During the last century, the public accountancy profession was mostly self-regulated. National level professional bodies in different parts of the world acted as the sole regulatory authority for the jurisdiction, and were in charge of accounting and auditing standard setting, as well as quality control of audit work of their members.
The system worked reasonably well for a long time, with occasional lawsuits filed against auditors. The collapse of Enron in the earlier part of this century, however, raised serious concerns about the profession's ability to govern itself, and turned the tide against the auditors. Consequently, we saw a radical shift from the long established system of self-regulation to an independent oversight regime.
The formulation of these independent oversight bodies led to a plethora of regulatory interventions aimed at clipping the wings of the auditing profession. Such measures included prohibition on non-audit services by audit firms, restrictions on audit tenure, introduction of mandatory tendering for audit services, and enhanced role of the audit committee in recruitment and remuneration of external auditors.
The domination of Big Four audit firms, especially in the western countries, also led to concerns regarding competition in the audit market, and choice restrictions. Subsequently, a number of initiatives, ranging from introduction of joint audits to imposing a market cap on audit firms are currently being considered.
Overall, the global audit regulatory environment, after years of stability in the last century, has been experiencing significant turbulence in recent times, especially in context of developed countries. In a globally connected world, naturally, this wind of change has also affected the developing countries.
At this point, it is important to highlight that the audit markets in developing countries, such as Bangladesh, possess features that are significantly different from those in the developed world. Audit markets in developing countries are characterised by the absence of complete institutions, highly concentrated ownership, poor monitoring, and lack of investor activism.
However, despite these significantly different features, developing countries have been keen to adopt the western models auditing reforms. The adoption of such western practices have been driven by the desire of governments in developing countries to attract foreign investment, and facilitated by the activities of development partners, such as the World Bank, that have pushed for such reforms through various capacity building projects.
Consequently, we have seen a worldwide convergence of auditing reforms policies. However, many of these reforms have been pushed forward, or imposed without considering the local context in developing countries. For example, the family dominance in the corporate sector in Bangladesh implies that many family-owners, even in listed companies consider their corporations as effectively extensions of their family, and any attempts to install corporate governance practices is met with strong resistance.
The presence of a very small pool of professionally qualified accountants means that many listed companies operating without the services of one, resulting in failure to meet international standards of financial reporting. Investor activism is weak, and there are allegations that attempts by shareholders to speak in Annual General Meetings (AGMs) are often thwarted.
These institutional weaknesses, along with the presence of a weak capital market that does not appreciate the value of a good audit, has resulted in the auditors in Bangladesh being offered very poor levels of audit fees. This has, in turn, resulted in auditors being able to devote limited resources for the purpose of an audit, resulting in poor audit quality.
At the absence of market forces that drive demand and supply of audit services, therefore, some regulatory interventions are justified in the Bangladeshi audit market. Indeed, over the last few years, we have seen the Bangladesh Securities and Exchange Commission (BSEC) impose a number of regulatory interventions, including prohibitions on non-audit services, and restricting the maximum audit tenure to three years. Also, the Financial Reporting Act (2015) has resulted in the establishment of a new audit regulatory body, the Financial Reporting Council (FRC).
However, the uniqueness of the audit market in Bangladesh, as discussed above, provides sufficient indication that a western-styled reforms regime may not be very effective in Bangladesh. Take the example on BSEC's order relating to the prohibition of non-audit services (NAS) by the incumbent auditor. Despite all the noise, there is actually very limited evidence that the provision of NAS affects audit independence in fact.
However, there is significant research evidence that such provision affects independence in appearance, meaning that buying consultancy services from the incumbent auditors creates a negative perception about the company in the minds of the investors as far as audit independence is concerned. For an efficient market, such a perception is important, and would need to be addressed, as otherwise, this may lead to fall in the share prices of the companies buying significant amounts of NAS from their auditors.
However, in the context of Bangladesh, where most shareholders hardly use the audited financial statements as a tool for making investment decisions, would such a prohibition be effective in any way? In other words, do we really think that investors in Bangladesh would carefully scrutinise the financial statements of a company to check if they had purchased high amounts of NAS from their auditors, and this would affect their investment decisions?
The problem is, due to such prohibitions in place, listed companies in Bangladesh are unable to purchase any kind of consultancy services from their auditors. In a country where listed corporations already struggle to recruit highly qualified professional accountants, such prohibitions, in my opinion, are unnecessarily denying them the opportunity of obtaining the services of professional accountancy firms.
