Jeremy Newman’s CEO Insights

Thoughts of a frequent traveller

Jeremy Newman — Tue, 20 Jul 2010 09:01:19 +0100

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.

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A bizarre market

Jeremy Newman — Mon, 19 Jul 2010 10:47:05 +0100

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.

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Too soon to slow convergence further

Jeremy Newman — Thu, 15 Jul 2010 08:02:00 +0100

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.

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Restrictive bank covenants keep the Big Four on top…

Jeremy Newman — Fri, 18 Jun 2010 11:17:20 +0100

… 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.

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Concentration, Competition, Choice

Jeremy Newman — Fri, 11 Jun 2010 08:42:01 +0100

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.

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Welcome developments

Jeremy Newman — Thu, 3 Jun 2010 11:05:26 +0100

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.

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The balancing act of convergence

Jeremy Newman — Thu, 3 Jun 2010 08:21:53 +0100

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.

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I welcome….

Jeremy Newman — Mon, 24 May 2010 06:51:01 +0100

… 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.

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An accounting proposal that makes sense

Jeremy Newman — Fri, 14 May 2010 09:01:53 +0100

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.

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Global perspectives (2)

Jeremy Newman — Tue, 11 May 2010 11:21:24 +0100

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.

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The role of the auditor

Jeremy Newman — Mon, 3 May 2010 15:43:23 +0100

Whilst I was in China last week I was contacted by both Reuters and the Financial Times to discuss the recent comments from Michel Barnier about the role of the auditor and how we should approach audit regulation. As you will know from earlier blog postings, I believe that it is appropriate for us to be considering the role of the auditor and ensuring that it is ‘fit for purpose’ in the current business environment. This is not to suggest that there is anything wrong – far from it – but that given fundamental changes in the nature of business I think it is appropriate to check that the audit is not only fulfilling its purpose but that auditors are adding as much value as possible.

Of course, a review of the role and purpose of an audit – and ensuring it adds maximum value – will necessitate some difficult discussions, not least the need to build a global consensus. Further, if the role of the audit is going to be broadened (for example, to have a greater involvement in the ‘front end’ of financial statements or perhaps more ‘real time ‘reporting) there will also need to be a review of auditor liability and perhaps some ‘safe harbour’ provisions.

The global aspects of change are very important – which is why I welcome in particular one aspect of M Barnier’s comments suggesting audit regulation be carried out on a European basis and why I especially liked the article in the Financial Times http://www.ft.com/cms/s/0/cd1f4bc2-5326-11df-813e-00144feab49a.html suggesting that “A move towards global audit regulation is the better aim”. It may be we have to start building consensus initially in Europe but the prospect of getting to a global regulation of the audit profession is one that I welcome.

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I have just returned from a fascinating week in China

Jeremy Newman — Fri, 30 Apr 2010 08:11:06 +0100

I always find China an interesting place – I have visited it more times than any other country since I took on this role (apart from Belgium, where our International Executive Office is based) – but this visit was different to all the others.

China changes on every visit – new buildings are always appearing and this time was no different. Shanghai has been transformed for EXPO 2010 – there is a new promenade on the Bund alongside the river (it was all boarded up when I was last in Shanghai only three months ago) and there are the various pavilions that have been built for EXPO as well as new trees and flowers everywhere. I didn’t visit EXPO but hope to do so when I am next in Shanghai in July.

But the real difference this time was the purpose of my visit. My previous trips have been mostly internally focussed – sorting out our presence in China, securing a new member firm, getting our existing firm to merge with the new firm, creating a management company structure in accordance with the Ministry of Finance guidelines and various other tasks in order to help develop BDO China into the firm it is today – easily the largest aside the Big 4 and growing rapidly.

So this time I could focus on meeting referrers of work and regulators – getting feedback on BDO China (fortunately it was all good and universally positive about our new member firm being part of BDO) and explaining its capabilities and those of BDO International in order to develop new work opportunities. Inevitably this meant meeting with Government (and Government related) officials as most large Chinese businesses are ultimately state controlled – albeit many now operating in a ‘socialist free market economy’ and many either with, or likely to seek, external capital. What other country would have a “State-owned Assets Supervision and Administration Committee” (‘SASAC’) and not just one? There is a national SASAC and most municipalities and local governments have a SASAC as well. It is an interesting business model and one that seems to work well – even if it is not one that I could imagine being replicated in other countries. Indeed, it is the uniqueness of China and the way they do business; the mix of business and politics; the apparent efficiency of parts of their economy and the apparent waste due to lack of efficiency in parts of their economy; the generally friendly and helpful nature of the people I meet and their apparent willingness to comply with guidance that would be seen as interfering in other countries that makes China so fascinating.

