Jeffrey Knapp on John Lennon and the Big 4: give public interest a chance

by | Aug 6, 2020 | Finance & Tax

KPMG and the other Big Four audit firms are at a crossroads, writes Jeff Knapp. Their work with multinational clients to skirt ethical accounting rules and regulations has been on show time and time again. They need to decide what they really are; a salesforce, or – what they profess to be – an accounting profession.

A retired accounting lecturer, I have analysed hundreds of audits by the Big 4 of large multinational proprietary companies in Australia over the past decade. In that time, the Big Four have allowed their multinational clients to declassify from “reporting entity” status and dispense with General Purpose financial reports.

The Big 4 audit practices for these companies have largely avoided public scrutiny and without scrutiny they appear to have turned bad. Financial reporting by multinational proprietary companies in Australia has become weak. When they consented to their clients switching from General Purpose to Special Purpose accounts, the Big 4 firms made financial reporting in Australia weak.

Some of their multinational clients even stopped producing consolidated financial statements, which means they ceased to be publicly accountable for all their economic activities in Australia. The switching out of general purpose financial reports has undermined Australian generally accepted accounting practice (GAAP) yet none of the major firms or the myriad professional bodies and organs of government oversight tried to stop the rot, at least until now with the Senate inquiry.

There was no explanation either of the switch to lower disclosure, nothing said at the time which could possibly justify the change in accounting policy, nor any action from regulators. Rather, it was the stuff of backroom deals.

The Big 4 audit firms have deemed that multinational proprietary companies do not qualify as public interest entities and, in doing so, they have avoided higher standards of audit independence for these wealthy clients. This means the Big 4 audit firms can profit from these clients by offering a wider suite of non-audit services. It appears the self-interest of the Big 4 audit firms has trumped the public interest.

The self-interest of the Big 4 audit firms has trumped the public interest. “Standards”, “public interest” and “professional judgment” are empty words if not backed by actions, yet their actions give the public little hope.

An audit road trip

Let me take you on my voyage of discovery.

I was sitting in the Sydney hearing room for the Senate Inquiry into corporate tax avoidance on 18 November 2015. It was a smallish room with plenty of attendees. Somehow I managed to find a seat in a row towards the front.

Prior to the hearing, I briefed Michael West about the extraordinary evidence of multinational clients of Big 4 audit firms declassifying from reporting entity status and switching to lower levels of financial reporting disclosure.

I understood that the issue would be ventilated during the hearing. Considering the evidence, I believed that the Big 4 firms were suffering from a sense entitlement to bend the rules of financial reporting for large multinational clients and I looked forward to seeing a parliamentary committee pull them into line.

A cabal from each of the Big 4 audit firms turned up for the afternoon proceedings. One cabal moved towards my position in the room. I believe it was KPMG. They had an in-house administrator taking care of things for the group and she was arranging where they would all sit as if it was a wedding reception.

She stood nearby and looked at me long and hard as if preparing to demand that I move to accommodate her seating plans but then at the last moment she seemed think better of it. My dress sense may have protected me: old jeans and a Pendle Hill over 45s football shirt. The group settled in the seats behind instead, which allowed me to overhear their whispered cheers whenever there was a witty response (or elegant non-response) from their colleagues presenting at the hearing.

The chair of the Senate Committee on corporate tax avoidance was Senator Sam Dastyari. Sam subsequently fell on bad political times but his work at the 18 November 2015 hearing was outstanding. He asked simple questions that made bums shift on seats.

He guffawed at ridiculous answers. He broke through the pompous edifice of “multinational tax affairs are too complex for you to understand” in a way that no federal politician ever has or will probably ever do again. Sam grilled a representative of Chevron Australia about its Bermudan tax haven connections in the morning and was advised that there were compelling non- tax reasons for Chevron’s presence in Bermuda. To wit, this location is globally
recognised for the highest level of safety, environmental, and maritime standards.

The Chevron answers about Bermuda and shipping were still tormenting Sam’s mind in the afternoon when he was asking questions of a representative from Airbnb; at which point he produced this zinger:“Bermuda as a place for ship safety is something that goes against everything I was taught as a small child”.

Yes Sam, corporate tax avoidance goes against everything we were taught as small children too.

Around 3pm, it was KPMG’s turn to give evidence. One of the questions at hand was the extent of financial disclosures by large multinational clients that are large proprietary companies. The KPMG representatives readily noted concerns that supported less disclosure such as compliance costs and competitiveness.

When asked about how the firm would provide advice to a client about whether they are a reporting entity [that must do fuller financial disclosures], the KPMG representatives were unable to assist: “Across the table, we are all tax partners. There are 600 partners — or thereabouts — within our firm. There will be many people there who understand the accounting and regulatory regime better than any of us. I am afraid that is just not an area I can comment on”.

Unfortunately, none of KPMG partners subsequently explained, or indeed have been asked to explain by the Parliament, why they allowed large multinational clients like Unilever, Bupa ANZ, BMW, Roche, and Pfizer to declassify from reporting entity status and switch to lower disclosures in special purpose financial reports.

In my opinion, this is an important question that goes to systemic audit failure in Australia and it ought to be answered.

Then KPMG brought John Lennon into the room. A KPMG representative dealing with the notion of increasing disclosure and mandating more disclosure by corporations about their financial and tax affairs responded with this pearl: “To misquote John Lennon: give voluntary disclosure a chance.”

