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December 16, 2014


Greg Carney

The problem with governments taking larger roles in audits or directing audit firms is that this would necessarily result in the audit profession becoming slower in responding to the needs of changing business and far less useful (if that is possible) to the day to day needs of their clients and their clients' investors. It would also replace the perceived problem of the deleterious influence of economic consideration on the accuracy and usefulness of the audit with a problem of political considerations (think of the ramifications of CO2 emissions related disclosure and risk assessment requirements) doing the same.

As for audit insurance, for better or worse, the audit firms do act in effect as underwriters to Boards and investors of not the risk of inaccurate financial reporting but of business reverses and failure. Unfortunately the premiums charged (audit fees) do not accurately account for or reflect the true underlying business risk as the audit is not designed to determine that. Furthermore, the audit fee/risk calculus is further confused when other fees from the audit client are considered (as the case of Enron and numerous incidents at most of the large audit firms suggest). As the profession does not set audit fees appropriately, there might be a benefit from involving those large insurance institutions who are adept at evaluating existential risk and charging appropriately.

The audit profession is largely a creation of government requirements rather than market demand. If there was no requirement for an formal audit imposed by the SEC, what services would audit clients demand of the profession? What would they rather pay for? Since companies are forced by governments to have audits, the profession should try as much as possible to understand the value actually provided, provide those services that deliver that value, and charge appropriately. It is hard for an industry made up of highly competitive professional groups to move as an industry away from current practices and adopt a new approach. It is also hard for a profession with such a focus on consistency, year to year, to make changes like this, but the current situation is obviously far from the best.

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