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About this programme by Peter Day
It was the House of Lords that was the true begetter of the practice of auditing some 150 years ago.
Railways in Britain had started at the beginning of the 19th century: the horse-drawn Surrey Iron Railway seems to have been the first, plying between Wandsworth and Croydon.
In 1821, the Stockton and Darlington railway, steam-powered, was given an operational act of parliament, and then the new railways sprouted thick and fast.
A huge network of speculative venture boomed, rewarding some early railway kings with great fortunes while others were bankrupted. There is argument to this day about how profitable (if at all) the early railways were.
Many were run by opportunists who were more aware than most of the vast returns available to people in the highly speculative business of financing the new modes of transport.
In the 18th century, canal builders had got their money back within three years, an extraordinary rate of return, seldom rivalled again in history until the coming of the Internet.
The railway revolution in early Victorian England led to the great railway investment mania of 1845-47, an investment catastrophe very similar to the Internet dot-com 1.0 bubble of the late 1990s. People swarmed to pump money into Victorian railway projects, and lost all their money or most of it.
That venerable magazine The Economist, founded in 1843, changed its name for a time in 1845 to include the title "The Railway Monitor".
In response to the debacle (one of several railway panics), the House of Lords set up a formal select committee inquiry into the auditing of the railway industry in 1849, bemused by the state of the accounts of companies at the heart of the development of the 19th century industrial economy.
The resulting Select Committee report is said to have created the profession of auditing, as opposed to someone writing down numbers in a report. Auditing meant someone else assessing the numbers, on behalf of interested parties such as shareholders.
Twenty years later, GWR Great Western had an external auditor and an audit committee and from those beginnings a mighty profession developed … and auditing and reporting practices at the heart of the credibility of Capitalism itself.
I mention this history because the UK seems to have maintained its position at the heart of the practice of auditing which is still getting close scrutiny, from the House of Lords among others.
All the Big Four accounting firms have names with familiar British antecedents: Price Waterhouse, Deloitte, Peat Marwick, Ernst and Whinney (Ernst was American from the start). Two of the Big Four are based in London.
UK accounting practices are still hugely influential worldwide.
But in the wake of the great banking crisis of 2008 that has become a continuing great economic crisis, the accountants are under investigation, in particular the way that auditing works.
The European Commission has tabled proposals to rein in the power of the Big Four firms.
In Britain, there’s a new Competition Commission inquiry into the apparent oligopoly of the Big Four when it comes to auditing: 99 of the FTSE 100 quoted companies are audited by one of the Big Four accountancy firms.
The American authorities are also examining the issue. The Chinese authorities have just laid down rules to put locals in charge of the China branches of the Big Four firms over the next few years.
The grounds for these inquiries are easily stated. When I started reporting on business 35 years or so ago, international auditing was in the hands of eight large accountancy firms. A reasonable number you might say.
Most were British or American, or both. German, French, Japanese accounting was rather different, with rather different principles.
The great merger movement began in 1989 when the Big Eight were reduced to the Big Six.
Accountants started to become obsessed with size: their global reach, their income (they were always cautions about their profitability, and their status as limited liability partnerships allowed them to be so), the size of their staff and partnerships, the number of recruits they took on every year.
The recruits were called "audit fodder", for they were the people who counted beans while they were getting their official accountancy qualifications.
The firms recruited thousands of people they would not employ after they qualified in the hope that many of them would retain an affection for the firm in which they trained when they passed out into the general world of business and needed accounting advice.
The accountants started becoming ambitious. Auditing was a competitive market place, but there were extra fees to be had by evolving from accountancy pure and simple into business advisory firms.
Tax advice was an obvious service they could provide to clients. But then they started adding other advisory services: information technology became a huge new business, all kinds of consultancy, legal services, and then the management of billing and fulfilment services.
Another major merger in 1998 produced the Big Five; then the Enron disaster resulted in the implosion of Arthur Anderson, though a legal conviction of the firm in the USA was later overturned.
The Big Eight had become the Big Four in less than 20 years. The vital business of auditing the accounts of the biggest global companies on behalf of the shareholders has fallen into few hands.
But perhaps it is what you might expect in a global world. Few firms, say the Big Four, have the global reach properly to undertake the on the ground, detailed bean counting required before an auditor can declare that the annual results are "a true and fair record" of the business.
They are paid big fees to deliver that vital phrase after due investigation of what the figures actually show.
But there does not appear to have been much auditor warning of the terrible trouble many banks got themselves into four years ago.
Who is an audit for? The shareholders, chorus the auditors. And the independent directors who make up the company’s audit committee.
In other words auditors are not policing the system as a whole. And of course they are paid by the companies they provide audit services for, services required by law.
How dispassionate are auditors? On average the big British public companies change their auditor once every 48 years.
The accountant leading a particular company’s audit is now forced by the regulator to be replaced by the firm every so many years, a move designed to prevent auditors getting too cosy with their client companies.
Creating new competition in a global industry is a difficult thing to do.
"Let us in to create new competition," say the second tier accountancy firms, insisting that they have the global reach of staff to do the job.
But even if the firms are willing, the big international corporations do not appear to be very interested. The imprimatur of an internationally famous firm on their accounts looks just right for them.
There's also been a tendency of big lenders (such as banks) to make it clear that they need a Big Four firm's audit on companies they lend money to.
One thing is pretty clear: any further reduction of the Big Four would not be acceptable to international authorities. We know something like it could happen: look at Arthur Anderson.
So future regulators might be forced to pull their punches in disciplining audit firms that are found to have stepped over the line.
Preserving the status quo may be dangerous when it might put at risk the credibility of accounts, the building blocks of the continued health of capitalist public companies.
And that is where the arcane matter of audit practice becomes a matter of great public interest, and why the current rash of inquiries into accounting and auditing is so important.
The railway companies needed proper auditing in the 1840s because they were misrepresenting their financial health to thousands of people: investors, customers, employees.
As the financial crisis has shown, we still need to understand far more about how companies are running their businesses. The auditors ought to be able to help.
Contributors to this programme:
Chairman, Lafferty Group
Sir David Tweedie
President of ICAS, The Institute of Chartered Accountants of Scotland
Managing Partner Assurance, UK and Ireland, Ernst & Young
Chairman, KPMG UK
Senior Audit Partner Partner, BDO
Deputy Chairman, the Hundred Group of Finance Directors and Finance Director, Pearson
Insights into the business world with Peter Day - featuring content from his Radio 4 In Business…