It could be seen as a cry for help: the world’s biggest accounting firms on November 8th unveiled their vision for the auditing business of the future. In their Utopian fantasy, out would go quarterly reports loaded with complex historical figures and rules-dictated footnotes. Instead, readily accessible updates on a company’s state of health would be posted in (almost) real time on the internet.
Not only would this put more onus on companies to post meaningful, rather than selective, information on their websites; it would also conveniently reduce the potential liability of the auditing company. An auditor would apply principles, not rules, to judge the fairness of a company’s numbers. And the judgment would be a rolling opinion, not one set in stone at the end of each reporting period.
Neat, it is true, yet a bit naive. The beancounters are right that few investors or analysts use financial reports as anything more than a rear-view mirror these days. They would prefer forward-looking information including “soft” data on customer relationships, staffing levels and product development.
But whether such information can be standardised enough to be computer-readable for comparison on company websites is questionable. So is the likely effect on share-price volatility of quasi real-time data: would it make some investors even more short-termist in their outlook? And how would the market cope with the inevitable revisions?
There are other practical difficulties. After years of toil, auditing firms are still wrestling to reconcile America’s rules-based GAAP (generally accepted accounting principles) with their international counterpart, IFRS (international financial reporting standards), which rely more on broad principles. And some companies doubt the wisdom of IFRS at all.
Partly, their exercise appears to be a clever attempt to deal with an issue that continues to dog the accounting profession, especially the biggest practitioners: limiting the potential liability for frauds and misstatements which they fail to detect. They and their regulators are haunted by the disappearance of Arthur Andersen in 2002 in a welter of litigation after the collapse of Enron. The big four, consisting of PWC, Deloitte, Ernst & Young and KPMG, could possibly become three or even fewer if too many of those lawsuits went against them. A study for the European Commission published last month recommended a cap on liabilities to discourage such a catastrophic outcome.
Critics of the big four argue that auditors are well paid for the risks that they run, and that legal pressures are the only way to keep their feet to the fire, ensuring high-quality work. But the big audit firms believe the risks are disproportionate.
Against that background, they have started a process that they hope will lead to more appropriate and less risky audit practices. They argue that the risk of ruin not only makes it hard for them to retain top staff, but it also stops competitors from entering the market. In such an environment, it is no doubt galling that the reporting exercise that firms and their auditors are expected to go through is increasingly seen as meaningless and irrelevant.