AUDITING firms could be forced to rotate between companies to stop them becoming too close to the companies they audit after a review of the industry found a "significant deterioration" in the quality of audits over the past two years.
Greg Medcraft, the head of the Australian Securities and Investments Commission, has warned the industry it is "on notice'' after ASIC released an audit inspection report showing the quality of audits produced by large and small auditing firms has worsened considerably since January 2011.
Of the 20 auditing firms inspected, the report shows 18 per cent of the 602 audit areas reviewed did not perform all of the procedures necessary to get a "reasonable assurance" that the audited financial report was not "materially misstated."
It shows the number of such problems at large firms has increased from 10 per cent to 13 per cent over the inspection period.
For smaller firms, the number increased from 18 per cent to 21 per cent.
It also found auditors are not being sceptical enough when auditing companies' books and that they are relying too heavily on the work of other auditors or experts.
The report comes after a series of company collapses - such as Centro, Trio Capital, and Banksia - in which auditor failure or oversight problems were a big issue. In Banksia's case, accounts were signed off by the group's auditors only a few weeks before the group collapsed, owing investors more than $660 million.
Mr Medcraft said too many audits were being signed off without sufficient ''audit evidence'', and if auditors did not improve then ASIC would consider asking the federal government to compel them to rotate between companies.
''Next year if we [don't] see the situation … improving, then we may consider writing to Treasury on options for reform,'' he said.
''Clearly we just can't sit by and see a further deterioration. Investors and other users of financial statements have got to be confident that there is no material misstatement in them,'' he said.
Duncan McLennan, KPMG's head of Audit, said the ASIC inspection process was ''an important part of the continuous improvement cycle'' and that his company was committed to the ''highest levels of audit quality''.
But the chief executive of the Institute of Chartered Accountants Australia, Lee White, said although he agreed with ASIC's concerns, he believed its report needed to be clearer about its implications.
''You can get departures from auditing standards, but you need to understand the significance of those departures,'' he said.
''[ASIC] had two instances where their inspection work led to restatements of a financial report; that's a piece that sometimes isn't well understood. So of the 117 files that ASIC reviewed, less than 2 per cent of the departures had an impact on the restatements of the financial reports.''
But Ownership Matters analyst Martin Lawrence said the question of auditing firms becoming too close to the companies was difficult to overcome.
''I have some sympathy for auditors because they're in the position where they're expected to bite the hand that feeds them … They're similar to a whistleblower. People may admire them but they're not going to hire them because they might do it to you,'' he said.