20th July 2010:
As I have previously said, one of the privileges of this job is the opportunity it gives for me to meet people from so many different countries and cultures. This has particularly been the case over the past few weeks with our annual regional meetings. I have previously commented on
my visit to Saudi Arabia for our Middle East regional meeting and the fact that I was
unable to get to Pretoria for our Sub- Saharan Africa regional meeting. However, over the past few weeks I have been to Vienna for our European meeting, to Santiago de Chile for Latin America, to Shanghai for the Asia Pac region and I am in Curacao this week for the North America & Caribbean meeting.
Whilst the differences in culture were evident so were the similarities in the challenges and opportunities for the BDO firms in each of these regions. This was perhaps surprising given the different economic circumstances of each region – some still facing no or very limited economic growth whilst others, particularly Asia Pac, are continuing to enjoy a buoyant economy. Further, some our firms are fairly new – either as firms or to BDO – whilst others are long established; some operate in developing economies whilst others are in mature economies; some operate in a highly regulated environment whilst others are self regulated or have limited external regulation. And of course, in some countries the audit and accounting profession is still relatively new whilst in others it has a long history.
As a traveller I was impressed by the beauty and history of Vienna. I have never visited this city before and am determined to return as a tourist when I will have time to enjoy the architecture, the museums, the art and the music. We had time for a quick coach tour of the highlights of Vienna and had dinner in the famous Hotel Sacher - the home of the sacher torte and a client of BDO.
I wasn’t sure what to expect in Santiago and was impressed that there are no lasting signs of damage in the city from the recent earthquake – indeed a visitor to Santiago wouldn’t even know of this tragedy that struck Chile only a few months ago. We had over 160 partners at this meeting, the largest regional meeting as all firms send many partners to the meeting, and there was a great party atmosphere every evening – particularly at our dinner at the end of the meeting in a winery. I can highly recommend Chilean wine! Meetings in Latin America are always a great family occasion – helped because everyone (apart from me and a few North Americans and Europeans) speak the same language (I know the Brazilians speak Portuguese but they all seem able to make themselves understood in Spanish if they don’t actually speak it).
I always enjoy my visits to China – it is such a fast changing country and is always very exciting. I rarely have any time to ‘see the sights’ so I was pleased that I was able to spend just over half a day at EXPO 2010; I am only sorry I couldn’t spend the whole day there and see it lit up at night. It was amazing. Full of people, full of queues but vibrant and exciting. Some of the buildings are extraordinary and it is a shame that most of them will be taken down after the EXPO finishes at the end of October. The China pavilion dominates – a striking red building shaped like a pagoda on stilts – but there are plenty of interesting buildings even if the displays inside the pavilions are somewhat variable. There is also a new concert hall, shaped like a flying saucer, with a balcony all round the top from which the views, of both EXPO but also of Shanghai, are spectacular.
As for Curacao, the sky is a perfect blue with hardly a cloud and the sea is sparkling – a perfect location for the final regional meeting. We had dinner last night on the terrace of a new hotel overlooking the sea - magical. A very different location but similar issues, challenges and opportunities.
BDO International 
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July 20th, 2010
19th July 2010:
One of the biggest challenges we face at present, particularly in the more developed economies, is what my US colleagues call ‘fee compression’ - what I would call ‘extreme downward pressure on fees’. Many companies, understandably given the tough economic environment, are putting their audit firms under considerable pressure to reduce their fees and most firms appear to feel they have no option but to respond by reducing their fees because they know that if they won’t do so then one of their competitors will happily take the work at the lower fee.
Many will say that this is evidence of a healthy, competitive market and is one of the advantages of a free market economy. That it is a reflection of surplus capacity and that competition will drive prices down and that capacity will reduce until we will reach what my economics tutor called ‘equilibrium’. Prices will then stabilise because supply and demand are balanced.
Unfortunately, I don’t think the marketplace for audit services is that straightforward. I have no doubt that the overall level of demand for audit services has reduced, due to a lower level of corporate transactions, failing companies and greater efficiencies. However, the decline in overall demand is offset by the continuing need for companies to have audits, additional complexity due to regulation and changing accounting standards and, above all, the need for an unrelenting focus by the audit firms on quality that means that, whatever the client wishes to achieve in terms of reduced costs for an audit, the hours spent on each audit can not fall too far. Capacity has also fallen due to lower recruitment levels and staff redundancies and, in my view, in most cases by more than the fall in demand for audit services. In these circumstances, according to elementary economic theory prices should, if anything, rise. Yet this is not happening – and fees (ie the price charged for audit services) are falling.
