Mario Christodoulou, Accountancy Age, Thursday 22 July 2010 at 10:31:00

17% of FTSE 350 companies now use some form of ?extended audit?

Almost two out of every ten listed companies have embraced a controversialextended audit model, despite concerns from regulators the arrangement may skirtethical boundaries.

The UK?s reporting regulator, Audit Inspection Unit (AIU), which sits withinthe Financial Reporting Council (FRC) found 17 % of FTSE 350 companies wereusing some form of ?extended audit? arrangement which first came to light whenBig Four firm KPMG won the audit of business services firm Rentokil in August2009.

The package, marketed as ?extended assurance?, fulfills all the functions ofan external audit, while performing tasks usually performed by internalauditors.

The package shaved 30% off Rentokil?s audit costs, but raised ethicalquestions.

Regulators worry that if auditors fill roles usually performed by internalauditors, this might inadvertently influence management and taint thereliability of the external audit.

In November, the FRC urged caution if companies were considering taking onthe audit arrangement which would be prohibited in the US and France whereindependence criteria is more strict.

In September the Institute of Internal Auditors chief executive Dr Ian Peterswarned about the potential of ?serious conflicts of interest? if internal andexternal audit are merged.

"Internal auditors answer to management and the non-executive directors?external audit reports to shareholders. Merging these two important functionshas the potential to cause serious conflicts of interest and reduce theeffectiveness of internal controls and the management of risk," he said at thetime.

In August 2009, Richard Sexton, PwC?s audit chief, responding to questions onthe issue, said it was important auditors were not seen to act as part ofmanagement infrastructure.

"The UK ethics model relies on a risk and safeguard analysis. It is vitalthat we maintain our independence from ? and in no way are seen to act as partof ? management infrastructure,? he said.

?Internal audit can often be regarded as acting as part of thatinfrastructure.?

Some businesses have been supportive of the package. In November, KevinChidwick, finance director of FTSE 100 car insurer Admiral Group admitted thearrangement ?would be potentially controversial?, but said he was interested inlearning more.

"If they can add value to what we're doing, and overall it somehow [can be]combined to keep down external audit costs, I'm all for it," he said at thetime.

The AIU found in some cases the extra work was subject to a separateengagement letter and billing arrangements, but in other cases it was treated aspart of the audit engagement.

The body said it would continue to monitor developments ?including theapplication and

effectiveness of safeguards in practice?.

KPMG has consistently defended the arrangement as ?perfectly feasible to doin the spirit and letter of the law.?

A spokesman said yesterday it was its were looking for a ?broader assurancemodel? to address a range of risk-related issues.

?This is what we are seeking to provide to clients, whilst fully adhering tothe ethical guidelines for the profession,? he said.

Further reading:

Cut-priceRentokil-KPMG deal raises ethical questions for auditors

Auditreports targeted for reform

Rentokilaudit - All their own work