Julia Irvine 22 Sep 2017 04:22pm

Profession defends audit in wake of HBOS decision

ICAEW chief executive Michael Izza has warned that the row over the decision by the Financial Reporting Council to close its investigation into KPMG’s role as HBOS auditor, risks undermining all the “very real improvements” in audit that have been made over the past decade

The financial crisis, he said in his latest blog, highlighted the size of the expectation gap between what the public thinks an audit is supposed to do and what its actual purpose is.

Since then ICAEW  has been working with the FRC, the firms and other audit stakeholders “to reinforce and safeguard audit quality”.

As well as the Audit Firm Governance Code, there have been improvements in the dialogue between auditors of banks and insurers and the prudential regulator to enhance the understanding of the roles and responsibilities of both parties, and new assurance tools including frameworks for Libor and capital ratios.

The profession is also looking at how technological developments such as artificial intelligence and machine learning can be used to improve audit and minimise the scope for human error.

“It is clear that there were lessons to be learned and it would be premature and self-regarding to imagine that there are not still things that must change,” Izza said. “But change has happened for the better and is continuing.”

Of course, audit has to scrutinise and re-evaluate constantly the role it plays in business and society. Similarly, seeking to improve audit quality and underpin trust in business was a never-ending quest.

But, he warned, there is a danger in focusing on individual cases and in trying to simplify discussions and investigations that are often “complex and comprehensive”. To do so could inflame public opinion and provoke kneejerk responses that have unintended consequences.

“The cry of ‘something must be done’ is too often siren to policy-makers who seek, from the best of intentions, the quickest fix.”

Earlier this week, the FRC announced that it had ended its investigation into KPMG and HBOS.

It had been looking into the reason why HBoS had been given “going concern” status in 2007, a year before it collapsed and had to be rescued following the financial crash.

In a decision that has proved controversial, the accountancy regulator concluded that there was no realistic prospect that a tribunal would make an adverse finding against KPMG.

This has caused outrage in the press with commentators accusing the FRC of being weak because of the vested interests of former Big Four employees who now work within its ranks.

As Nicky Morgan, chairman of the House of Commons’ influential Treasury Select Committee (TSC), said, “As early as 2004, the FSA [Financial Services Authority, the predecessor body to the Financial Conduct Authority] described HBOS as ‘an accident waiting to happen’.

“As the PRA [Prudential Regulation Authority] and FCA have since made clear, responsibility for its subsequent failure lies not with external market conditions during the financial crisis, but with the failure of its board to instil an appropriate culture, and to provide the necessary challenge to the executive. HBOS’ corporate governance was, in the words of the PCBS, ‘a model of self-delusion’.”

She pointed out that the FRC initially decided not to investigate KPMG's audit of HBOS but was forced to reconsider its decision after the TSC  concluded it was “a serious mistake” that suggested a “lack of curiosity and diligence”.

“It was only after pressure from the committee that the FRC decided to investigate the role of auditors in the bank’s demise,” she added.

And she warned the FRC that when it publishes its detailed report next month on its decision to drop the investigation, it will need to provide a full explanation, otherwise the committee might “take further evidence in due course”.

Speaking at a press briefing yesterday, though, PwC’s head of assurance Hermione Hudson suggested that, whatever improvements were made, audit would never be 100% foolproof because there would always be human judgment involved particularly since many of the key judgments were future looking.

Technology would undoubtedly lead to big improvements but at the end of the day data analysis was about looking for anomalies. Collusion between individuals would always be able to get round audits.

PwC’s UK chairman and senior partner Kevin Ellis added that it was easy to home in on the occasional mistake and ignore the thousands of audits each year that take place with no issues at all.