Of course, this should not be a concern if it means that fees are reverting to a sensible level (ie equilibrium) perhaps having been high for some years. But this doesn’t seem to be the case. There is increasing evidence that fees are being forced down to such an extent that one worries this will encourage audit firms to ‘cut corners’ to reduce their own costs and thereby reduce audit quality – particularly given that the buyers of audit services (ie clients) do not monitor or determine audit quality which is a role taken on by regulators who are not involved in the pricing discussion between the client and the audit firm.
It is thus interesting to note that a number of regulators have started to express concerns about the potential effect of reducing audit fees on audit quality.
In their recent report on the 2009 inspections of audit firms, the Canadian Public Accountability Board (‘CPAB’) stated:
“CPAB has learned that certain audit committees are pressuring firms to significantly reduce audit fees. This stance may be incompatible with the audit committees’ important role … in helping to ensure the integrity of financial reporting. There will always be negotiations … regarding what constitutes appropriate and fair audit fees, however, given that one of an audit committee’s key priorities should be obtaining high quality audit services, CPAB believes audit committees should not focus solely on fees or place undue pressure on audit firms to arbitrarily reduce them. While CPAB has yet to find any evidence of a loss of focus on audit quality … it remains concerned that this may become an issue … CPAB is not alone in these concerns…”
In a similar vein, the audit inspection program public report for 2008–09 from the Australian Securities and Investments Commission stated:
“We will also focus on audit quality for new or existing audits where audit fees appear low or appear to have been reduced for reasons other than changes in the underlying business of the entity being audited.”
And Stephen Hadrill, the Chief Executive of the UK’s Financial Reporting Council, in a speech in April 2010 said:
“There is a role for the market in setting higher expectations of auditors. So far the market has not played that role. Quite the opposite. It is more likely to applaud lower audit fees than higher quality.”
Of course you may say this is a very self-interested argument by me – and that I am only raising this because of the effect it has on the revenues, and profits, of BDO Member Firms. Now that, of course, is true but my worry is more than self-interest. Like the above regulators, and others, I am concerned about the potential effect on audit quality. I am concerned about the effect this will have in enabling us to continue to attract high quality, committed people to the profession. And I am also concerned at what this phenomenon says about the operation of the audit market and the extent to which it is a free market.
BDO is committed to delivering quality – in the robustness of our audits, in our advice and in our client service – and we will continue to do so despite the pressure on us to reduce costs. But one does wonder about the bizarre market place we operate in.
Standards & Regulators 2 Comments
July 19th, 2010
15th July 2010:
Regular readers of my blog may recall that I gave a qualified welcome to the announcement in early June by the IASB (who set IFRS) and the FASB (the US accounting standard setter) that they were modifying their approach to give additional time to stakeholders to consider proposals and give feedback, with the timetable for the completion of certain projects being moved from 30 June to 31 December 2011. I believed then, as I do now, that, although the IASB and (in particular) the FASB are being ambitious and that some of the projects are controversial, the changes in timing should hopefully be sufficient to enable the new standards to be developed in a suitably considered way.
I think it is unfortunate therefore that there are now some calling for a further slowing of the pace of accounting standard setting by the IASB and FASB. The arguments set out are not unfamiliar, focusing on the limited amount of time that will be available to the accounting standard setters to develop robust proposals and give full and proper consideration to comments received, and for constituents to be able to provide the right level of input. It is noted that both the extent of regulatory change and the effects of the global recession are adding to difficulties for constituents. There is also an overall reference to the need to take sufficient time to develop high quality accounting standards, a sentiment with which I agree.
It is also worth considering the implications of substantial changes that will take place in 2011 to the membership of the IASB, which include the replacement of Sir David Tweedie as his second term comes to an end. While this is not a reason in itself to continue to a specific deadline, it is the case that a further relaxation of the timetable could result in the issue of certain significant new accounting standards being substantially delayed, due to the need for new Board members to be fully brought up to speed.
Therefore, while I have sympathy with those calling for a further revision of the convergence timetable (and I have particular sympathy for preparers of accounts), I do think that it is premature to be calling for further changes in timetable at this stage. It is right to keep the position under review but I believe that the revised approach set out last month should be achievable and that a further change at this stage might damage the credibility of any timetable. Unless the standard setters remain ambitious and focused on driving through much needed changes and improvements, we could all be left waiting too long.
