In Defense of Auditors

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IMGCAP(1)]In a recent article on Accounting Today’s website, Auditors: Friends or Foes, Jillian Rojas explored an interesting comparison between public company auditors and the police.

Leaving the policing side for another time, and for those with competence in the theory and practice of police science—some further exploration of the function and role of the auditors is indicated

Rojas sees a “clear conflict of interest” in the auditor/client relationship because, as she puts it, “public companies hire auditors because of an obligation to scrutinize their financial statements … not on their behalf, but on behalf of the public, outsiders and government agencies.” She goes so far as to describe the model of client-provided compensation as an “ongoing unethical activity”—one that is “enabling crime” and “simply unethical and illegal.”

Some historical perspective might well serve to reduce the heated tone of this rhetoric. To start, it should be remembered that, ever since the original development of the “independent” audit function in the middle of the 19th century, “client pays” has been the only relationship model to stand the tests of practical application, broad user satisfaction and acceptance by the capital markets. 

Private delivery of audit services under “client pays” has been challenged, but prevailed—in England in the 1860s when Parliament first required audits of the railroads, and in the 1930s with passage of the foundational U.S. securities laws. The concept of auditor obligations to third parties and the eventual layering on of legal duties also followed. But however subject to debate and criticism over the elusive and shifting limits of “appearance of independence,” the fundamental principle of auditor selection and payment by the company has a history spanning over 160 years.

Likewise, from today’s end of the timeline, Rojas’s further suggestion that “clients should not be allowed to choose the firm they work with” appears— rather than being “rather practical” in implementation, as she puts it—to be a considerable step too far.

Although Rojas presents no particulars of an alternative mechanism for the selection, assignment and payment of public company auditors, the concept of a supra-national audit supervisory authority defies both the logic of global business reality and the capability of the agencies of government.

Simply put—and with focus on the large-company sector of the global market, as completely dominated by today’s Big Four networks—the question practically answers itself, “What structure of civil servants could conceivably be authorized and capable of evaluating and choosing among competing Big Four networks, when the execution of a global-scale audit engagement could involve the personnel and resources of separate country-level firms in 125 or more different countries?”  

Auditor skills and resources are neither fungible nor transferable, either by geography or by industry specialty. To pick a single, simple example, while KPMG is by far the dominant firm serving large companies based in Germany, across the border in France it has by good measure the smallest presence among the Big Four in that market.

Consider the limits on the jurisdiction, geographic scope and effectiveness of even the most mature of the world’s regulators—the Financial Reporting Council in the United Kingdom or the Public Company Accounting Oversight Board in the United States. How could a regulator with limited remit, staff, language skills and resources hope to make a selection on behalf of, say, a large American-based company such as Apple or Ford or JP Morgan Chase, whose far-flung operations would require audit expertise in each of those foreign countries (and scores of others)?

The persistence of the “expectations gap” between auditor performance and the professed needs and desires of financial information users make entirely legitimate the kind of inquiry proposed by Rojas about the nature and value of the current audit model.

At the same time, a grounding in both history and the dynamics of the marketplace should shape the dialogue for which she calls.    

Jim Peterson, an attorney who specializes in representing international accounting firms, regularly blogs about accounting and auditing and is the author of the recently published book, Count Down: The Past, Present and Uncertain Future of the Big Four Accounting Firms.

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