The growing role of non-accountants in audit regulation

It’s not just capital market regulators, even accounting professional bodies like the ACCA are turning to outsiders to regulate member auditors

In developed economies, professional accountants and practicing auditors no longer dominate regulatory boards that have oversight over their work. The accounting bodies they belong to follow the same principle, where a majority of non-accountants oversee the professional conduct of member auditors.

Since the global financial crisis, auditors in developed countries have been subject to strict regulations. In the UK, auditors have broader responsibilities apart from their core function of verifying the accuracy of financial statements of public firms. Auditors are required to delve into internal controls of firms and report any irregularities to the regulator if management and shareholders fail to fix the problem. Regulators can demand auditors to submit client files. Auditors are also subject to inspections to ensure sound auditing processes are in place.

Accounting bodies that practice oversight over the professional conduct of their members are also subject to regulatory scrutiny. Because of this, regulatory boards that practice audit oversight, such as UK’s Financial Conduct Authority (FCA) and the Irish Accounting and Auditing Supervisory Authority (IAASA), are dominated by non-accountants to avoid conflicts of interest that can arise when accounting professionals sit on the board.

“This is only proper because auditors are entrusted with oversight for the public good, and we need to respect that,” said Brian McEnery, president of ACCA, a global accounting body based in the UK with 198,000 professionas and 486,000 students across 178 countries including Sri Lanka. ACCA’s own member-regulatory board comprises a majority of non-accountants, because self-regulation has its limits.

Excerpts from the interview are as follows:

Much more is expected of auditors apart from verifying the accuracy of financial statements. What are some of these
responsibilities?
The core function of an auditor is to express an opinion as to whether or not the financial statements are true, fair and free from material error. Our job is not to go and continually find fault. The auditor is a watchdog, not a bloodhound.

Has this role changed? Aren’t auditors expected to be bloodhounds?
It has changed to a certain extent. Remember that the core function of the management of a company is to produce financial statements and to have a system of internal controls for that purpose.

So, an auditor should not just determining if the books are free from material mistakes and giving a true and fair view, but also be looking at the adequacy of internal controls. This is a valuable part of an auditor’s role, if it is done well, and an important part of the audit process.

Auditing is about oversight and ensuring, for instance, that financial systems are robust, not just free of material error. We have to use our judgment and skills to see if there are adequate controls and proper reporting

In the UK, what’s the procedure if an auditor comes across an issue?
If an auditor comes across an issue, the first step is to determine whether it’s an intentional or unintentional error. Management usually rectifies unintentional errors and quickly improves controls. If they don’t, an auditor has to take the matter up with shareholders. If shareholders too fail to take action, then the auditors must take the matter up with the regulator.

Does the law require them to do so?
Absolutely! This is also the case in my country, Ireland. Say, for instance, there is a company that is a separate legal entity from the individual owner. The owner takes money out of the company in the form of loans.

In other words, he’s depleting the value of the company to enrich himself. The law allows that to a certain limit, beyond that, this practice is illegal. If an auditor sees this happening, he is obliged to report the matter to the regulator, in this case, the revenue authority. It’s the same in the UK.

If the regulator is investigating a public listed company, can they call on the auditor for confidential information?
Of course. Regulators are absolutely entitled to. In fact, they can inspect the audit files of the auditors, too. This happens in the UK and Ireland. Furthermore, the regulator can even inspect the files of the accounting bodies, such as the ACCA, who regulate their member accounting professionals.

The Irish Auditing and Accounting Supervisory Authority has the power to go in and examine the files of practicing accountants and auditors in the country. This is only proper because auditors are entrusted with oversight for the public good, and we need to respect that.

Accountants have the responsibility of auditors. Auditing is about oversight and ensuring, for instance, that financial systems are robust, not just free of material error. We have to use our judgment and skills to see if there are adequately controls and proper reporting. It’s a big responsibility. Did the auditing profession fulfil this mandate during the global financial crisis? In some respects, maybe they could have done better. It’s important to say that. Auditors have privileges, and we have to ensure that we live up to that.

This is why, very often, in developed countries, the accounting regulator is different from the accounting body.

What happens when accounting professionals or auditors get appointed to regulator boards?
There are legislative firewalls to curb conflicts of interest. For instance, the regulator in the UK, the Financial Reporting Council has a board that includes a majority of lay people, not accountants. It’s the same in Ireland. That’s important. In fact, the regulatory board of the ACCA is composed of a majority of non-accountants. So, it has got members of the public and lay members who don’t have any association with the ACCA come in and adjudicate, and they will determine whether or not sanctions should be taken. If sanctions are going to be taken, then it is publicised and fines are imposed, and ultimately, in many instances, members are expelled.

Trump is proposing to relax regulations in the US, particularly in banking. What are your thoughts on this?
I believe in regulation. I believe in appropriate regulation. Not over burdensome. I don’t want it to become a barrier to sensible trade, but I fundamentally believe in regulation. I believe in regulating banks. I do not believe in being light on the regulation of banks. I would worry that, within such a short period since the global financial crisis, there would be a trend towards relaxing regulation. To my mind, that is illogical and dangerous.

I would worry that, within such a short period since the global financial crisis, there would be a trend towards relaxing banking regulations. To my mind, that is illogical and dangerous

There was a famous piece of US legislation called the Glass-Steagall Act introduced in the 1930s after the great recession. That effectively broke the link between retail and investment banking to insulate depositors because banks started taking riskier investments. This law was repealed in the US some 60-odd years later and was a part of the reason for the global financial crisis. If regulations are benign, people are bound to exploit them.

So, I worry about some of the recent discussions around the relaxing of the regulatory burden. There is a reason why regulation is needed. It’s to ensure that the principles of capitalism are not distorted. Whether it’s accounting or banking, I fundamentally believe in regulation. I believe in setting up proper standards in the first instance to ensure compliance. I’d be very firm on that.

With BREXIT and many countries threatening to close their borders, what happens to the promise of ACCA being a global passport?
ACCA believes in and supports free trade, including the movement of talent. We are unapologetic about that. Living standards have improved everywhere since the advent of the General Agreement on Tariffs and Trade many years ago, which became the World Trade Organization. This is true for both developing and advanced countries. We disagree with the concept that trade is not good for the US economy, for instance. We believe trade is good, and that trade is to be sensibly negotiated. But generally, we don’t believe that tariffs and artificial barriers are good for business, and if it is bad for business, it is inevitably going to be bad for employment, because commerce that flows well employs more people. If countries start going down the route of economic nationalism, the world will be substantially worse off financially, but certainly worse off politically. Nationalism almost inevitably leads to other forms of nationalism, which can lead to conflict; it is only appropriate to state that. We believe the best means of ensuring that there is stability in economies is in that people are not idle; and we believe the best way to ensure that people are not idle and there is greater economic activity is by ensuring that there is free trade.

What did ACCA as a body do before the BREXIT vote?
ACCA made its pro-trade stance clear to all members. We said free trade and the movement of talent can better meet the needs of society. ACCA preferred the UK to remain a part of the European Union. Obviously, we don’t tell people how to vote. It would be wrong for us to tell people how to vote, but we made ACCA’s view clear. The outcome of the vote surprised us, like it did everybody else.