Australia's audit pressure cooker

A combination of business screwing down audit fees, increasing regulatory pressures, more risk from class actions and public opprobrium is hitting the bottom line of audit firms.

Five years ago, there were 9000 registered auditors, now there are 5000. According to Institute of Chartered Accountants of Australia research, less than 50 per cent of auditors now believe audit is an appealing profession.

This consolidation in the sector means companies now have less choice in who will look over their books. They are more likely to go for the bigger firms, but that's no way for an efficient competitive market to work and history shows, it's no guarantee of a job well done.

Take PricewaterhouseCoopers' complete botch up of Centro's books. The Australian Securities and Investments Commission had asked for directors to be barred for failing to detect the error in Centro's accounts. In his judgement, however, Justice Middleton decided not to go down that track. Their reputations, he said, had already been shattered.

Still, the company's chief financial officer and auditor were barred and PwC had to stump up $67 million to pay for the class action.

For sure, PricewaterhouseCoopers had misapplied accounting standards and had screwed up badly. But what is striking here is that the accounts belonged to the directors, not PwC. And yet the directors were not penalised the same way.

With so much market uncertainty, audit firms are now targeted by regulators around the world, including ASIC.

Last week, it put out a report which found there had been no improvement in audit work this year. It found auditors were not obtaining sufficiently appropriate evidence to support their opinions, nor exercising sufficient scepticism. According to ASIC, 18 per cent of auditors are not doing their job properly.

ASIC's critics say the regulator's assessment is based only on a handful of firms – of all the audit firms around the country, ASIC only picked 20 firms suggesting it really needs to employ more people before it puts out reports purportedly reflecting the broader market. You could also ask what ASIC is doing to lift audit quality. Don't hold your breath.

Still, it is worth comparing the regulator's findings to those of the ICAA earlier this year. There are similarities.

The ICAA review looked at a broader sample than the regulator and its findings were even more damning. In its Quality Review Report to the year ended June 2012, which assessed more than 400 practices, it found that 24 per cent, or one in four, failed to meet regulatory requirements and professional standards.

Part of the problem is that audit standards are becoming more complex, more convoluted – just try reading some – and more prescriptive. And they now have force of law. There are about 600 mandatory requirements that have to be applied to an audit and because many are inter-related, if you get one wrong, you get 10 wrong.

Any company now preparing its books needs to make sure its auditors are right across those standards. If the ASIC and ICAA reports are anything to go by, there are no rock solid guarantees.

At the same time, the regulatory pressure has increased in response to all the guesswork that companies and investors are putting into the market.

The government has strengthened ASIC's powers. It can now conduct audit inspection programs. It can issue inspection reports and firms are required to respond, telling the regulator how they intend to fix it. What's more, ASIC has the power to revisit the firm 12 months later to make sure it did the job. If the business fails to take remedial action, ASIC can publish a report naming and shaming it. This is giving ASIC pretty much the same powers over auditors as its overseas counterparts.

Meanwhile, companies are forcing audit firms to keep their fees low. At a time where there is more focus on issues like impairment and fair value, you would expect audit fees would go up. That hasn't happened.

Colin Parker, who runs an accounting and audit consultancy practice GAAP, says auditors are caught in a squeeze. There are tougher expectations of them with more rigorous standards that now have legal backing, there's the blow torch from regulators and businesses still expect them to keep a lid on their fees. Ultimately, he says, that will hit companies and investors. Auditors have it tough.

"They can't decrease the quality of the work because the auditing standards and regulatory sanctions are now so heavy,'' Parker says. "It just make auditing an increasingly marginal business proposition. The profitability declines.

"Directors are screwing the audit fees down time after time so it becomes a race to the bottom. That increases the directors and company's exposure.

"It also makes it hard for auditors to turn a profit and comply with the standards. It means larger accounting firms tend to push the staff harder, which can lead to the staff working under more severe pressure and that can lead to mistakes.”'

"We may well see a number of the smaller type of accounting firms saying audit is not the place for us or saying there are some types of audit activities they won't be involved in. With the lack of choice for companies, audit will be done by the bigger players.”

In the meantime, auditors will continue to be in the gun. It's like shooting fish in a barrel – businesses and investors will suffer the collateral damage.