Facts first to fall at Senate’s corporate tax avoidance inquiry

When I was a teenager, John Lennon was a hero of mine. Of course, there was the entire Beatles catalogue, but my most prized possession was a vinyl copy of John Lennon’s Rock ‘n’ Roll from 1975. Side 1, Track 2, Stand by Me was the single from this album.

I do not think John Lennon had the partners of KPMG and their multinational clients in mind when he sang the chorus to that song. Can you imagine John Lennon’s response to corporate tax avoidance, falling standards of financial reporting, and auditor servitude to large multinational clients?

If the KPMG representatives were to quote John Lennon in a more relevant context while addressing the question of weak disclosure, they could have used  Side 1, Track 5, Ain’t That a Shame and Side 2, Track 6, Just Because.

Parliamentary inquiry into Audit Regulation.

Four years later, in November 2019, I am back sitting in a hearing room for a parliamentary inquiry into audit. This time, the subject is audit regulation. This time I am one of the witnesses called to give evidence. I am not here for the politics. I do not need to impress anybody or toe an organisational line.

There is no financial benefit in this for me. I am not here to mince words or fumble around with irrelevant research papers from social science as other witnesses did, I am here to present normative analysis. I am here to give the Big 4 audit firms and especially KPMG the public lashing they deserve.

I table 36 audit failures of the Big 4 audit firms for multinational companies which have not prepared general purpose financial reports. I turned my attention to the Big 4 audit firms and public interest entities. Does KPMG voluntarily disclose all audit clients that are large (gigantic) multinational companies as public interest entities?

No chance. KPMG and the other Big 4 firms have avoided classifying as public interest entities their large multinational clients that are proprietary companies and disclosing the identities of these multinationals in their annual Audit Transparency Reports. It appears the reason for the avoidance is so the Big 4 firms can maintain lower standards of audit independence for a segment of their wealthiest of clients.

Classifying a large multinational audit client as a public interest entity means having to apply higher standards of audit independence as set out by the Accounting Professional & Ethical Standards Board (APESB) in APES 110 Code of Ethics for Professional Accountants.

Audit independence: things like:

  • a cooling off period before a key audit partner or senior managing partner can join an audit client as a director or officer. (
  • key audit partner rotation every seven years.
  • less scope for rendering non-audit services including: providing accounting and bookkeeping services, including payroll services,
    preparing financial statements on which the firm expresses an audit opinion or preparing financial information which forms the basis of those financial statements, providing valuation services if the valuations would have a material effect on the financial statements, preparing tax calculations of current and deferred tax liabilities (or assets) for the purpose of preparing accounting entries that are material to the financial statements, providing internal auditing services that relate to a significant part of the internal controls over financial reporting, and providing services involving the design or implementation of IT systems that generate information that is significant to the client’s accounting records In an earlier version of APES 110,

Paragraph 290.26 originally stated that firms are encouraged to determine whether to treat additional entities, or certain categories of entities, as Public Interest Entities because they have a large number and wide range of stakeholders. Factors to be considered include: the nature of the business, such as the holding of assets in a fiduciary capacity for a large number of stakeholders. Examples may include financial institutions, such as banks and insurance companies, and pension funds.

Then the APESB changed the wording of paragraph 290.26. “Firms are encouraged” was replaced with “Firms shall determine. The words changed but the Big 4 audit firm practices did not. The Big 4 audit firms have continued to avoid classifying multinational giants that are proprietary companies as public interest entities.

According to EY, Apple Pty Ltd can have $7.5 billion of annual revenue and 3,729 employees but it is not a public interest entity (they audit Rupert Murdoch’s News Australia too, which they apparently deem not to be a public interest entity).

According to PwC, ExxonMobil Australia Pty Ltd can have $10.3 billion of annual revenue and 1,604 employees but it is not a public interest entity.

According to KPMG, Bupa ANZ Healthcare Holdings Pty Ltd can have $1.4 billion of annual revenue and 16,708 employees but it is not a public interest entity.

According to Deloitte, Serco Australia Pty Ltd can have $1.2 billion of annual revenue and 5,252 employees but it is not a public interest entity.

How much revenue and how many employees would one of these companies need before a Big 4 firm classified it as a public interest entity? A zillion?

Did KPMG and the other Big 4 audit firms voluntarily disclose their approach of omitting multinational giants as public interest entities when they made submissions or gave evidence to the current parliamentary inquiry into audit regulation?

No chance. It was left to me to bring the matter of the Big 4 audit firms gaming the definition of public interest entities when I appeared before the parliamentary committee in Canberra on 29 November 2019. And this was the response:

Mr GORMAN: I would put this on notice: I’d be interested in any further submissions you may wish to make. I’ll also be interested in us having a further discussion about this as a committee. If you are not applying the prohibitions of conflict of financial interests, material loans, serving as counsel and providing bookkeeping and accounting services, and you’re not applying any of those to Facebook Australia, Netflix Australia and the like, we have a huge problem.

Yes, you have a huge problem to deal with Senator Patterson, Senator Georganas, Senator Bragg, Senator Falinski, Senator Gorman, Senator Hammond, Senator O’Neill, Senator Pratt, Senator van Manen, and Senator Whish-Wilson. What are you going to do about it? Perhaps you could begin by misquoting John Lennon back to KPMG and the other Big 4 audit firms: “give public interest a chance”.

Uppercut: call for violence at Parliamentary Inquiry into accountants


Jeffrey Knapp

Jeffrey Knapp

Jeffrey is a retired lecturer in accounting at the University of NSW. His forensic accounting work exposing multinational companies for tax avoidance and accounting irregularities led to the 2015 Senate Inquiry into Corporate Tax Avoidance and subsequent reforms.

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