No More Auditors, Please

(Bloomberg Opinion) -- The quality of U.K. company audits is deteriorating in general and at KPMG LLP in particular.

Beancounters are too credulous of the numbers their corporate clients put before them, laments Britain's accountancy watchdog. This is a problem of culture as much as a lack of competition between the Big Four audit firms.

In the Financial Reporting Council's latest review, only 61 percent of audits performed by KPMG were deemed good or good enough — down from an already poor 65 percent last year. Ernst & Young LLP achieved 67 percent, although the fall from last year was greater. The scores of PricewaterhouseCoopers LLP and Deloitte LLP dipped too, if slightly.

The FRC's own effectiveness is the subject of a government review so it has an incentive to look tough. But there are better explanations for the deterioration.

This year's sample included more banks. Their book-keeping offers heightened scope for executives to bamboozle the auditor by, for instance, massaging the adequacy of loan-loss provisions. So the year-on-year comparison may mix apples and pears.

The FRC suggests that auditors are failing to adequately press managers to write down the goodwill they book on acquisitions. Intuitively, Britain's long period of weak growth should now be putting pressure on asset values. Managers, though, are hardly likely to rush to tell their auditors that the assets they bought aren't worth what they paid for them. The collapse of Carillion Plc is a painful lesson in the need to question this part of the balance sheet.

As for KPMG, its failure to challenge clients was part of an overall problem with consistency. That suggests a failure on the part of central management to apply standards throughout the firm.

Given the grip that the big four have on the market, it's tempting to see greater competition is the answer, either through forced disposal of clients and teams or by strengthening the second tier of firms.

But consider EY, which has been building out its financial services practice. The FRC has required it to raise its game after poaching banking clients from its rivals. The impression is that the firm's client list expanded beyond its existing resources.

The implication is that competitive behavior such as EY's can damage as much as improve audit quality. There just isn't enough profit in audit to support the kind of permanent teams of sector specialists that investment banks still keep hanging by the goal-mouth.

True, a bad rap from the FRC would be more effective if clients could more easily switch among a greater number of firms. Yet the fear of an FRC shaming probably wouldn't be much greater among a "Big Five", especially as its surveys involve relatively small samples.

It's no secret that the bigger problem is probably the client-pleasing culture created by the consultancy operations that cohabit with audit in the big firms. So long as the watchdogs are required to double as lapdogs, it's going to be impossible to create a climate that rewards auditors for mauling the CFO's math.

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net