The Blog Single

How the auditors broke capitalism

Finance

We are programmed to regard accountants with reverence and unquestioning trust. They are the record keepers of the economy and arbiters of financial truth, says Moneyweb.

Double-entry bookkeeping was an astounding development. It allowed business owners to record assets and liabilities rather than simply track the movement of cash and goods. It introduced the concept of ‘capital’ to the business world centuries before Karl Marx wrote Das Kapital. With this new insight, business owners could accurately reflect profits, which in turn opened up opportunities for outside investors.

Just as astounding is the rise of the Big Four accounting firms – EY, PwC, Deloitte and KPMG – as business titans equal to or even mightier than their clients. The Big Four audit 97% of US public companies, 100% of the UK’s top companies and 80% of Japanese-listed companies. Not to mention their overwhelming representation among the JSE’s top companies. Yet trust in the accounting profession has seldom been lower.

Richard Brooks – author of Bean Counters: The Triumph of the Accountants and How They Broke Capitalism – details why this trust has slipped, and how a nicely balanced set of figures can often be a fraudster’s friend.

The major accounting firms have managed to avoid the scrutiny that their importance warrants. Perhaps, as Brooks advises, we should force them to open their financial statements to public scrutiny so we can see how they earn their money.

Before the Big Four there were the Big Five – Arthur Andersen & Co having disappeared in a puff of smoke after it cooked up false accounts for the now defunct US energy company Enron.

A mandatory 10-year audit rotation is the latest solution to this overwhelming concentration and the inevitable Stockholm syndrome that comes from having auditors sleep with the same client, year after year. Consider that KPMG counted General Electric as a 106-year-old client and PwC stepped down from the Barclays audit in 2016 after 120 years. It hardly needs pointing out that given enough time, the Big Four (if they are still around in 10 years, which is a pretty safe bet) will eventually cycle back to the clients who rotated them out of their engagements.

Accounting regulators are working overtime to keep up with the schemes being hatched to boost revenue (think Tongaat) or hide liabilities (Steinhoff). Given enough accounting scandals, and we surely have enough of those, investors will start to apply a ‘truth discount’ on all public companies’ figures.

It would be foolhardy to count on the regulators to bring sanity to the profession. As Brooks points out, the accounting standard-setters are swimming in alumni from the Big Four, ensuring that the rules are crafted to suit the major accounting firms and their clients. If you are a major company, you cannot stray very far from one of the Big Four, despite the efforts of the Independent Regulatory Board for Auditors (Irba) to transform the sector and introduce co-audits for black firms.

Every crisis is a revenue opportunity

What is astonishing is the growth in revenue of the Big Four firms through good times and bad. Brooks demonstrates that their revenue growth barely paused for breath during the 2008/9 financial collapse. Every crisis, or indeed change, is a revenue opportunity for these firms: Y2K, climate change, cyber security, corporate governance, business restructuring and integrated reporting. You name it, they have a solution for you. The result is sports-star-level incomes for men and women employing no special talent and taking no personal or entrepreneurial risk.

Worldwide, these firms make just 39% of their income from audit. They have become consulting firms with auditing sidelines. Though these firms will swear that auditing and getting the numbers right is the sacrosanct heart of their business, the evidence suggests otherwise. With so many inadequate audits on their own ledgers, one might expect a dip in their earnings. You would be wrong. Poor performance is not a matter of life and death when there are so few competitors from which to choose.