Standards & Regulators 0 Comments
July 15th, 2010
18th June 2010:
… is the headline in an article published by Accountancy Age yesterday commenting on the issue of ‘Big 4 only’ clauses; it is worth reading.
www.accountancyage.com/accountancyage/news/2264881/restrictive-bank-covenants-keep As the article notes:
“The Big Four have long kept quiet on the subject, until last month. In a joint submission, the Big Four – along with the next two largest firms, Grant Thornton and BDO – officially acknowledged, for the first time, the existence of restrictive covenants in the UK.
‘These contractual limitations can distort the market for audit services,’ the firms said in their joint submission to the Organisation for Economic Co-operation and Development.”
We all agree they can distort the market; in my view they do.
BDO International Global Accounting 0 Comments
June 18th, 2010
11th June 2010:
There has been a fair amount of comment in the press recently on the above issues – though in truth they are all aspects of the same issue namely whether or not it is healthy for the audit market to be so heavily dominated by four firms and, if not, what can and should be done to change the status quo. I was thus particularly interested to read the fifth progress report from the UK’s Financial Reporting Council on the implementation of recommendations intended to promote choice in the UK audit market.
This is, in my view, a realistic report on progress or rather the lack of any real and meaningful progress. As Stephen Haddrill the Chief Executive of the FRC said “…whilst progress has been made…it is clear that the risks arising from the extent of concentration in the audit market persist…”
The report also included a number of other comments that whilst related to the UK I believe are true in many countries. These include:
“It is clear … that the largest firms focused heavily on their size in their [audit] proposal documents. The firm’s size, together with its brand, was marketed as a proxy for quality.”
“Most of the audit committee chairmen… expressed the view that they would like a larger number of firms to choose from. However, the majority were also reluctant to select a non-Big Four firm for perceived reputational reasons. This was surprising as most of the companies were from the smaller listed market…”
“… the biggest challenge to increasing choice in the audit market remains the question of perception.”
The report also commented on the use of ‘Big Four only’ clauses and noted that “Twenty eight companies stated explicitly that they were not subject to any contractual restrictions on their choice of auditor. It is unclear how many of those that were silent on the issue are subject to some form of restriction…” The report also referred to “…anecdotal reports of contractual restrictions…”
This remains a disappointment to me as we have frequently pointed out examples of these restrictions, both to the FRC and others.
I recently saw a particularly offensive version of such a clause, namely:
“The parent company, although not legally obliged to do so, undertakes to submit its individual and consolidated accounts to an annual audit by one of the four most solvent and internationally renowned audit firms (the Big Four).”
No doubt the comment “not legally obliged to” is to ensure this is not a contractual obligation and need not be disclosed in the UK, where this is a requirement to disclose contractual commitments of this nature. However, there is no doubt that this is an obligation a company would be foolish to ignore.
Further, the suggestion that the Big Four are the “most solvent” audit firms is difficult to sustain, if not offensive, not least given their own comments on the potential impact of pending litigation as part of their arguments for audit liability reform.
I was therefore especially pleased to see the comments in a recently published OECD report on this. The report is from the OECD Competition Committee and is entitled ‘
Competition and Regulation in Auditing and Related Professions’.
It makes a number of interesting points on both regulation of and competition in the audit profession. In particular, on page 27 of its report, commenting on ‘Big Four only’ clauses they state that
“…such restrictions are not based on a qualitative assessment of the pool of audit firms available and prevent excluded audit firms from competing with the Big Four firms and thus entering or expanding further into the audit market for quoted and larger companies...”
I couldn’t have said it better myself.
Global Accounting Standards & Regulators 5 Comments
June 11th, 2010
3rd June 2010:
In my blog posted this morning (but written yesterday) I said that I hoped the SEC would make a statement, in response to reports that the IASB/FASB convergence projects might be completed later than the anticipated 30 June 2011 deadline, making it clear that this would not affect its decision in 2011 about whether US domestic companies should be required to adopt IFRS. It is pleasing to see that Mary Shapiro, the Chair of the SEC, has done just that. In fact, she has gone further by welcoming a statement issued jointly by the IASB and FASB that outlines key aspects of their modified approach, in particular the additional time that will be given to stakeholders to consider the Boards’ proposals and give feedback.
