A matter of auditor independence

Published March 31, 2013

A look at how major SGX-listed companies disclose audit and non-audit fees paid to external auditors

Published in Business Times, January 09, 2013


IN SEPTEMBER 2011, the Singapore Exchange (SGX) amended its rulebook to require issuers to disclose the aggregate amount of fees paid to auditors, broken down into audit and non-audit services, rather than the existing requirement to disclose just the non-audit fees paid to these auditors. The rule amendment addressed a lacuna that had existed since July 2002, when the Ninth Schedule of the Companies Act requiring the disclosure of audit fees was repealed in conjunction with accounting standards becoming mandatory under the Companies Act.

Disclosing non-audit fees paid to external auditors without also disclosing the audit fees makes it difficult for stakeholders to properly assess the risk of the external auditors being more financially motivated by the non-audit services provided to the audit client, and also does not give them a full picture of the financial relationship between the external auditor and the auditor client – both of which could potentially compromise auditor independence.

Globally, revenues from non-audit services outweigh revenues from audit services and growth from non-audit services outstrips growth from audit services for the “Big Four” and other professional accounting firms. Most external auditors also provide non-audit services to their audit clients. Therefore, it is inevitable that there will be continuing concerns about auditor independence.

It has always struck me as odd that international financial reporting standards which have imposed ever-more stringent disclosure requirements do not require the disclosure of fees paid to auditors. Nevertheless, most major markets have long imposed such disclosure requirements either through modifications of their accounting standards or other regulatory requirements.

Using the latest annual reports for the largest 30 companies by market capitalisation listed on the SGX (excluding real estate investment trusts and business trusts), I examined how these companies disclose audit and non-audit fees paid to external auditors and their network firms.

KPMG is the external auditor for 10 of these companies, followed closely by E&Y (9) and PwC (8). Deloitte & Touche is the auditor for two of these companies, while Moore Stephens is the only non-Big Four auditor for the top 30 companies. Two of the companies, Thai Beverage and Noble, use overseas Big Four firms in their country of domicile.

Rule 715 in the SGX rulebook states that, subject to rule 716, an issuer “must engage the same auditing firm based in Singapore to audit its accounts, and its Singapore-incorporated subsidiaries and significant associated companies” and a “suitable auditing firm for its significant foreign-incorporated subsidiaries and associated companies”. Rule 716 allows an issuer to “appoint different auditing firms for its subsidiaries or significant associated companies – provided that – the issuer’s board and audit committee are satisfied that the appointment would not compromise the standard and effectiveness of the audit of the issuer (or) the issuer’s subsidiary or associated company is listed on a stock exchange”. These rules suggest a preference for having the same auditor or its network firms auditing all the major entities within a group. Rule 717 requires an issuer to disclose in the annual report the names of the auditing firm(s) for its significant subsidiaries and associated companies.

While there are good reasons for having the same auditor for all the group entities, it increases the mutual dependence between the auditor and the issuer. From the issuer’s standpoint, it becomes more costly to switch auditors as this may mean having to switch auditors for many group companies. From the auditor’s standpoint, winning the audit of the issuer comes with the potential bonus of winning the audits of other entities within the group, while losing an issuer as an incumbent client comes with the potential loss of many audit engagements.

Based on the disclosures in the notes to the financial statements, the estimated percentage of subsidiaries audited by the parent company’s auditor and its network firms ranged from 45 per cent to 100 per cent. Most issuers use the parent company’s auditor or its network firms to audit all or most of their subsidiaries. There are, however, some notable exceptions, with OCBC, Keppel Corp and Golden Agri having less than 50 per cent of the disclosed subsidiaries audited by the main auditor and its network firms.

The disclosures of audit and non-audit fees are inconsistent across companies, even where these companies have the same external auditors. This suggests that the disclosure practices are driven by the issuers themselves, with the auditors having relatively little influence.

Only eight companies separately disclosed the amount of audit and non-audit fees paid to the parent company’s auditor and its network firms. These are SingTel, DBS, OCBC, UOB, F&N, Thai Beverage, Sembcorp Industries and UIC. These companies also disclosed audit and non-audit fees paid to auditors other than the parent company’s auditor and its network firms, or had negligible use of other auditors.

Most companies instead show separate amounts for audit and non-audit fees paid to “other auditors”, in addition to amounts for the parent company’s auditor. These “other auditors” are auditors of the issuer’ s subsidiaries, and are often the parent company’s auditor or its network firms.

All the companies are compliant with rule 1207(6)(a) but the disclosures by the group of eight companies highlighted above provide the greatest transparency regarding the extent of the financial relationship between the auditors and the issuer, including both the overall level of audit fees and non-audit fees. Such disclosures also allow a better assessment of the relative significance of non-audit fees compared to audit fees for the auditors in a more comprehensive manner.
Only one of the 30 companies, Thai Beverage, did not use its auditors for non-audit services, based on its disclosure. Three companies had non-audit fees equal to or exceeding audit fees paid to the auditors, and they are Genting, CapitaMalls Asia and StarHub.

However, to properly assess the risk of non-audit services impairing the independence of the auditors, we need to consider the nature of the non-audit services provided. For example, where the non-audit services involve valuation services, they could pose a more serious threat to independence than if those non-audit services involve tax consulting.

Unfortunately, while companies generally include boilerplate statements about the audit committee having reviewed the non-audit services and approved them, they generally do not disclose the nature of the non-audit services provided. Only three companies – SingTel, CapitaMalls Asia and SPH – disclosed information on the nature of the non-audit services provided. In CapitaMalls Asia’s case, it disclosed that non-audit services included services provided in association with its secondary listing in Hong Kong, but did not specify the nature of other non-audit services.

In my view, the disclosure requirements for audit and non-audit fees should be enhanced to require separate disclosures of fees paid to both the parent company’s auditor and its network firms. This will also align the disclosure requirements better with the Code of Professional Conduct and Ethics under the Accountants (Public Accountants) Rules, which considers relationships involving network firms in its “conceptual approach to independence”.

It is also consistent with accounting standard requirements in countries such as Australia and New Zealand, which require the disclosure of audit and non-audit fees to include fees paid to network firms. In addition, similar to those requirements, companies should be required to disclose the nature of the non-audit services provided by the auditors.

With the pervasiveness of fair value accounting in today’s international financial reporting standards, the involvement of auditors or their network firms in providing valuation services may pose an increasingly important “self-review” threat to financial statement audits. Such valuation services may involve stock options, biological assets, derivatives, intangible assets, and “value in use” computations for impairment testing.

While the Code of Professional Conduct and Ethics recognises the threat of auditors providing valuation services to audit clients, it uses a principles-based approach and does not specifically prohibit it. Para 290.176 states: “If the valuation service involves the valuation of matters material to the financial statements and the valuation involves a significant degree of subjectivity, the self-review threat created could not be reduced to an acceptable level by the application of any safeguard. Accordingly, such valuation services should not be provided or, alternatively, the only course of action would be to withdraw from the financial statement audit engagement.”

There is a need for greater transparency, if not stricter rules, governing the provision of valuation services by auditors or their network firms to audit clients.

The writer is an associate professor of accounting at the NUS Business School, where he teaches corporate governance and ethics

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