Kurt Ramin, CPA, MBA, CEBS February 28, 2009 kurt.ramin@gmail.com CONSULTATION ON CONTROL STRUCTURES IN AUDIT FIRMS AND THEIR CONSEQUENCES ON THE AUDIT MARKET Dear Mr. Tiedje, below are comments on the consultation request I received via email in January. General Remarks Instead of an introduction: Over 10 years ago I co-authored an article on International Auditing Differences. Not much (except for advancements in technology) has changed since then and there are now only 4 large global firms left. 1 Specifically to your request, I like to offer the following comments: The Product: Audited Financial/Business Reports Management is responsible for preparing financial and business reports for their internal use, external parties and tax authorities. Auditors provide assurance on these reports. It is important, as much as possible, that the same standards and procedures are used by all entities to complete the reporting tasks. The more identical standards (e.g. IFRS) are applied in preparing and auditing the reports (e.g. GAAS) the lower are the costs involved. Therefore, the goal has to be to use the same formats, language and other infrastructure. The other important question is the level of assurance needed for particular reports. Non Publicly Accountable Entities (NPAEs) need less audit attention than other 1 International Auditing Differences Journal article by Carol A. Frost, Kurt P. Ramin; Journal of Accountancy, Vol. 181, 1996
entities. The current attempt by the EU to allow Member States to completely abolish financial reporting obligations for the EU s smallest companies has to be applauded. But this can only be seen as a start. Compared to the USA there is still a huge difference in reporting requirements. Why an IFRS for NPAEs? 3 GAAP reporting required by law for all or most private companies? USA: Generally NO. 5,000,000 private corporations: No 15,000,000 other business: No 25,000 SEC/others FASB GAAP by law Rest of world: generally YES. Europe: 5,000,000 companies must prepare GAAP f/s and have audit by law 2009 IASC Foundation. 30 Cannon Street London EC4M 6XH UK. www.iasb.org The IASB plans to issue a standard for NPAEs (formerly IFRS for SMEs, IFRS for Private Entities) this year. It is a re-formatted, better codified and abbreviated version of the current volume of IFRSs, which EU public companies are required to apply. As indicated by the frequent name changes of the proposed NPAE standard, the often debated question is to which set of companies the standard should apply to and, indirectly, for the requirement to be audited.
Who are we aiming at? In most countries, only 1% of businesses have over 50 employees. United Kingdom (2007): Number Percent Total Entities 4,679,000 100.0 Owner run (no employees) 3,460,000 74.0 1 9 employees 1,019,000 21.7 10 49 employees 167,000 3.6 50 99 employees 17,000 0.4 100 199 employees 8,000 0.2 200 499 employees 5,000 0.1 500 or more employees 3,000 0.1 14 For the majority of small companies (except for the legal and tax driven entities) the focus for management are people, products and infrastructure assets. Therefore, the reporting needs for a small entity needs a segmentation into these three areas as indicated in the following chart: Modular Format (period = time and location) operating, financial, other (units x value) Sort statements (Net) and unit of Accounts by: People Fixed Assets Product Financial Communication- Intangibles (time sensitive) Statement of Financial Position Cash Flows Recognized Income and Expense for Period Statement of Changes in Equity (including to owners) Add Related Disclosure: (People, Fixed Assets, Product, Financial, Communication Parallel Reporting FV, historical and Mirror accounting, Copyright: K. Ramin Financial Reporting Goes Global
People related items (compensation and benefits, travel, etc) and related party information and disclosure Products purchased and sold and related information and disclosure Long lived Assets used and supplemented by related information and disclosure Financial assets and liabilities and related information and disclosure Communication-intangible items and related information and disclosure Transactions with owners and related information and disclosures 2 The Infrastructure Regardless of the reporting standards used, the EU auditing infrastructure is still influenced by a lot of other important factors: Language The number of languages used and possible combinations thereof in the EU is still the major obstacle for comparative use of financial information and related issues relating to audit and education. Common European Numeric XBRL taxonomies (or intelligent charts of accounts) by industry would improve the situation dramatically. Based on studies of translating IFRSs into all the European languages the indication is that a translation of the IFRS taxonomy amounts to only 10 to 15 % of the costs of a full IFRS translation. However, the EU only financially supports the translation of the legally required portion of IFRSs, instead of marketing the use of taxonomies. With the use of hyperlinks from the taxonomies, legal issues of IFRS interpretation are reduced and concepts are easier to understand. Tax laws The other competing factors for resources (and audit personnel) in the audit market are compliance costs to the mostly middle aged and overgrown income tax laws in the EU. Smart countries use IFRS as a base for income taxation. If one would multiply the hours used in tax compliance by the standard audit rates charged by the big 4 accounting firms one would get eye-opening numbers, probably much higher than the ones quoted in your report. Why not speed up the current project of a common invoice format in the EU and then privatize VAT audits and create a totally new audit market in the EU? Some kind of TUV or ISO stamp could indicate compliance. Revenue related issues are always at the heart of any audit. Good oversight, covering independence issues, are obviously needed for this model. The electronic use of invoices (or scanning) should be pushed as an incentive in this system. European wide use of electronic payment and transfer systems are another key to reduce audit fees. Technology From the above comments it should become clear that the use of technology is the key to expand resources and competition in the audit market. Legacy systems in certain sectors (like banking) could hinder the progress. XBRL can be used as an independent 2 See my comments to the SEC report to Congress http://www.sec.gov/news/studies/2008/marktomarket123008.pdf page A 7