Similar questions can be raised regarding the BSEC provision restricting audit tenure to three years only. Understandably, prolonged audit engagement can be detrimental to audit quality, as it creates the possibility that the auditors would be too familiar with a particularly client, and lose their ability to ask difficult questions.
The issue of familiarity threat to auditor independence, and the efficacy of auditor rotation has been widely debated by accounting professional and regulators, with limited solutions on offer. In 2010, the European Commission proposed a mandatory auditor rotation of five years for its member countries.
However, after a prolonged debate, this was rejected. Eventually, the members decided to allow public interest entities (PIEs) a maximum of 10 years with their incumbent auditors. The current UK regulations actually allows PIEs to continue with the same audit firm for a maximum period of 20 years, but requires a change of the audit engagement partner after seven years.
Therefore, as we can see, even in western countries, there is limited appetite to restrict audit firm tenure. In the context of Bangladesh, the requirement to rotate auditors after three years, therefore, appears to be too restrictive, and may actually be detrimental to audit quality, as large PIEs are forced to look for competent auditors every three years in a small audit market.
The FRC, again, is a western concept, propagated for Bangladesh by the World Bank Report on Observance of Statues and Codes (ROSC) in 2002. I have evaluated the performance of the FRC in a recent column in The Business Standard (published on September 20, 2020), so I wouldn't go into much details. Overall, we can see that over the last three years, the FRC's activities have been constrained by severe capacity limitations.
Also, the colossal scope of FRC's work, where it is supposed to monitor the financial reporting practices of a very large number PIEs, as defined by its rules, does not really help. Consequently, in the first three years of its existence, the regulator has underperformed, compared to its regional counterparts (for example, the National Financial Reporting Authority of India). Also, the audit oversight body has suffered from problems of visibility with its stakeholders.
Overall, it appears that audit reforms in Bangladesh have mostly been conducted in an ad-hoc basis, and has had limited contribution in terms of improving audit quality. There has been limited attempts to engage with key stakeholders, or to conduct a regulatory impact study before the formulation of a new regulation. This has resulted in a 'cart before the horse approach' to regulatory interventions.
For a sustainable enhancement of audit quality, regulators therefore need to take a more holistic approach to address the long-standing problems affecting the auditing profession in Bangladesh, based on consultations with key stakeholders. The FRC can start by formulating short, medium and long-term roadmaps for sustainable development of the auditing profession in Bangladesh.
For the short term period (perhaps 1-3 years), as the FRC builds its capacity, it can consider delegating some of its powers, such as accounting and auditing standard setting and quality control to the professional accountancy bodies, such as the Institute of Chartered Accountants of Bangladesh (ICAB) and the Institute of Cost and Management Accountants of Bangladesh (ICMAB) who have years of experience and expertise in conducting such functions.
Such delegation can involve close monitoring and supervision by the FRC. Meanwhile, the FRC can concentrate on ensuring that auditors are sufficiently paid by the PIEs to be able to deliver quality audit work, and develop a code of corporate governance (for non-listed entities) that would result in improvement of financial reporting quality. The definition of PIEs, as mentioned in its current rules, may need further consideration.
At the moment, the threshold for PIEs to fall under the purview of the FRC appears to be too low, and can create unnecessary workload for the oversight body. During this short-term period, the audit oversight body can also increase its visibility, for example, by responding to high profile accounting scandals, and by organising regular events involving its key stakeholder groups. Such activities will not only help FRC gain legitimacy with its key stakeholder, but also help negotiate its boundaries with other established regulators, such as the BSEC.
Having established a code of corporate governance, and ensured that auditors are being properly remunerated, the FRC can then focus on ensuring compliance with its regulations in the medium to long term. By this time, the FRC is expected to attain sufficient capacity to be able to monitor financial reporting and auditing activities for all PIEs (after reconsidering the threshold).
At this stage, the FRC can consider effectively engaging with professional accounting bodies (ICAB and ICMAB) and review the governance structures of audit firms, as well as of the professional accountancy bodies. Overall, the FRC needs to ensure that future reforms should take a more comprehensive view of the problems relating to the auditing profession in Bangladesh and suggest interventions based on consultations and evidence.
Dr Javed Siddiqui is an associate Professor of Financial Reporting at the Alliance Manchester Business School, the University of Manchester, UK. Email: [email protected]