Are We Using Auditors as Punching Bags?
Auditors and the accounting profession in countries such as the UK and The Netherlands are facing their worst crisis in a generation. There is a widespread perception that weak audits have contributed to business failures and that auditors are not fulfilling their mandates. In particular, the Big 4 firms are accused of putting their self-interest ahead of the public interest. And, following the financial crisis of 2008 and the ensuing scandals, there is public outrage and intense media scrutiny on the accountancy sector. Never before have auditors been so famous for all the wrong reasons, says José R. Hernandez.
Auditors have become punching bags for governments that have struggled to respond to the aftermaths of the financial crisis. Anger and distrust remains in the public domain. There is little sense of accountability for misconduct for executives or their intermediaries. The few trials against individuals have resulted in little to no jail time. Intermediaries such as bankers have gone largely unscathed.
The weaknesses in capitalism have never been felt with such intensity, so raw and painful. We are wrestling with issues of inequality, with dwindling expectations or hopes for more shared prosperity. Capitalism is rightfully under attack for delivering uneven prosperity and leaving so many behind. There are important voices in business such as Warren Buffett and Larry Fink who have been calling for more responsible leadership and investing to address the shortcomings. Amidst these daunting challenges, auditors present an easy target for governments to signal accountability and reform.
We must resist following myopic and uninformed views. Reforms are needed to make capitalism more effective. Audit reforms won’t prevent bad judgements in business or avoid governance and business collapses. The failure rates in auditing are extremely low in comparison to the number of audit opinions issued every day. That is not to say that processes within audit firms could not be improved, as identified from various reviews. But true audit failures – those where audit opinions missed material frauds and such failures led to business collapses – are exceptionally rare. Simply put, material accounting frauds are rare events and this has not changed in the last decade.
The weaknesses in capitalism have never been felt with such intensity, so raw and painful.
The limitations of financial reporting will inevitably remain and therefore the probability of future business failures occurring may not necessarily change by altering the audit market. Specifically, accounting is reliant on the historical cost convention and mark-to-market adjustments, based on rules set internationally. Additionally, the ‘expectation’ gap for auditors to be guardians against fraud will largely remain. When management and third-party collusion is involved, fraud, corruption, and money laundering will remain increasingly difficult to detect for an organisation’s internal controls and the best auditors.
The work ahead
Although questions remain about how to best implement reforms, it is clear that there are valid trust and credibility issues affecting the accounting profession that need to be studied and addressed. There is legitimate public anger and frustration from corporate failures. It is correct to demand that executives involved in misconduct (or who are wilfully blind to it) are held personally accountable and face prosecution. The same should apply to those that facilitate misconduct as intermediaries or gatekeepers.
Business and auditing failures have contributed to the erosion of trust and it is incumbent on all of us to restore trust in both business and its gatekeepers. The profession can and should take further steps to improve audit quality.
To find effective solutions, it is important to apply a more holistic approach and analyse concerns, issues and solutions in the context of the entire business and reporting ecosystem. Using auditors as punching bags today is distracting from the important reform work ahead to address the shortcomings of our current form of capitalism.
About the author:
José Hernandez is the CEO of Ortus Strategies and the author of the new book Broken Business: Seven Steps to Reform Good Companies Gone Bad (published by Wiley), which is available now in hardback and ebook.