Audit firms have expanded far from their roots. They now offer a range of tax, business and IT consultancy services which earn higher margins than traditional compliance work. As two giants, Coopers & Lybrand and Price Waterhouse, decide whether to merge, the variety of services that companies can receive from any one firm looks set to increase further. Inevitably, conflicts of interest arise, so is there a limit to the amount of extra services UK businesses should take from one audit firm?
It is a problem the auditors themselves are aware of. An ethical framework established by the Chartered Accountants Joint Ethics Committee (CAJEC) requires auditors to examine threats to their independence. An audit firm, or individual office, should not accept an audit assignment from a listed client where total recurring audit and non-audit fees represent 10% of gross practice income. 'You have to demonstrate that you conduct a regular review when you are anywhere near 5%,' says CAJEC secretary Jack Maurice.
Indeed it has recently been suggested that the 10% limit be cut, and 5% has been mooted as a possibility. It is also essential that audit committees play a key role where auditors supplied 'a substantial volume of non-audit services' to a client, attempting to 'balance the maintenance of objectivity with keeping costs to a minimum'.
This reflects the key to the dilemma. The auditors' inside knowledge can make them efficient non-audit advisers, benefiting company management and shareholders. Christopher Pearce, finance director of Rentokil Initial and chairman of the 100 Group, believes that for assignments such as acquisition, due diligence and some areas of tax advice, using the auditors is 'efficient and convenient' because it relates to their year-end audit work. However, the argument weakens in areas less closely related to the auditors' traditional work, such as IT or management consultancy. 'As finance director, you do want the auditors looking at things critically to get a second opinion,' says Pearce. For example, if the audit firm advised on the installation of a computer system, it might not take such a critical view of the system during the audit.
Auditors strongly defend their independence. Roger Davis, head of audit at Coopers & Lybrand, says: 'There is no evidence that any audit failure is due to the auditors having done consultancy work. What matters is the audit firm's dependence on any one client.' If an audit firm earns a total fee of, say, £1million from a client, it makes no difference whether 10%, 50% or 90% comes from consulting work. 'If you are going to have any restriction, it should be on the total, rather than on any individual type of service.'
Some auditors do earn huge extra fees from other activities. Price Waterhouse, for example, earned £16.2 million in non-audit fees from British Gas in 1996, the year the group restructured, a huge sum compared to its audit fee of £1.5 million. The problem for companies and auditors is that perception is everything. 'People feel that, if the auditors are doing a lot of consultancy work, there has to be a question about a potential conflict of interest,' says Katie Morris, chief executive of small company City pressure group, CISCO. 'It's fair to say that a number of institutions are expressing genuine concern where non-audit fees exceed audit fees by 100%,' agrees Sarah Wilson, managing director of proxy voting agency Manifest.
At one extreme, auditors could be banned from providing any extra services beyond the audit. That would preserve them from any accusations of lost objectivity and save company directors from any suggestion that soft audits are the reward for doling out consulting contracts. The other extreme would be to set no limit on consulting work.
Best practice lies somewhere between the two, depending on the circumstances.
As Denby says: '(The conflict of interest) is not the sort of thing you can set down a list of rules for. You have to use common sense.'.