A taxing issue
Having sidetracked last time onto issues of ageism, it is time (having survived my birthday) to return to the matter of auditor independence.
Following on from Enron, the European Union, under pressure from France, is trying to ban the provision of tax-advisory services to audit clients. The argument goes that if a tax department provides aggressive tax advice to a client, it will then be difficult for the auditors from the same firm to question whether the tax solution is defensible or not, and this could lead to a conflict of interest.
It is at present not clear whether the option is for a ban on the provision of tax services by audit firms to all of their audit clients or just to quoted companies. The argument that only quoted clients should be covered by the ban arises from the fact that the auditor has a duty of care to all the shareholders, and that this duty can be compromised by too close a relationship with management. In a quoted company it is likely that there are a significant number of shareholders who do not participate in the management of the company, and that in order to retain an objective view, the auditor should not assist management in the performance of its duties which include tax planning and tax compliance. In a privately owned company, the owners are far more likely to be closely involved in the day-to-day management, and therefore there is less potential for conflicts of interest between owners and management with the auditor being stuck in the middle (in effect explaining to shareholders why his advice to management may have been wrong).
The reality, of course, is that an auditor is usually well placed to advise a client by having gained a deep and thorough understanding of the client's business as part of the audit process. Clearly, synergies can arise between tax advice, other advisory work and audit services, with clients obtaining a better and more cost effective service.
But a significant problem exists which may be difficult to resolve. There is at least anecdotal evidence to suggest that audit firms have pitched for audit work at a very low price in the hope of gaining more lucrative consultancy work in the future. If this is indeed the case, then audit fees will have to rise in future if audit firms will no longer be able to cross-sell other services. This is irrespective of the fact that audit fees may need to rise in order to pay for increased levels of assurance, which the regulators and the public quite rightly would like to see.
On the fundamental issue of conflict of interest, I would strongly suggest that any internal pressure within firms for auditors to cover up the mistakes of the advisory departments is more tacit than real. Clearly, there have been significant audit failures in the last couple of years. In most cases these can be traced to either rogue individuals with over-close relationships with their clients or to failures of quality-control procedures within firms. There is very little evidence to suggest that the audit failures were the result of trying to cover up for aggressive or incompetent advice.
It is evident that there must be a ban on auditors taking part in the management of a client. I do not, however, believe that it is possible to define a boundary between advice and decision-making. This being the case, we either have to accept a complete ban on auditors doing other work and a proportionate rise in audit fees or we need to limit the ban to those companies and those situations where a real conflict of interest could arise.
In the case of Poland, the provision of tax-advisory services is one of the few services we are allowed to provide to audit clients, and long may it continue. Particularly so where most companies do not have their own internal advisers and look to one firm to provide all their advisory services. In the case of subsidiaries of foreign multinationals, clearly the owner (i.e., the head office) manages the company, and is therefore entitled to expect that his adviser will not only certify the financial statements, but also will provide a wide range of advisory services.
Following on from Enron, the European Union, under pressure from France, is trying to ban the provision of tax-advisory services to audit clients. The argument goes that if a tax department provides aggressive tax advice to a client, it will then be difficult for the auditors from the same firm to question whether the tax solution is defensible or not, and this could lead to a conflict of interest.
It is at present not clear whether the option is for a ban on the provision of tax services by audit firms to all of their audit clients or just to quoted companies. The argument that only quoted clients should be covered by the ban arises from the fact that the auditor has a duty of care to all the shareholders, and that this duty can be compromised by too close a relationship with management. In a quoted company it is likely that there are a significant number of shareholders who do not participate in the management of the company, and that in order to retain an objective view, the auditor should not assist management in the performance of its duties which include tax planning and tax compliance. In a privately owned company, the owners are far more likely to be closely involved in the day-to-day management, and therefore there is less potential for conflicts of interest between owners and management with the auditor being stuck in the middle (in effect explaining to shareholders why his advice to management may have been wrong).
The reality, of course, is that an auditor is usually well placed to advise a client by having gained a deep and thorough understanding of the client's business as part of the audit process. Clearly, synergies can arise between tax advice, other advisory work and audit services, with clients obtaining a better and more cost effective service.
But a significant problem exists which may be difficult to resolve. There is at least anecdotal evidence to suggest that audit firms have pitched for audit work at a very low price in the hope of gaining more lucrative consultancy work in the future. If this is indeed the case, then audit fees will have to rise in future if audit firms will no longer be able to cross-sell other services. This is irrespective of the fact that audit fees may need to rise in order to pay for increased levels of assurance, which the regulators and the public quite rightly would like to see.
On the fundamental issue of conflict of interest, I would strongly suggest that any internal pressure within firms for auditors to cover up the mistakes of the advisory departments is more tacit than real. Clearly, there have been significant audit failures in the last couple of years. In most cases these can be traced to either rogue individuals with over-close relationships with their clients or to failures of quality-control procedures within firms. There is very little evidence to suggest that the audit failures were the result of trying to cover up for aggressive or incompetent advice.
It is evident that there must be a ban on auditors taking part in the management of a client. I do not, however, believe that it is possible to define a boundary between advice and decision-making. This being the case, we either have to accept a complete ban on auditors doing other work and a proportionate rise in audit fees or we need to limit the ban to those companies and those situations where a real conflict of interest could arise.
In the case of Poland, the provision of tax-advisory services is one of the few services we are allowed to provide to audit clients, and long may it continue. Particularly so where most companies do not have their own internal advisers and look to one firm to provide all their advisory services. In the case of subsidiaries of foreign multinationals, clearly the owner (i.e., the head office) manages the company, and is therefore entitled to expect that his adviser will not only certify the financial statements, but also will provide a wide range of advisory services.
