Auditor independence

Should auditors be multi-tasking? Dr Jill Collis and Professor Robin Jarvis consider the debate

The first ethic with which most budding accountants are confronted in their studies is the concept of auditor independence - in particular the idea of separating audit from other work for the same client. But, for many years in the UK, auditors have combined audit work with accounts preparation and other business services for pragmatic reasons.

From the client's perspective, it is argued that multitasking by the auditor increases the auditor's knowledge of the business and reduces the overall cost. At the same time, it is recognised that by performing a number of services to one client, auditors are likely to enhance their fees.

Not surprisingly, post Enron, WorldCom and Parmalat, the regulators are looking for scalps and have attacked large quoted companies and their auditors for what is perceived to be a lack of auditor independence.

In the UK, the Auditing Practices Board (APB) has responded by issuing sweeping changes that impose restrictions on the services that practitioners are permitted to provide. These include:

prohibiting an audit for any client that would constitute more than 15% of practice income
• restricting the representation of clients at tax tribunals, and
• restricting the provision of accountancy services, except where there is 'informed management' to oversee the non-audit work.

During the formulation of the APB Ethical Standards, ACCA and other Consultative Committee of Accountancy Bodies members emphasised that the ethical standards should strike a balance between dealing with external perceptions and restricting regulation to areas that raise genuine threats to independence. They also pointed out that many of the new requirements would be inappropriate for smaller entities.

To address this point, the APB issued a further Consultation Paper, Exemptions Available for Smaller Entities (APB, 2004). This proposed that entities with a turnover under the audit exemption turnover threshold of £5.6m should be granted relief from some aspects of the requirements. Although this would have lessened the burden on auditors, the overall impact would still have been to alter the balance between costs and benefits of the audit for small businesses. Indeed, the Forum of Private Business and the Federation of Small Business issued press releases expressing their anxiety over the proposals and, eventually, the APB received an unprecedented 583 (almost all adverse) responses to that exposure draft.

The imposition of ethical standards on the auditors of small businesses is typical of the top-down way in which 'little GAAP' has developed in the UK. What regulators generally fail to recognise are the particular needs of small businesses. A survey for the DTI by Kingston University (The Collis Report, 2003) examined the views of directors of 790 small companies. The findings of this study offer evidence that makes an important contribution to the independence debate.

In 85% of small companies, the accounts are prepared by an external accountant, even though 31% of companies in the study employ a qualified accountant. Among those that were eligible for audit exemption, 42% chose to have a voluntary audit. The study found that in companies where the preparer of the accounts was also the auditor, the following additional services were used:

• taxation services
• VAT services
• written explanations/analysis of the annual results, and
• advice on raising finance.

These findings link with the factors that drive the demand for voluntary audit. The directors are willing to pay for the audit because they see it as improving the quality of the financial information, having a positive effect on credit rating and providing a check on records and systems. They also want audited accounts to provide assurance to shareholders and lenders, as well as the tax authorities. The accountant is in a far better position to provide an analysis with the year-end results and advise on finance with the detailed knowledge of the business gained from the audit.

The overlapping nature of services provided results in lower fees. If the audit were conducted by another external accountant, it would have an adverse effect on the quality of financial and management advice, delays in decision-making and, more importantly, increase costs for smaller entities.

The research reveals that the directors of small companies have a valued and longstanding relationship with their external accountant; most commonly, this was an association of at least 10 years. This evidence adds up to small private companies having a very different relationship with their external accountants than large quoted firms. Therefore, the notion that the audit function can be separated from other services provided by the external accountant will clearly not reflect the reality for small businesses.

Dr Jill Collis is a senior lecturer at Kingston University and Professor Robin Jarvis is head of small business at ACCA and professor of accounting and finance at Kingston University.