SINGAPORE (June 10): Audit firms have been in the crosshairs of investors and regulators in recent years, and little wonder.
There has been a spate of corporate scandals over the last couple of years, for reasons ranging from poor financial management and excessive valuations of assets, to outright theft and fraud. Each of the scandals emerged despite their financial statements having being given the all-clear by auditors for years. They have left scores of retail investors out of pocket and many wondering about the effectiveness and reliability of auditors.
There is apparently a disconnect between what auditors do and what people expect them to do. In a survey by the Association of Chartered Certified Accountants, more than half of the respondents believes that auditors are responsible for avoiding company failures.
This has been commonly referred to as the “expectation gap” by industry practitioners, who assert that failure to detect fraud is not simply “an audit issue”. Indeed, the task of the auditor is specifically not to look for fraud, but to see that companies comply with accounting standards. They argue that it should be a combination of efforts by the company’s management and directors, and internal controls, as well as shareholders, who should be on the lookout for hanky-panky.
Indeed, in a study conducted by the Association of Certified Fraud Examiners, a non-profit organisation based in Texas, only 8% of the fraud cases detected in Asia-Pacific are flagged by external auditors. A management review detected 10% of the cases, while internal audit uncovered 16%. Most of the cases, or 47%, were as a result of a tip-off, likely by a whistleblower.
Yet, surely retail investors should be able to rely on the professional opinions of auditors, who have privileged access to companies’ management and financial statements, and who have been paid to ensure that their reports are a reasonable representation of the companies’ financial positions?
But perhaps that in itself is the biggest problem. Audit firms are engaged and compensated for an audit job by the company whose books they are meant to scrutinise with a degree of impartiality and “professional scepticism”. However, in interviews with industry insiders, The Edge Singapore found that in practice, the payment of audit fees can be used to pressure auditors to conduct an audit in a company’s favour.
To be fair, audit firms are commercially driven. But there are ways to eliminate conflict of interest, such as having audit fees pooled or paid into escrow and administered by a third-party authority.
And if, for instance, a company’s management is intent on defrauding investors, it would be hard for an audit team that works with material provided by the company to uncover it.
Whatever the case, the scandals have been damaging not just for the audit industry, but also the market as a whole, as investors have lost faith in auditors. As such, there needs to be more effective oversight as well as actual penalties for auditors found to have been negligent. In the UK, for instance, the Financial Reporting Council, as the country’s accounting watchdog, has opened a full review into KPMG after the Big Four firm audited the books of a number of companies that subsequently collapsed. In the last six months alone, more than £20 million ($35 million) in fines have been levied on it by the FRC.
To be sure, there have been efforts here to improve accountability. The market regulator, the Singapore Exchange Regulation (SGX RegCo), plans to require companies to appoint a second auditor to review books that have already been signed off on. In fact, it has already ordered some companies such as SBI Offshore, which entered into a questionable property sale, to appoint a special auditor and report the findings directly to SGX RegCo.
Our reporters were unable to get audit firms to comment for this story, the common response being that it would be inappropriate for auditors to comment on their peers’ and their work.
Yet, SGX Regco’s proposal to require companies to appoint a second auditor to review books that have already been signed off on is effectively having one auditor comment on another’s work.
In the case of Noble Group, its external auditor EY signed off the accounts and stood by it even under regulatory scrutiny. PwC, which was later brought in as special auditor to take another look, came to the same conclusions despite there being concerns over how the commodity trader’s assets were valued. For instance, Noble’s earnings for FY2016 took into account some US$126 million in unrealised gains on assets, whose valuations were determined by the company itself. “[The auditors] basically nailed their colours to the mast,” said SGX RegCo CEO Tan Boon Gin.
Ultimately, as the economy expands and new business models emerge, the audit profession will become more challenging. The public’s expectations of it will also grow. As this happens, so should the level of accountability in the industry. The integrity of our markets depends on it.
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