The accounting standard setters have noted in their joint statement that stakeholders have expressed concern that the large number of exposure drafts scheduled for publication by 30 June 2010 would make it difficult for them to respond in an appropriately considered way. While that is true, I suspect that the standard setters themselves may also have found the workload quite challenging. Whatever the reasons, it is right to have taken action to limit the number of exposure drafts issued on significant or complex topics to four in any one quarter; this remains a substantial volume but it is manageable. The prioritisation on issues that have the most substantial effect on enhancing the quality of accounting standards, and on the convergence of US GAAP and IFRS, also makes sense as does the proposed consultation on effective dates and transitional arrangements for the new standards.
So, welcome developments which I support, but we should bear in mind that the IASB/FASB convergence work plan remains ambitious and includes a number of projects that will be controversial. The modified strategy, as outlined in the Boards’ statement, will remove some of the pressure but we are still moving at a quite considerable pace.
Standards & Regulators 2 Comments
June 3rd, 2010
3rd June 2010:
FASB, the US standard setter, has issued its long awaited exposure draft of proposals to change the accounting requirements for financial instruments. Whilst there is considerable detail in its 214 pages, the headline is that the proposals would require almost all financial instruments to be measured at fair value, with changes in the fair value of some instruments being recorded in profit or loss in their entirety and other changes being split between profit or loss, and Other Comprehensive Income. While this is what we expected, it is disappointing that the FASB has not moved closer to the IASB’s approach set out in IFRS 9 although some encouragement can be drawn from a statement in the exposure draft that the IASB and FASB have ‘jointly committed to continue attempting to reduce differences in the accounting for financial instruments under US GAAP and IFRS’.
IFRS 9 has what I believe to be a well judged balance between measurement at fair value and amortised cost, with the requirement to look at both an entity’s business model and the characteristics of each financial instrument leading to an appropriate split between the two measurement categories. This means that, for example, a standard interest bearing loan which is held for the collection of contractual cash flows is measured at amortised cost, while all derivatives are measured at fair value. It is debatable whether the FASB’s proposed approach is a better one; I have my doubts, and it will be interesting to see the comment letters.
While it is right for the FASB to seek to develop accounting standards that represent an improvement to US financial reporting, it is particularly disappointing to see a comment on page 2 of the document that ‘…what may be considered an improvement in jurisdictions with less developed financial reporting systems applying International Financial Reporting Standards (IFRS) may not be considered an improvement in the United States.’ This statement seems ill judged in the context of the significant number of mature and developed financial markets that require companies to report in accordance with IFRS, and is unnecessarily inflammatory at a time when there is such political sensitivity around accounting standard setting. It also seems inconsistent, given that foreign registrants are permitted to report under IFRS for the purposes of their US financial reporting.
Meanwhile, reports are emerging of an interview with Bob Herz, the FASB Chairman, in which he has indicated that the 30 June 2011 deadline for the IASB/FASB convergence projects to be completed may be revisited, with the two boards working on a revised work plan. It would seem that, as I suggested might need to happen in my blog of 16 April, a ‘Plan B’ has been developed. The approach that the standard setters will take remains to be seen but, whatever this ultimately entails, it is to be hoped that the SEC will make a clear statement that this will not affect its decision about whether US domestic companies should be required to adopt IFRS.
Global Accounting Standards & Regulators 2 Comments
June 3rd, 2010
24th May 2010:
… the contribution to the ‘Role of the Audit’ debate by an investor – the well respected Guy Jubb of Standard Life in the UK. His considered article in the UK’s Accountancy Age is worth a read.
www.accountancyage.com/accountancyage/comment/2263349/viva-la-audit-revolution My main concern is Guy’s apparent focus on the form and content of the audit report – albeit this does reflect the form and content of the audit. At present, audit reports are, of necessity, ‘boiler plate’ as most regulators mandate the form and content of the audit report and any such report that is ‘out of the ordinary’ tends to raise concerns rather than give any comfort that the audit report reflects the circumstances of the particular company.
I agree with Guy, however, that ‘…the momentum for audit change is building irreversibly…’ and I hope this is supported not only by regulators and investors but also by auditors.
We need to be careful however to remember that the financial statements, and related disclosures, are those of management and that auditors are required to express a view on them. A parallel system whereby auditors disclosed views different to those of management, or in addition to those of management, could be confusing. Indeed, the strength of the current system is that the threat of a non-standard audit report usually prompts management to amend the offending accounting treatment or disclosure – thereby ensuring a ‘boiler plate’ audit report. I would regard this as a positive outcome – even if the audit report is somewhat less exciting.
