Rank audit firms and tie pay to quality, government told
The IPA has called for major reforms to address firm culture, including public performance ratings and quality-based remuneration.
Audit firms should be publicly ranked and auditors’ compensation should be tied to the quality of their work rather than the amount of money they bring in, the Institute of Public Accountants says.
The IPA’s proposal, addressed to the Treasury, aims to address a culture among audit firms it said prioritised efficiency over effectiveness and created conflicts of interest.
“Economic fundamentals suggest that incentives drive behaviour,” the accounting body’s submission said. “If revenue generation drives compensation, then it may be given priority over conflicts of interest.”
The Treasury is considering reforms to the accounting and auditing sector, including splitting off audit services, in response to the PwC tax leaks scandal and the subsequent parliamentary inquiries that raised concerns with multidisciplinary firms’ audit practices.
The IPA said that instead of mandating the separation of audit and non-audit work, which would impact both bigger and smaller firms, reforms should be targeted at changing audit culture.
It pointed to research suggesting revenue generation was a “significant” influence on audit partners’ salaries and a determinant of partner performance, which in turn had a negative impact on audit quality.
“These quality-threatening behaviours are usually associated with various forms of on-the-job pressures such as revenue generation reward-based systems appearing to provide stronger incentives for audit efficiency rather than effectiveness,” it said.
“In IPA’s view, this culture would also raise significant risks for conflict of interest.”
It said compensation needed to be based on auditors’ quality of work and their ability to prevent conflicts of interest rather than an excessive focus on profitability.
“Regulators should ensure that audit firms build remuneration incentives around audit effectiveness and prevention of conflicts of interest rather than on an excessive focus on efficiency and profitability,” it said.
Another proposed solution was the implementation of a public rating system for audit firm quality, developed and overseen by a new, dedicated watchdog.
This system would provide a more transparent evaluation of auditor performance, potentially becoming a key component of firms’ compensation schemes, the IPA said.
“It is only through such reforms and shifts in reward systems that Treasury will be able to reduce quality-threatening behaviours and thereby observe a cultural change in audit firms,” it said.
In its submission, the IPA also advocated for legislative changes that would give the accounting code of ethics under APES 110 the force of law.
The proposal would grant accounting bodies or a new dedicated regulator the power to enforce ethical standards and impose sanctions on non-compliant practitioners.
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