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I was lucky….

Jeremy Newman — Thu, 29 Apr 2010 09:54:11 +0100

… last week as I was ‘stuck’ in the UK, rather than away from home, as a result of the cancellation of flights in much of Europe due to volcanic ash. I was actually due to be in South Africa for our Sub Saharan Africa Regional Meeting and whilst it was great shame that I could not be there I did have the benefit of a few more nights at home and some extra time with my wife and family.

I was luckier than many – the web is full of stories of people who struggled to get home or to meetings such as a number of journalists who write for The Economist. http://www.economist.com/blogs/gulliver/2010/04/flying_difficulties

These stories, and others, prompted many articles which reflected on the volcano eruption in Iceland and the disruption it has caused to business travel. One of the more thoughtful ones I saw was also in The Economist
http://www.economist.com/business-finance/displaystory.cfm?story_id=15943255. This article focussed on risk management but noted:

“The aim is less about trying to predict what unlikely events may come along, and more about creating mechanisms and relationships that would help the firm and its partners respond with agility if disaster did strike.”

The point being that close cooperation, common practices and consistent standards (as well as robust infrastructure) across a network are essential for international businesses to cope effectively when extraordinary events like this take place.

We had many people stuck where they didn’t necessarily want to be – and most took the opportunity to see relatives and friends whom they don’t often get the time to visit whilst on business trips or even to do a bit of sightseeing. Technology enabled most people to keep in touch and do most of their work.

I did one long video call with South Africa – it worked OK though the quality of the picture wasn’t great and the level of engagement was less than a personal meeting; but it was acceptable. I was also due to make two presentations to our Sub Saharan Africa Regional Meeting – instead, and arranged at very short notice, I did two short video presentations which were then made available to download in South Africa where they were shown with my slides. The feedback has been pretty good – particularly given they were arranged at the last minute so were unrehearsed and unedited. One of the positives is that they can be shared with a wider audience in the region and not just the 80 or so partners who were there; the biggest downside was again the lack of any personal engagement and no opportunity to discuss the issues I raised in the discussions at coffee, lunch and dinner around the conference. I did one feedback session on Skype but the internet access was not good and we kept on losing the connection so we resorted to email to deal with the issues raised – far short of what we could have achieved had I been in South Africa.

So, overall the disruption to flying was not a disaster – more an irritation and one I would have coped with far better had there been an advance warning. But I still think there is no substitute for personal engagement, so I guess no less travelling for me.

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The role of the auditor – or at least of the audit report

Jeremy Newman — Thu, 22 Apr 2010 10:33:26 +0100

Monday’s Financial Times – in an article headlined “Audit reports ‘should give more subjective view’” – reported on the results of a survey recently published by the ICAEW entitled “Audit of banks: lessons from the crisis”. The report, albeit limited to audit of banks, has some interesting observations on the role of the auditor.

First, the report notes that the audit process is “… highly valued…” and is “…regarded as essential in imposing discipline upon directors’ presentation of financial information…” and that the “…skills of auditors are highly respected…”. The ICAEW report also noted that one investor suggested that “…the real value of audits is in changing behaviour…” whilst bank representatives stated that “…the value of audit lies in what goes behind the audit report…”. They also commented that “…the current auditing system was not top of their list of issues to be addressed, and was not thought to be significantly broken…”.

All pretty good. But (isn’t there always a ‘but’?) concerns were expressed about the nature of audit reports and also that more needs to be done on the presentation of information about risk. There was also a strong view that the level of communication between the regulator and auditors “…needs to be improved”.

It is this former issue – the nature of audit reports – that was the main item focussed on by the FT who summarised the position thus:
“The audit report does not provide useful information and auditors should give a more subjective view of their clients to help investors and regulators make decisions…”

Not unfair – albeit I would argue selective reporting of the ICAEW survey. Indeed, as the report from the ICAEW makes clear, the current approach of audit standards is to discourage the use of emphases of matter. Further, under present regulations, the audit report “…has always been an opinion on directors’ presentation of the financial statements, rather than a wider business commentary”.

