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EC’S GREEN PAPER HAS GENERATED EXTENSIVE DISCUSSION

Auditing profession faces changes

THE FINANCIAL crisis has raised a multitude of questions about the roles and responsibilities of professional auditors. In autumn last year the European Commission published a Green Paper on Audit which has initiated extensive discussion about the responsibilities of auditors, their governance structures and potential changes that may be warranted in this important profession. The EC received about 700 responses with about 10,000 pages of suggestions in reaction to its document.

THE FINANCIAL crisis has raised a multitude of questions about the roles and responsibilities of professional auditors. In autumn last year the European Commission published a Green Paper on Audit which has initiated extensive discussion about the responsibilities of auditors, their governance structures and potential changes that may be warranted in this important profession. The EC received about 700 responses with about 10,000 pages of suggestions in reaction to its document.

The Green Paper was also a main topic at the Financial Reporting and Auditing conference organised by the EC in Brussels on February 9 and 10. In his opening speech the EU’s Internal Market Commissioner, Michel Barnier, told the conference participants that changes must be made in how auditors do their work so that there is more competition in the auditing business and auditors are more independent. He also presented a plan to prepare new legislation by November to curb what he called increased concentration in an audit market that is dominated by a small handful of major firms, the so-called Big Four.

The Slovak Spectator spoke with Ondrej Baláž, the president of the Slovak Chamber of Auditors, about the Green Paper, his opinions about concentration in the auditing business, Barnier’s ideas for legislative solutions and how the financial crisis had impacted the auditing profession.


The Slovak Spectator (TSS): How do you perceive the statement of Michel Barnier that the auditing business is too concentrated and largely dominated by the Big Four (KPMG, PwC, Ernst & Young and Deloitte)? What is the situation in the Slovak market?
Ondrej Baláž (OB):
Concerns about growing concentration in the audit market is only one partial problem raised in the Green Paper. The perception that the major part of the market for statutory auditing of public-interest entities is controlled by four worldwide networks is not so unambiguous. The majority of voices perceive this problem as a systemic risk. But not all people think so, as at the conference there were also some voices, coming from investors, who do not see this as a risk.

The situation in the Slovak market is similar to that abroad even though the [market] share of the Big Four is a little bit smaller here than in other EU countries. This is because of the smaller size of Slovakia’s economy and because smaller entities here are also subject to statutory audit. In Slovakia an audit is also obligatory for municipalities, foundations and similar smaller entities which are not important because of their size but for their importance to society. Most of these entities are not interesting for the Big Four companies or they are not globally interconnected and it is not necessary to have an audit of a consolidated financial statement. If we consider only public-interest entities on the basis of European criteria, i.e. banks, insurance companies, large companies and so forth, the concentration of audits done by the Big Four companies would be almost 100 percent.


TSS: How do you view the plan to curb increased concentration via new legislation?
OB:
The high concentration is an indisputable fact. But this situation has not grown from artificial intervention. It is a consequence of a certain development and globalisation and is not a phenomenon occurring only in auditing. The question is what can be done about this or whether it is necessary to do something about it.

As a consequence of the infamous Enron case the then-biggest auditing network, Arthur Andersen, disappeared. This has led to even more concentration in the audit market.

I personally perceive as the problem the fact that nobody has so far proposed a real solution.
Moreover, in my opinion, some hoped for changes flowing from the EC Green Paper initiative will have the opposite effect. These will lead to even higher concentration.


TSS: At the conference Commissioner Barnier introduced several ways that the auditing market could be made more open, for example by limiting market shares for larger companies, through the concept of audit partners, or by creation of the ‘European passport’. Which of these measures do you see as feasible and beneficial to the Slovak market?
OB:
I would not like to create the impression that the auditing profession in Slovakia rejects changes. It is clear to us that changes are inevitable. And they are also truly happening. As of 2008 there is a new law on auditors which has implemented requirements of the Eighth EC Directive on Statutory Audit. Conditions for performance of an audit have become stricter, the International Standards on Auditing (ISA) have become national standards in Slovakia, and the Office for Oversight of the Performance of Audit has been launched, and so on. These changes have gradually borne fruit.

But it is too early to assess all their effects. The Slovak Chamber of Auditors believes that even the Green Paper has not been based on an assessment of the impacts of these changes in European legislation. Thus, introduction of additional administrative measures, without any in-depth assessment, can bring an effect opposite to that which is originally expected.

Some proposed measures, for example joint audit, may bring more opportunities for smaller audit companies. Maybe this is a way to reduce the concentration in the audit market. But it is questionable whether users of audits will be willing to accept the consequences that this would bring. Other proposed changes seem too administrative to me. We can limit the market share of large auditing companies by a law. But who will fill in the gap that will occur in the market? The market will likely be able to handle this. But there remains a question whether this will lead to higher quality in auditing.

I am even more sceptical with regards to the ‘European passport’. For its introduction to make sense and bring tangible effects, rules for auditing for the entire EU should first be harmonised. This raises a question of how the differences in legislation of individual countries would be resolved. Moreover, there is a question of language. Will a foreign auditor understand documents in Slovak, for example?

With regards to this issue, especially for small economies, I see one more problem here. The specific feature of the Slovak market is that it is small. Because of this, the criteria under which companies and entities are obliged to undergo an audit have been set lower than in larger countries. A large company in Slovakia is only a small company when assessed according to European conditions but that company is important for Slovak society.

Moreover, municipalities, foundations and others are also obliged to undergo auditing in Slovakia. After setting the conditions for compulsory auditing according to the EC directive’s threshold, the profession of auditor would be endangered in Slovakia. Then those companies subject to auditing could be simply audited by auditors with the ‘European passport’ from outside Slovakia.


TSS: How did the economic crisis change the auditing market and the role of audit firms? Did the Slovak experience differ from other countries?
OB:
The situation in Slovakia has been similar to that of other countries, especially within the new EU member countries. The crisis brought higher demands on auditors and on the quality of auditing.

On the other hand, fees for audits are decreasing. A situation in which more work is required for less money does not contribute to an increase in the quality of auditing. And the situation when an auditor is pressed by circumstances to accept orders for a price that does not enable allocation of enough funds for their proper performance endangers the independence of the auditor.


The Slovak Spectator also spoke with Alica Pavúková, a partner of PwC in Slovakia; Peter Potoček, manager of the audit department of Ernst & Young in Slovakia, and Mickaël Compagnon, managing partner of Mazars in Slovakia, about the EU’s Green Paper and related topics. To see their responses, read article Audit in the spotlight

Topic: Finances and Advisory


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