buckinghamshire firm Peter Mitchell & Co and chairman of the Society of Professional Accountants (SPA), says audit is increasingly a specialism rather than a given for small practices. The number of small accountancy firms providing audit has been falling over the past decade. According to a report from the FRC’s Professional Oversight Board last year, Key Facts and Trends in the Accountancy Profession, the number of audit firms registered in 2010 (7,457) was 21.9% lower than in 2005.

From the SPA’s perspective, as audit exemption limits have gone up the number of clients requiring an audit has fallen. Those dwindling numbers plus the compliance and registration burden of audit mean audit business starts to look too onerous.

About four years ago, Mitchell and co-partner Bridget Makinson decided audit was no longer
a viable business stream for the firm. The risk of giving up audit – losing clients to other firms – has been offset by business it has picked up as result of increasing complexity on the taxation side. “The gap caused by giving up audit has been largely filled,” says Mitchell.

What’s more, the firm can be less compliance-driven and more proactive with clients. “We can give them greater guidance,” he says, “rather than piling the data into a set of accounts at year end.”

Giving up audit work is a one-way decision, Mitchell says. But few firms appear to regret it. His experience is that it improves work-life balance. “There is less stress and less concern that you might do something to disappoint the regulators.”

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