So, should we be reviewing the nature and content of audit reports? I would answer unequivocally ‘yes’ but we need to do so alongside a review of the nature and purpose of audits.

The current approach to audits, and thus to audit reports, is heavily based on a model that dates from immediately post World War 2, if not earlier. This approach was designed for a far less complex, and certainly less multinational and less connected, business world. It was also designed for world in which there was less technology and no ability for ‘real time’ reporting. Financial accounts were simpler (and far shorter) because businesses were simpler; we didn’t have complex derivatives, CDOs, subprime, hedge funds and much else.

It may well be that the nature of the audit has withstood the test of time but surely no one can disagree that it is appropriate to review this from time to time – and now seems like a good time to do so.

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IASB and FASB Commitment to Memorandum of Understanding

Jeremy Newman — Fri, 16 Apr 2010 09:24:48 +0100

The IASB and FASB issued a 13 page Press Release earlier this week giving an update on their progress on the convergence of IFRS and US GAAP – which could ultimately lead to US adoption of IFRS.

As with other recent statements on this topic the Press Release had a balance of ‘good news’ and ‘bad news’.

Overall, whilst it is positive in suggesting the Boards are actively working together to progress matters, the differences in some major projects are not helpful. In particular the ‘jury is out’ on financial instruments until we get a flavour of reactions to the FASB proposals (but it's helpful to see that the FASB may expose for comment both their own and the IASB proposals). I am also increasingly concerned at the potential for failure to meet the June 2011 deadline (or for significant chunks of projects to be deferred so that the deadline can be met).

It is helpful that both Boards published the update, and that it was posted on both the IASB and FASB websites at the same time. It helps reinforce the impression that they are working together - albeit there are cracks beginning to show. The differences on the financial instruments project have been well trailed - the real question is the reaction that the FASB's proposals for full fair value will get from constituents when they (finally) get exposed for comment in May. The timing of the FASB project illustrates one of the most significant problems - the FASB doesn't seem to be working with the same sense of urgency as the IASB.

It is also good to see specific mention that the strategy for addressing differences calls for both Boards to publish both its own proposals and those of the other Board for comment.

The bit that seems to be of most concern is the timing of release of documents and completion of projects. Although we have been used to the IASB project timetables moving out in previous years, they don't have any flexibility for the June 2011 deadline. For too many of the projects, the anticipated release date of exposure drafts is later than was expected a few months ago - this covers financial instruments (both Boards), consolidations (FASB), fair value measurement (FASB) and financial statement presentation (both Boards). There is also a comment for leases that, while the Q2 2010 date has been retained, a Board decision in March to explore an alternative approach for lessor accounting might delay this.

The unanswered question is what the Boards might have as ‘Plan B’ in the event that they just can't get everything finished in time. At the moment there doesn’t appear to be one. Our concern is that in the event that they are running out of time, any non essential parts of the new standards (and more controversial aspects where it's hard to reach agreement) may be deferred to be dealt with post June 2011. I don't like the prospect, but I do think that there's a real risk of it happening.

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‘Window dressing’

Jeremy Newman — Tue, 13 Apr 2010 13:18:47 +0100

BBC business editor, Robert Peston, posted an article on his blog on Friday that stated:

“There's no great secret that public companies, especially banks, use cosmetic devices to make their published accounts look as attractive as possible.”
www.bbc.co.uk/blogs/thereporters/robertpeston/2010/04/dressing_the_banks_window.html

There has also been similar commentary in a variety of newspapers both in the USA and the UK over the weekend and, as Robert Peston’s article notes, in Friday’s Wall Street Journal.

Whilst I agree with the view that many (if not all) companies seek to present themselves to the marketplace and to investors in as positive a light as possible I don’t accept that this necessarily means they are making use of “cosmetic devices”. It may be that companies trading activities are influenced by their reporting requirements which means that a balance sheet at a particular moment in time presents a better impression of the company than would have been the case a few days earlier or may be the case a few days later. This is not “cosmetic” but is a consequence of the nature of corporate reporting.

A few years ago the then CEOs of the world’s six largest accounting networks (including BDO) published a paper suggesting we need to examine how we move to a system of “real time reporting” and what challenges this would pose for the financial community and for the audit profession. At the time the proposals were widely criticised and they were quickly dropped. However, this didn’t mean that the issue went away.

