External and Internal Audit – An Unhappy Relationship?

The Competition Commission in the UK has released details of new rules which will force firm’s listed on the FTSE 350 to consider changing their external auditor every five years. An article on this can be found here. This comment on the article caught my eye:

“As a retired Internal Audit Manager, I believe that the performance of external audit firms was almost a complete waste of time. They collected large fees for positive comments, or at worst, no comments. The individual external auditors were all very well paid, mostly focused on pursuing their education and all looking for an easy assignment. Their work was usually very poor and they relied almost entirely on the work done by the Internal Audit department. A good accountant could save the company in tax dodges more than the profit from doubling sales, so of course the accounting and consulting arms of Audit companies were pursued and big fees for Audits were one way of doing this. But, they were a totally useless bunch. Well paid, but useless”.

The ‘performance’ of external audit is, in a sense, immaterial. The vast majority of Finance Directors, CFO’s, Head of Finance, whatever, just want a clean Audit Report and the books signed off. No more, no less. They aren’t looking for external audit to be superb, (if anything hopeless is desirable), just as long as the financial statements go through.

‘Individual external auditors are very well paid’. This varies. The grunts doing the bulk of the work as usually trainees on training contracts and paid the market rate or shirt buttons. The carrot they get dangled is qualifying with a Big 4 firm which will propel their career forward. The Partners are the ones raking it in. This also holds for provincial firms. I recall a meeting with an external audit Partner in Manchester and he had a dirty great big Rolex hanging off his wrist. Ironically I was breaking the news that his outstanding audit fees were unlikely to be paid as the client was insolvent.

‘Their work is very poor’. Difficult to comment but given the threat of litigation, I would have thought thorough working papers and sign off was paramount. Certainly at my last firm, the external audit Partner came in and went through the working papers, discussing matters with the CFO. The financial statements don’t go through on a nod and a wink.

As for chasing consultancy fees, at one Big 4 firm I worked at, it was forbidden to pursue an external audit client for advisory work but it didn’t stop the Partners from trying. I do believe that consultancy should be split from audit practice due to the conflicts that can arise. As for tax consultancy, this is a more woolly area. As the tax code in the UK is so voluminous, I’m not surprised external help is required to ensure firm’s are on the right side of the line.

‘Big fees for audits’. Whenever I’ve worked in an audit practice, the gripe has always been that there is no money in external audit as there is pressure from clients to keep fees static or low and the threat from competitors of discounted fees to snuffle the work. I suspect this a red herring as external audit work is profitable as firms use trainees. I would agree that to some extent they are ‘useless’ as they are often green as grass. This is the nub of the problem; as the trainees are ignorant and often auditing part a small part of a client firm, they will not see the over all picture so things are missed. They haven’t the luxury of detailed reviews of systems due to the pressure on budgets. Then again, external audit’s role is very perfunctory so I wouldn’t expect great things. To use a phrase British phrase, it is money for old rope.