Who’s auditing the auditors?

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By Tomas Muller – Tomas.Muller@EthicalBoardroom.com

From the auditors involved in the Enron scandal to the more recent Lehman Brothers accounting debacle, there is a widespread mistrust of the audit profession. Investors are only able to trust the integrity of capital markets if they are able to trust company auditors. Understandably financial market participants and corporate governance groups are increasingly asking the question: who’s auditing the auditors? In much the same way that investors require data and information in order to make informed decisions about investments, they also need information to properly assess auditor integrity, quality and competence so that they can have faith in the financial system as a whole.  Accounting firms that audit publicly traded companies are also required to provide annual reports which should include detailed financial statements and discuss their risk management and internal control measures. However, these audits of auditors have shown themselves be flawed in some cases as a number of shortcomings have come to light over the last decade and has left relevant parties wondering how this issue can be resolved.

The auditor’s purpose is to ensure that company accounts and reports are accurate, complete, fair and representative of the business operations for the relevant period in time.

In a world of increasing transparency and increased obligations to comply with rules, auditors are being utilised to a significantly greater degree in helping company boards maintain the integrity of organisation’s activities. Over the last decade, however, it has come to light that a series of mistakes have been made by auditors and in some cases these have even stemmed from The Big Four companies. Enterprises are therefore asking and reassessing the extent to which they can rely on their auditors, especially given these shortcomings. Further to this investors are left wondering as to what extent they may be able to trust audited accounts when looking at various assets for investment if audit mistakes have been made in the past.

More often than not, the audit committee of a company will trust the findings of its auditors without question. This kind of blind trust means that mistakes made by the auditors are not identified in a timely and efficient manner. Even today, in the heightened risk aware post credit crisis climate, many companies fail to have the due diligence in place to provide an internal system to oversee the effectiveness of the auditors’ work. Even if auditors become aware that they are not doing the job to the best of their ability and to meet the job needs, they will rarely withdraw from an engagement as they may prioritise their profit making above providing the best service. Additionally, when companies attempt to improve accountability of auditors they are often hesitant and slow to terminate the audit service. The problem companies have had in the past is that investors are known to frown on companies that keep changing their auditors. This is because historically this kind of activity has indicated to investors that the company may be attempting to hide something. 

These restrictive and negatively impacting factors have led to a growing sentiment that companies should make auditors accountable to a much greater extent for their actions. Auditors should be placed under increased scrutiny and held to a higher standard of accountability to rebuild trust in the profession. A further difficulty lies in the fact that major accounting firms feel that they are not able to admit discovering a breach given that this will negatively impact their ability to obtain future engagements with companies. If they find a breach of auditing standards they are very unlikely to withdraw any previously issued reports given the reputational risk and damage that this poses.

Some corporate governance parties are now pushing for regulations to require the naming of auditors and the attribution of their actions. Another suggestion has been a regulatory enforced periodic rotation of audit firms. The first step will be improved transparency and disclosure from these firms. With this type of open communication relevant parties will be better able to engage in discussions of real audit issues and shortcomings and through this discussion the profession will see improved performance and efficiency.