Joint audit series, part 1: Joint audit and shared audit: are more auditors better?

The Wirecard case in Germany has sparked a comprehensive social and political debate around auditing and the role of the auditor. The German government reacted to this and set up the Wirecard Investigation Committee.

There, measures were to be developed to ensure that the risk of fraud was reduced. The result: in summer 2021, the Financial Market Integrity Strengthening Act (FISG), was passed. In connection with audit reform, the question of alternative models of audit was also raised, in particular, so-called joint audits.

In our four-part series on joint audit, we introduce this model of audit, and take a closer look at the various facets. What are the advantages of joint audit? How do joint audits work in practice, and do they result in additional costs? We will also clear up some persistent misunderstandings and myths.

Our first article deals with the question of what a joint audit is, why the model can be an interesting alternative for companies, and what the differences are between joint and shared audits.

What is a joint audit?

In a joint audit, several independent auditors are appointed to conduct an audit of the annual or consolidated financial statements. This means the audited company engages two (in rare cases three or more) audit firms. The unique feature compared to an ordinary single audit is that joint auditors both jointly conduct the audit and jointly certify the audited financial statements. It is important to distinguish here that a joint audit is not a dual audit, where the entire audit is carried out twice.

 In a joint audit, the auditors have precisely defined responsibilities, which are regulated in a dedicated auditing standard (in Germany, this is IDW PS 208, On the performance of joint audits). The joint auditors mutually agree on the scope and division of the audit work, either by subject matter, business area or geographic region, in order to ensure complete coverage of the financial statements to be audited. At the end of the audit, the other side performs a cross review of the completed work. Once finalised, the resulting joint audit and audit opinion are based on the judgements of both appointed auditors.

 An interesting alternative for companies

What sounds like a little more work at first glance can actually offer added value for companies. A joint audit promotes both a strengthening of independence of both auditors through the “four-eyes” principle, and improved audit quality through two quality assurance systems. After all, four eyes see more than two. This creates security and trust between stakeholders and the public. Building trust is very important following recent, high-profile, and much-discussed accounting scandals. Companies also benefit from the different professional expertise of two audit firms that bring in different auditors. This is particularly true in cases where there are complex accounting issues, or with regards to expertise in certain business segments or geographical areas.

 Joint audits are currently voluntary in Germany, and so far, little has been known about them, even amongst listed companies. In 2016, however, the joint audit model gained significant prominence in the course of the implementation in Germany of the EU Audit Reform 2014, and was explicitly included in the HGB (German Commercial Code) for the first time as an incentive to extend rotation periods. It is noteworthy that joint audits have previously been used in Germany in cases where the public needed a particularly high level of confidence in a company's financial statements; and in order to avoid discussions about the regularity of financial statements. A prominent example is Telekom, whose financial statements were audited by two audit firms for nine years.

 If we look to the experience in France, joint audits have been a widespread and successful practice there for more than 50 years. Joint audits have been mandatory for French listed companies since 1966. Compared to the rest of the EU, this has led to a much more diverse audit market in France, which ultimately also benefits companies, as they have more choice.

 Joint audit vs. shared audit - what are the differences?

A joint audit differs fundamentally from a shared audit. In a shared audit, only one audit firm, the so-called “primary auditor”, has full responsibility for the financial statements to be audited and for issuing the audit opinion. The other audit firm(s) involved, the “shared auditors”, are responsible for specific areas of the audit, and work with the lead auditor. The majority of the areas audited by the shared auditors are also non-significant entities of the company.

 Another form of shared audit is managed shared audit, which became better-known in the United Kingdom through their audit reform discussions. A UK government proposal, published in March 2021 (White Paper "Restoring trust in audit and corporate governance: proposals on reforms"), provides for mandatory managed shared audits for companies listed in the FTSE 350, whereby the primary auditor must share a percentage of the audit with a challenger audit firm -, i.e. not a Big Four firm. The shared auditor must take on a significant share of the audit:  between 10% and 30% in relation to the turnover, result and/or balance sheet total of the company to be audited, or the fee volume.

In our opinion, joint audits are the ideal way to achieve more diversity and competition in the audit market, and to offer companies real added-value from two auditors. Shared audits and managed shared audits can only achieve this to a limited extent, and can be a transitional solution at best. This is because, in contrast to joint audits, shared audits do not significantly reduce the barriers to entry to the audit market for medium-sized companies. Medium-sized audit firms are often in the role of "junior partner" in shared audits and would concentrate on smaller engagements, while the more complex areas of the audit would be still carried out by the Big Four. This would not promote diversity in the market and would not improve audit quality to the same extent as joint audits.

 After the FISG and before the FISG II: What's next for joint audit in Germany?

Even though the advantages are obvious, the FISG has not yet implemented mandatory joint audit. However, with a review mandate for joint audit formulated in the framework text of the FISG, the legislator has made it clear that it considers functioning competition in the audit market for public interest entities to be essential, and greater participation by medium-sized audit firms to be desirable. The German government is now called upon to examine whether market diversity can be promoted through joint audit. At the EU-level, the joint audit model will also be the subject of the consultation process, as the EU Commissioner for Financial Services, Financial Stability and Capital Markets Union, Mairead McGuinness, announced in her speech on 27 May 2021. Audit reform in Germany is therefore far-from complete with the decision of the , and the course has been set for further necessary reform.