Global Accounting Standards & Regulators 0 Comments
May 24th, 2010
14th May 2010:
The IASB has issued its anticipated, and welcome, exposure draft that proposes changes to the accounting for some financial liabilities. This follows its decision in the first phase of IFRS 9, the accounting standard for financial instruments that will ultimately replace IAS 39, to restrict the scope of changes in phase 1 to financial assets. We, in common with some other respondents, had called for this approach so that the IASB could give fuller consideration to financial liabilities, in particular in the context of changes in an entity’s own credit risk.
The proposals would result in the elimination of what the IASB itself has described in its press release as ‘counter intuitive’ effects that result from a decline in the credit status of an entity that uses the option in IAS 39 to measure financial liabilities at fair value through profit or loss. Because fair value includes the effect of changes in an entity’s own credit status, under the existing guidance a credit rating downgrade results in a reduction in the carrying amount of those liabilities, and a gain in the income statement.
So the worse the credit rating gets, the larger the gain that is recorded in the income statement; while (arguably) this is technically pure, it makes little sense from a commercial perspective. Anecdotally, some banks have even suggested that, during the financial crisis, the remeasurement of their financial liabilities to fair value was one of the more profitable parts of their business.
Sensibly, the IASB has not proposed a new measurement category, so liabilities to be measured at fair value will still include the effect of changes in credit rating in their balance sheet carrying amount. While superficially attractive, a new category would have brought the introduction of a new measure that was neither amortised cost nor fair value, with little conceptual merit. However, the element of changes in value that relates to changes in credit rating will now be excluded from the income statement, instead being recorded separately within Other Comprehensive Income.
I am pleased that the IASB has listened and responded in the way it has. While I will criticise where this is due, IASB’s outreach to, and consultation with, its constituents during the development of its proposals and new requirements for financial instrument accounting has been excellent. As we move forward, I hope that this level of engagement and responsiveness will continue in order that the IASB has the best chance of retaining the support that it will need to complete current significant, and in some cases controversial, projects.
Standards & Regulators 0 Comments
May 14th, 2010
11th May 2010:
I have previously commented (
see my blog of 2 April 2010) on the need to be respectful of different cultures and different ways of doing business and was particularly looking forward to my first ever visit to Saudi Arabia last week. I went to Riyadh for our Middle East Regional Conference but also to welcome our new Saudi member firm and to meet some of their clients and the Saudi Press.
It was a fascinating experience but there were two things that are particularly worthy of note as they were totally unexpected.
The first was that the opening speaker for the conference was a woman – in a country where women are rarely involved in business and where there are strict rules on women appearing in public. We were addressed by the Strategy Officer of the Saudi Arabian General Investment Authority (SAGIA) – a body that was established by King Abdullah to promote Saudi Arabia as a good place to do business. SAGIA’s mission is ‘To position Saudi Arabia among the top ten most competitive nations by 2010 through the creation of a pro-business environment, a knowledge-based society, and by developing world-class Economic Cities’. It is a fascinating programme focussed on three sectors – energy, transportation and knowledge-based industries. In 2005, Saudi Arabia was rated the 67
th most competitive country by the World Bank; this has improved to 13
th in 2009 – the aim being to get to 10
th by the end of this year. It was a fascinating presentation about an ambitious project presented intelligently and with clarity – and by a woman in a very male dominated society.
My second surprise was the weather. Riyadh is in the middle of the desert and I expected it to be hot and dry. I was therefore completely shocked by an unexpected rainstorm that, as you can see from the pictures below, left Riyadh flooded. We had just arrived at a client of BDO Saudi Arabia when the rain started – and struggled to get from the car to the client’s office. On the way back to the hotel where we holding the conference, many roads were closed as cars had been abandoned due to the level of water. I was fortunate to be in a 4x4 so we were higher than many cars. We also drove on the central reservation and on the pavement in order to avoid the worst of the water. A 20 minute journey took some 2 hours. This was not what I expected in Riyadh.
It was, however, a fascinating experience. The Saudis were immensely friendly and I was made to feel very welcome. I was also pleased to get great feedback from clients on our new Saudi firm. I am looking forward to my next visit.
BDO International 0 Comments
May 11th, 2010