Audit regulation: A partial solution expanded
| DOI | https://doi.org/10.1108/eb024995 |
| Pages | 31-47 |
| Date | 01 January 1999 |
| Published date | 01 January 1999 |
| Author | Vivien Beattie,Richard Brandt,Stella Fearnley |
| Subject Matter | Accounting & finance |
Journal of Financial Regulation and Compliance Volume 7 Number 1
Audit regulation: A partial solution expanded
Vivien Beattie,* Richard Brandt and Stella Fearnley†
Received: 8th December, 1998
*Department of Accounting, Finance and Law, University of Stirling, Stirling FK9 4LA;
tel:
01786 467306; fax: 01786 467308.
†Department of Accounting and Management Science, University of Portsmouth, Locksway Road,
Portsmouth, Hants PO4 8JF; tel: 01705 844095; fax: 01705 844037.
Vivien Beattie MA(Hons), CA, PhD, is Pro-
fessor of Accounting in the Department of
Accounting Finance and Law, University of
Stirling.
Richard Brandt MA, FCA, FRSA, is a
Research Fellow in the Department of
Accounting and Management Science at
Portsmouth Business School.
Stella Fearnley BA, FCA, FRSA, is a Prin-
cipal Lecturer in Accounting in the Depart-
ment of Accounting and Management
Science at Portsmouth Business School.
ABSTRACT
The Department of Trade and Industry (DTI)
issued a consultation document in November
1998, which set out
a
framework for the inde-
pendent regulation of the accountancy profes-
sion.
This framework broadly adopts the
proposals put forward by the profession
itself.
In this paper, the focus is on audit regulation.
The current regime is outlined and its
structural
weaknesses and procedural problems identified.
The proposed reforms are described and criti-
cally evaluated. It is argued that the proposed
reforms offer only a partial solution to regula-
tory
concerns,
since no changes are proposed to
the existing regime either for
registration,
or for
monitoring and discipline of the majority of
audit
cases.
An expanded framework that ratio-
nalises current practices and provides a more
comprehensive solution is suggested. A critical
feature of the proposal is that a distinction is
made between audits of small entities and audits
of major listed companies, only the latter of
which are of public interest. Each would have
distinct
licensing
and monitoring
procedures.
INTRODUCTION
Public confidence in the integrity of the
statutory audit is fundamental to the opera-
tion of capital markets as audit provides
assurance to investors on the reliability of
companies' financial statements and helps
to reduce the cost of capital. The main
threat to confidence arises from major cor-
porate collapses in circumstances where the
competence or independence of the auditor
is publicly questioned.1 Where audit failure
is suspected, the effectiveness of the process
of investigation and discipline of auditors
also becomes a matter of public interest.2
Loss of confidence in the audit process is
damaging not only to the operation of
capital markets but also to the economic
interests of audit firms and to the credibil-
ity of those responsible for regulating
them. It is, therefore, to the mutual advan-
tage of investors, auditors and regulators in
the UK that the regulatory framework
should be able to minimise the risk of loss
of confidence in the audit process. In order
to achieve this, the framework needs to
demonstrate two key attributes which are
well recognised in the economic theory of
regulation.3 First, it must have mechanisms
to reduce the risk of failures by ensuring
that audits are generally competently per-
Journal of Financial Regulation
and Compliance, Vol. 7, No 1,
1999,
pp.
31-47
© Henry Stewart Publications,
1353-1988
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Audit regulation: A partial solution expanded
formed. Second, it must be able to deal
effectively with cases where failures have
taken place. A further vital attribute of any
regulatory framework is that the costs of
compliance for the entities regulated must
not outweigh the public benefits arising
from
it.4
Responsibility for the management of
the process of qualification, regulation and
discipline of auditors has historically been
delegated by the DTI to the professional
accountancy bodies. The main bodies that
are involved in audit work are the Institute
of Chartered Accountants in England and
Wales (ICAEW), the Institute of Chartered
Accountants of Scotland (ICAS), the Insti-
tute of Chartered Accountants in Ireland
(ICAI) and the Association of Chartered
Certified Accountants (ACCA). The pre-
sent regime for regulating auditors, which
represented a fundamental change in
itself,
was introduced in 1991, under the provi-
sions of the 1989 Companies Act. Further
changes to the regime were recently pro-
posed by the accountancy bodies to the
DTI as part of a wider plan to reform the
overall framework for regulating the
accounting profession (the Swinson propo-
sals).5 A consultation paper based on the
Swinson proposals was issued by the DTI
in November 19986 setting out revised
proposals which will be reviewed at the
end of five years. The issue of this docu-
ment was accompanied by a heavy handed
threat from the trade minister, Ian McCart-
ney, of further statutory control: 'if it docs
not deliver independence, transparency and
effectiveness then it will be
revisited'.7
The regulatory framework can be
viewed as a 'system'. Indeed the DTI's con-
sultation document refers explicitly to the
'new system of independent regulation'.8 A
system comprises structures and processes
which must be appropriate and effective if
the system is to remain stable. With respect
to audit regulation, there must be struc-
tures and processes in place to deal with
various activities, viz. training, qualifica-
tion, registration (ie licensing) monitoring,
investigation and discipline.
This paper begins with a brief review of
relevant aspects of regulatory theory and
outlines the background to the introduc-
tion of the current regulatory regime for
auditors. Then the issues that have arisen
since implementation of the current regime
which have resulted in the proposed
reforms are discussed. Thereafter, the pro-
posed reforms are reviewed and whether
they actually address the identified con-
cerns is evaluated. An expanded model that
the authors believe would be more effec-
tive in controlling the risk of future pro-
blems arising regarding audit regulation is
then suggested, as any subsequent problems
would inevitably result in more criticism
of the regulatory framework and under-
mine its credibility. Finally, a long-term
view of the proposed framework is taken,
alongside the wider issues of company law
reform and insolvency regulation.
RELEVANT THEORIES OF REGULATION
Self-regulation has been described as a pro-
cess by which the state's power to coerce is
actively sought and obtained by influential
economic groups ultimately for their own
benefit.9 Regulatory agencies may be cap-
tured by the industry they are intended to
control.10 Regulatory capture is recognised
as a particular problem in the case of pro-
fessional bodies who undertake to regulate
themselves. Suspicions and accusations of
capture arise, with or without justification,
because it is well recognised that a key role
of a professional body is to promote the
interests of its members.11 Furthermore, as
regulatory authority increases the economic
power and status of a professional body,
professional bodies generally seek to retain
this.12 The professional bodies also argue
that self-regulation is in the public interest
because practitioners are best equipped to
understand and deal with the problems
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