When big companies appoint smaller auditors, shareholders must know why
IN the Audit Oversight Board’s scheme of things, an audit firm is either one of a few large players or it belongs with the rest.
This distinction isn’t meant to separate the industry into an upstairs and a downstairs, but we can’t ignore the fact that only a handful of firms are responsible for issuing audit reports on the accounts of an overwhelming majority of our most impactful companies.
Of the 50 audit firms registered with the board, six have more than 10 partners each, and these firms audit more than 50 public-interest entities (PIEs) whose combined market capitalisation exceeds RM20bil. These firms are classified as Major Audit Firms.
The remaining 44 audit firms are known as Other Audit Firms.
The law requires those who audit PIEs and schedule funds to come under the AOB’s supervision.
The list of PIEs originally included listed companies; banking and financial institutions; insurance companies and takaful operators; and those with Capital Market Services Licences, such as securities and futures trading firms, and fund management companies.
The definition of PIEs was widened last September to also cover other capital market institutions such as the Capital Market Compensation Fund Corp, exchanges, central depositories, clearing houses, self-regulatory organisations, private retirement scheme administrators, and trade repositories.
Schedule funds are private retirement schemes and unit trust schemes.
Released on May 10, the board’s annual report 2015 shows the dominance of the large audit firms. As at December last year, 68% of the country’s PIEs were clients of the six Major Audit Firms.
If the pool of firms is expanded slightly to include another two that also had at least 10 partners, the concentration becomes even more pronounced.
According to the AOB, these eight firms collectively audited listed companies and schedule funds that accounted for 95.6% of the stock market capitalisation and 99.3% of the fund size in Malaysia.
There are no prizes that come with being one of the Major Audit Firms. In fact, when a firm is in that category, it can expect annual inspections by the AOB.
These firms’ work has the most impact on the capital market simply because they are auditors of most of the PIEs and schedule funds.
But it appears that there’s a noticeable preference among PIEs to move from large audit firms to smaller ones. Last year, 25 PIEs switched from Major Audit Firms to Other Audit Firms. In comparison, only seven PIEs upgraded to Major Audit Firms.
In the latest AOB report, former executive chairman Nik Mohd Hasyudeen Yusoff wrote:
“We also observed active movements of PIE clients from Major Audit Firms to Other Audit Firms.
“While it is encouraging to note that there is increased competitiveness among audit firms, it is important to bear in mind that it should not be at the expense of audit quality.”
(Nik Hasyudeen’s contract with the AOB ended in March, which was soon after the report had been finalised.)
It’s unfair to equate small firms with lower audit quality — just as it’s silly to believe that large firms never falter — but when a listed company opts to appoint a smaller auditor in place of a Top 6 firm, questions need to be asked. For that matter, any change of auditor shouldn’t be taken lightly.
Shareholders have to approve such a change and they should demand for a satisfactory explanation as to why the company ought to have new auditors.
Often, there are harmless reasons, such as the company being absorbed into a group audited by another firm.
But other rationales may invite more scrutiny.
For example, if the board and the management say they’re doing the company a favour by appointing another firm that has quoted a lower fee, shareholders have every right to know how are the directors convinced that the new firm can deliver audit quality at a lower price. If the business is growing rapidly, does it make sense to sign on a smaller audit firm?
And what if the change of auditors comes after the current auditors have issued a qualified audit opinion, shareholders must satisfy themselves that new firm is not appointed because it happens to agree with the board.
All audit firms, big and small, face the same problems — difficulties attracting and retaining talent, increasingly complex accounting rules, increasing costs, and tougher regulation.
Part of the solution is for those who rely on audit reports to understand that the audit of financial statements isn’t a commodity. They have to make sure that auditors are appointed for the right reasons always.
Executive editor Errol Oh wishes there’s an easy way to know when an audit firn, regardless of its size, has done a good job.