Richard Brandt

Perceptions of auditor independence: U.K. evidence

The reality and perception of auditor independence is fundamental to public confidence in financial reporting. A new Independence Standards Board was set up in the U.S. in 1997 and the European Union (EU) is currently seeking to establish a common core of independence principles. The general setting within which audit decisions are made and independence perceptions are formed is evolving rapidly due to competitive and regulatory changes. Policy-makers must work continuously to evaluate the critical threat factors and develop appropriate independence principles. This paper explores the potential of recent regulatory reforms in the United Kingdom (U.K.), many of which are unique to that country, to strengthen the independence framework. Using a questionnaire instrument, U.K. interested parties’ perceptions of the influence on auditor independence of a large set of 45 economic and regulatory factors are elicited. Most factors have a significant impact on independence perceptions for all groups (finance directors, audit partners, and financial journalists). The principal threat factors relate to economic dependence and non-audit service provision, while the principal enhancement factors relate to regulatory changes introduced in the early 1990s (the existence of an audit committee, the risk of referral to the Financial Reporting Review Panel and the risk to the audit firm of loss of Registered Auditor status). Exploratory factor analysis reduces the factor set to a smaller number of uncorrelated underlying dimensions.

Behind the Audit Report: A Descriptive Study of Discussions and Negotiations Between Auditors and Directors

This paper presents direct evidence concerning the extent, nature, and outcome of interactions between the two primary parties in the auditor-client relationship — finance directors (FDs) and audit engagement partners (AEPs). A questionnaire instrument is used to elicit the frequency with which, over a three year period, an extensive set of 46 audit and audit-related issues is discussed, is negotiated, and results in a change to either the accounting numbers or disclosures. Three hundred FDs and 307 AEPs of listed UK companies are surveyed, with response rates of 51% and 80%, respectively. Principal findings are that: (i) compliance issues dominate discussions, while accounting and fee issues dominate negotiations; (ii) audit committees generally reduce the level of negotiation and increase the level of discussion, suggesting that the overall degree of confrontation declines; and (iii) in the majority of cases (57%), negotiation results in a change to the financial statements, providing evidence of the auditors influence on the financial statements.

Financial regulation of public limited companies in the UK: A way forward post‐Enron

On 16th April, 2002, the authors gave oral evidence to the House of Commons Treasury Committee Inquiry into Financial Regulation of Public Limited Companies which was set up following the collapse of Enron. This paper is adapted from the written submission to the Committee on which their oral evidence was based. The authors argue that the Enron collapse provides an opportunity for regulators to stand back and consider fundamental issues associated with the regulatory framework for financial reporting, auditing and corporate governance in the UK. They challenge the financial reporting framework as being muddled between the concepts of stewardship and decision usefulness. Company balance sheets are an amalgam of figures based on historical cost and accounting estimates. The increasing use of financial instruments and the inclusion of intangibles makes valuations complex and judgmental and therefore much more dfficult to audit. Incentives in the capital markets which drive the behaviour of all participants s...

Colin, Richard and Andrew (CRA plc)

This group’s core business was building materials and quarrying. It was also developing a waste disposal business. There was a desire to present the group to its investors in a good light but within the bounds of respectability.

Dennis and Alan (DA plc)

This group was originally a family company which had subsequently obtained a listing. It was still controlled by the shareholdings of the family members. A substantial proportion of the publicly owned shares were held by institutions. The group had two main divisions which complemented each other. One was a cash generator and the other needed substantial working capital. The group operated out of a number of sites. At the time of our visit the cash-rich division was experiencing poor trading conditions. Also the board was aware of an impending hid. The head office was a lean operation with most of the accounting done in the two divisions. The board was small, and some of the directors had substantial shareholdings. There were two independent non-executive directors.

Michael and Paul (MP plc)

This group was a very large international manufacturing company with substantial cash resources. The accounting function was well managed and there were a number of city luminaries on the board. The financial reporting culture within the group was conservative. Because of the group’s status in the market, the board did not wish to attract criticism of any kind for its accounting policies. The group had an in-house treasury function to manage its funds and hedge its foreign currency transactions. Paul, the lead audit engagement partner, had in the past raised concerns about the organisation of the group’s treasury activities. As the treasury function was growing it was becoming a more important issue and Paul raised the matter again. His concerns were supported by Michael, the group chief accountant, and the finance director, Joe. Michael was our interviewee. The matter was discussed by the audit committee and the main board and after some debate the treasury activities were restructured.

Robert and Charles (RC plc)

This group was a manufacturer and had established a reputation for high quality. In keeping with the group’s reputation, the board wished to maintain a respectable image with its financial reporting and avoid criticism. There were a number of accountants on the board and the audit committee. The composition of the audit committee had changed following the Cadbury1 corporate governance recommendations and the committee now contained a high level of accounting expertise.

Thomas and James (TJ plc)

This group had operations in the UK and overseas. It had been a private family owned company before its flotation and although it was listed the family still had a controlling interest in the group. There were no significant institutional shareholders. The group had performed well for several years since its flotation but trading had recently become more difficult. There were two underlying problems. First, quality defects in a key product line had undermined market share at a time when competitors were developing equivalent or better products. Second, a decision had been taken to develop a new product (henceforth Newpro), which required considerable investment. The development was progressing much more slowly than the board had expected. The reduction in profitability resulting from loss of market share had left the group with insufficient cash flow to continue to fund the development of Newpro at its existing level. Despite these setbacks, the group remained solvent, but further investment was needed to secure its long-term survival.

Introduction and Regulatory Framework

This book penetrates the closed world of the discussions and negotiations that take place between the finance director and the auditor of companies. It is out of this interaction process that the audited financial statements ultimately emerge. The book examines six case studies where the authors were able to have in-depth, matched interviews with both the finance director (FD) and the audit engagement partner (AEP) of listed UK public companies. These reveal, perhaps for the first time, the pressures on both parties and the effects on their interaction. These interviews were carried out in 1996 and 1997 and, therefore, reflect the economic and regulatory environment of that time. However, although the regulatory environment has changed since then, the fundamental issues that emerge remain unaffected by the passage of time — in particular the quality of earnings and auditor independence.

The Grounded Theory Process

The broad approach taken to the analysis was outlined in sections 4.6 to 4.9. Before embarking on the cross-case analysis in the next chapter, this chapter describes more fully the grounded theory methodology that will be used (and which also underpins the within-case analysis presented in Chapters 5 to 10).