In many ways, reporting responds to the market and whilst the marketplace punishes companies that don’t present themselves in the best possible light then companies will continue to do what they can to look as good as possible – as we all do when we face a camera. Auditors face a continuing challenge to ensure that this presentation is true & fair and is not misleading – not always an easy job.

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The role of the auditors

Jeremy Newman — Mon, 12 Apr 2010 07:15:13 +0100

Perhaps inevitably the debate on ‘who is to blame for the global financial crisis?’ has now turned to consider the role of the auditors. In a recent interview with Financial News, Michel Barnier made a number of comments that are relevant to the audit profession. http://www.efinancialnews.com/story/2010-03-29/barnier-sets-out-his-new-agenda-for-europe

It seems clear that audits, in the financial sector in particular, are going to come under renewed scrutiny this year by the European Commission. That seems bound to revive earlier debates on what users can expect from an audit and the so called ‘expectation gap’ that exists between auditors and many investors. Michel Barnier’s consultation means that the audit profession will need to be ready to explain the role of audits (including what they can’t be expected to do), as well as being prepared to engage in a wide-ranging debate. We should be open to the consideration of new ideas that could make existing arrangements more effective and audits more useful. Given the comment that there has already been on the role of audit in the financial crisis, there is no question that this is and will continue to be a subject of continuing interest to politicians and regulators around the world. The audit profession should both welcome and be prepared for that debate.

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There has been a flurry of articles and comments…

Jeremy Newman — Thu, 8 Apr 2010 10:24:22 +0100

… about IFRS and the IASB (in particular its’ funding and governance) over the past week or so following a number of meetings and interviews involving Mary Schapiro (the Chair of the US SEC) and Michel Barnier (the recently appointed EU Commissioner with responsibility for Internal Markets).

I must admit that, from my perspective, there was little new in all the various comments and most of the statements were much as expected and will include the establishment of political positions which are necessary if there is then to be a negotiated agreement on convergence and, in particular, the governance of the IASB. Indeed, if there is anything to be gleaned from the recent comments it is the importance of finding a suitable governance model for the IASB and the inadequacy of its existing governance structure. Regular readers of this blog will know this is something that has been a concern of mine for some time.

On balance, therefore, I do not share the concerns apparently expressed by some (according to a recent article in the Financial Times, Michel Barnier “…stunned the global accounting community…”) as I think these issues need to be addressed and debated if we are to have any chance to resolve them. The important thing, at the moment, is that there is engagement, debate and discussion and, critically, preparedness to listen to the views of others as well as expressing one’s own views. Thus, I am happy for Michel Barnier, Mary Schapiro and others to set out their views on the desired governance structure for a global accounting standard setter – because this at least shows support for there to be a global accounting standard setter.

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Global perspectives

Jeremy Newman — Fri, 2 Apr 2010 13:14:43 +0100

One of the privileges of my role is the opportunities I get to see so many different countries and different cultures.

In the past few weeks I have been in India and Japan and in the next several weeks I will be visiting South Africa and Saudi Arabia – as well as regular visits to Brussels and London and the more than occasional trip to the USA.

What is increasingly evident to me is that whilst we do business in an interconnected, global environment this has not made the world more homogeneous. Of course, there are global brands and even Japan has Starbucks and, of course, BDO. However, whilst many countries have embraced aspects of the culture of others (and this is as much about the West adopting aspects of Eastern culture as vice versa) where this has been successful it has been done in a way that reflects, and respects, local culture. Otherwise, it is merely there for visitors and expats and will not necessarily survive.

This is an important learning experience for the accountancy profession – as we are a very Anglo-Saxon/English speaking dominated profession. It is vital that we discover how best to adapt our ways of working and our business model to take account of the norms of countries where the profession is relatively new and doesn’t have the history of the profession in say the UK.

If we are to remain relevant in the 21^st century, and are to continue to have an important role in the growth and development of business and the capital markets, we need to take more time to understand others.

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Stability accounting

Jeremy Newman — Tue, 9 Mar 2010 10:08:48 +0100

Yesterday’s Lex column referred to the emerging conflict, on which I have commented before, between the needs of banking regulators and investors in banks. Lex suggested the conflict was between regulators and accountants but I think recognised that accountants – in this case accounting standard setters – were representing the interests of investors.

Lex is quite direct – “Accounting needs to stay a true business snapshot. Regulators must find their backbone elsewhere.”

I agree.

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