platform and is currently implemented into COREP and FINREP. In Germany, DATEV has created a accounting and reporting framework based on German GAAP, which could be used as a case study to see if additional audit steps and efforts are needed based on the suggestions and segmentation as described. I am sure similar case studies could be taken from other EU countries. Repositories ( Bundesanzeiger ) are currently created using XBRL data. But, the most effective way would be to let companies post their reports on their own websites in a prescribed format. Human Factors and Education There is currently no common European CPA and therefore a fragmented education market leading to different certifications from ACCA to US CPA and various light IFRS certifications exists. Only individual countries have licensing power, similar to the state boards in the US. (BTW, state boards are making a mockery of the profession in the US!). This creates slow incentives for change. Why should there be a business objective to create additional European auditing firms when there is no common market? I suggested several years ago that European-wide question banks be created (to test the knowledge on IFRS) for the tests and education leading to local licences. Similar question banks could be created for testing IT and auditing standards knowledge. This would be a stepping stone towards a common European certification. Only tax and legal modules would need to be added locally. This intent would lead to better transparency of the profession and have an integrating effect on internal, tax and other auditors. Obviously, with better transparency, the quality and interest in the profession would increase. Conclusion: The secret of good reporting is to deliver reports on time. Anything longer than a report delivered after two months of closing or valuation date, is less useful. This involves auditing as well. The deadline for filing quarterly information in the US is 45 days; with current systems in place it could be reduced to 30 days. Therefore, we have to find ways to speed up the process: use of interactive data, allow and incentive companies to put the information on their own websites (in a specified format) and use modular audit approaches to open up the market. I have not answered your specific questions directly, since I believe that the form of organization (questions 1 to 4) of audit firms will always be a play between legal liability, independence and risk assumed. Common European Regulation on audit firm ownership is an absolute must to attract more capital and increase borrowing power. This will create a more integrated audit market and more firms involved. Independence relates to transparency. Fewer layers in an organization usually lead towards better transparency. I think my comments include several ideas relating to question 5 (e.g. modular audit approach, in the US forensic auditors are the latest fashion) and my comments on Human Capital (questions 6 and 7) provide my concerns and ideas there.
To look at the market from a common European and technology perspective (external auditors, internal auditors, tax and other auditors) would bring back a lot of excitement to the profession and an incentive to be part of that profession. I would be glad to discuss this in further detail. Sincerely, Kurt Ramin kurtramin@yahoo.de 25 04 15.19 N 55 08 05.24 E 2009-03-02T09:01:02 Question 1: Do you see a need for opening up the market for the audit of international companies in order to have more European wide audit service providers compared to the existing situation? Do we need a more integrated audit market? If yes, why? Question 2: Do you believe that the current number and structures of the audit firms' networks are sufficient? Question 3: Is access to financial capital a key factor to accelerate further integration of audit firms and emergence of new players? Do you share the view that allowing for competing models (e.g. partnership model, investor model, ) will create the opportunity for more investments resulting in more global players? Are other models conceivable? Question 4: Would models other than the current one negatively affect auditors' independence? Is there a need for additional safeguards at European level to protect independence? If so, what safeguards should be strengthened? Question 5: Should the Commission examine other catalysts accelerating access to the international audit market? If so, which one and why? Question 6: Are the current partnership forms of ownership indispensable in order to recruit, retain and further develop human capital? Could alternative structures under revised control rules allow audit firms to retain human capital and preserve audit quality? Question 7: Is human capital a factor more important than financial capital to expand internationally? Do you see in the current regulation for the audit profession any obstacles related to human capital preventing further integration of audit firms?
Comments, preferably in the form of general remarks followed by answers to the questions listed in appendix, should be submitted by e-mail to the following address: marktf4@ ec.europa.eu. Respondents may alternatively send comments by post to the European Commission, DG Internal Market and Services, Unit F4 Auditing, SPA 2 (JII), 02/085, B- 1049 Brussels, Belgium. DG Internal Market and Services If so, please contact Ms. Anne-Françoise Mélot or Mr. Jürgen Tiedje (Tel.: 0032-2- 2950525).