Debt crisis thrusts auditors into spotlight

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Role of audit profession in the oversight process has been questioned, writes Amanda Visser Published: 2012/05/24 07:59:50 AM

TRUST in the audit profession has again taken a knock during the latest global financial crisis, although it could be said that auditors were not the only ones to blame this time around.

The role of the profession in the oversight process had been questioned when it emerged that there had been manipulation of financial reports, and off-balance-sheet reporting to hide losses and banks' debt exposure. This made it difficult for stakeholders to predict and deal with the financial crisis that followed.

The European Commission published proposals at the end of last year to assist in rebuilding trust in the profession; and several countries once again looked at their own legislation and regulations to address weaknesses. Corporate failures at the beginning of 2000 such as Enron, where financial statements were manipulated on a grand scale, had also weakened confidence in the oversight role of the auditing profession.

In the latest crisis it was not only auditors who were fingered, but bankers, rating agencies, regulators and oversight boards that overlooked serious issues that were happening, says Martin van Roekel, global CEO of mid-tier audit firm BDO.

"It is fair to say that although the audit profession cannot be blamed for what happened, it is necessary that we have to learn our lessons too," he says.

"It is fair to say the exchange of information by the audit profession, audit committees, financial regulators in many countries, has not been up to standard, which has contributed to what happened."

The commission's green paper, released last year, contained dramatic proposal s on ways to restructure the profession. The paper leaked out and created a little tsunami in the industry, leading to lobbying that saw many of the proposals being watered down or removed completely.

Key elements of the remaining proposals include the mandatory rotation of audit firms, mandatory tendering, and the prohibition of providing nonaudit services to audit clients. The commission said at the time when the final proposals were published that it was important that co-ordination of, and co-operation on, the oversight of audit networks is ensured globally.

Mr van Roekel is not convinced the proposals will change the "unhealthy market structure" where four firms — PwC, Ernst & Young, Deloitte and KPMG — dominate. He is convinced that better co-ordination is crucial.

"It is quite clear that there is a need for much closer co-operation between all the parties producing reliable financial information, including bank and audit regulators as well as standard-setting bodies."

It is simply not good enough to merely tick the boxes to show a certain financial reporting standard has been followed to the letter. It has to be combined with healthy audit scepticism: are the figures representing the reality and the underlying value of the transaction in an appropriate way, he says.

It is clear that audit scepticism has to be strengthened in the coming years in order to get a proper understanding of what is behind the numbers and what is the underlying value of a transaction. This will necessitate more initiatives from the auditor to get a better and deeper analysis of firms, more guidance from auditing institutions on how to deal with specific complex standards, and the sharing of best practices by global regulators during audit practice reviews.

The world of big business is moving at a breakneck speed, and this can be part of the problem. Auditors, in order to do a deeper analysis of transactions, need an intimate knowledge of the businesses they are auditing.

This, says John Spencer, CEO of BDO in SA, is still lacking.

"The amount of knowledge people have to acquire at university level to be technically competent leaves very little time to get knowledge on how companies are run. Generally, they learn about the world of business when they go out on audits, because that is really the only time to look at the business from the inside."

Mr van Roekel says if an auditor does not have a proper understanding of the business, the drivers of the company and its management and the quality of its governance systems, he is at risk.

"If a company does not have the right checks and balances, the auditor has to be extremely careful as it create possibilities to manipulate the numbers in ways that suit the management. There is always a temptation — when a company has to show continued performance — to present the numbers in a manner that is fit for purpose."

The answer is not more legislation and regulations. Ethical day-to-day behaviour combined with proper governance systems are crucial to avoid repetitions of past failures, says Mr van Roekel.