The Future of Professional Accounting Comments by Dan A. Simunic

1. The Future of Professional Accounting Comments by Dan A. Simunic Simon Fraser University and the University of British Columbia September 2018

2. Opening Thoughts • Important caveat: I don’t have a (reliable) crystal ball • When Len asked me to serve on this panel, I accepted because I was then writing a review commissioned by The Accounting Review of a book titled: The Big Four: The Curious Past and Perilous Future of the Global Accounting Monopoly, by Ian D. Gow & Stuart Kells

3. Future of the Big 4: Gow & Kells • “Digital disruption of audit technology” (AI, big data, blockchain, etc.). More the domain of IT companies than labor-intensive audit firms. • A weak, franchise based global structure (i.e. independent national partnerships) causes difficulties (e.g. raising capital, fostering common standards, distributing fees from multinational audits, large scale innovation)

4. Future of the Big 4: Gow & Kells • Consensus driven partnership model tends to attract competent, hard working people – not brilliant, innovative people (“average minds from average schools”). • Success (survival) in a rapidly changing environment requires correct assessment and pricing of risks. This is difficult, and firms have shown themselves to be poor at this (e.g. self-insurance; demise of L&H, AY, and AA).

5. Future of the Big 4: Gow & Kells • I think you get the picture – per G&K the future of the Big 4 – and traditional auditing – looks pretty bleak! Maybe it is! • From a research perspective though, the underlying issue seems to be a need for us (academics) to move from a labor-based characterization of audit production, to a labor & capital based model, and examine the economic implications.

6. The “New” Audit Production • I have been working on the issue of capital in audit production for some time with my former Ph.D. students: Louis-Philippe Sirois, Tracy Gu, and Mike Stein. • Here are two papers on the topic on SSRN: Auditor Size & Audit Quality Revisited: The Importance of Audit Technology, & Fixed Costs, Audit Production & Audit Markets: Theory & Evidence

7. Audit Production: Some Issues • Almost all existing research focuses on an auditor’s two-part cost function minimizing the sum of labor costs & expected losses. • Capital investments & their effects are ignored (sunk?) • Production function underlying the cost function is not modeled (i.e. how labor & capital interact to produce assurance) • Costs are treated on an audit-by-audit basis (e.g. a representative audit)

8. Audit Production: Some Issues • Optimal investment decision in capital requires a portfolio view; if utilization of investments is capacity constrained, then optimal use of this scarce capacity also requires a portfolio view. This is hard! • More capital-intensive production changes operations: ↑ operating leverage → ↑ variance of profits. This adds to the difficulties of pricing (uncertainty in both cost components).

9. Audit Production: Some Issues • A reasonable characterization of input interaction is that physical capital improves the efficiency & effectiveness of labor in producing assurance. • An implication of efficiency enhancing investments is that either the most efficient audit firm sweeps the market (natural monopoly) or multiple firms with the same level of investment & efficiency co-exist.

10. Audit Production: Some Issues • Capital investments can also act as a barrier to entry – further separating firms within the Big 4, and the Big 4 from non-Big 4. • Attempts to increase competition by encouraging small firms (e.g. in EU) appear doomed to fail.

11. Audit Production: Some Issues • Magnitude of viable investments is limited by the size of the market. Can investments be made and used across national franchises (within Big 4 firms)? • If not shared, then any attempt to equalize audit quality & auditing standards across (large & small) countries is also doomed to fail.

12. Concluding Thought • Maybe the profession is headed for a single dominant global audit supplier. Who?