Auditors' ethical lapses have battered investors' trust and seriously undermined audit effectiveness. Eugene O'Kelly, Chairman and CEO, KPMG, said: "What we do as a profession is critical to the capital markets".
The lack of confidence in audit has serious economic repercussions.
In "Rebuilding Public Confidence in Financial Reporting": An International Perspective", the International Federation of Accountancy (IFAC) observed: "reduced confidence results in an increased cost of capital and a reduction in the economy's productivity."
Several improvements are called for. First, as Rene Ricol, President the IFAC, said auditors' role needs to be made stronger. Strong audits influence boards' behaviour.
Richard Steinberg and John S. Scheid have pointed out that audit's present exclusive focus on the financial statements should be shifted to "providing a broader audit opinion covering elements like the possibility of fraud, risks, liquidity and future scenarios." ('Future Directions in Business Reporting' Price Water house Coopers' Americas Insurance Digest, 13 February 2003). A decade back, the UK Auditing Practice Board in1993 research paper, 'The Future Development of Audit', had recommended that auditors should report upon 'future risks attached to the company and the proper conduct of company affairs.'
Two, the audit standards need revisiting. There is a perception that inadequacy of the audit standards was a contributory factor in the corporate failures. Discussing the IFAC's audit standards, Lynn Turner, former chief accountant of the SEC observed, "You could drive a Mack truck through them."
Douglas Carmichael of the public companies accounting oversight board (PCAOB) and former AICPA audit standard setter observed the US standards' fundamental lapses was that they "state what an auditor does or might do and not what he was required to do." The IFAC's standards also suffer from the same problem
Third, 'expectation gap'- what an audit is and what it is perceived to be - remains the unremedied problem for the profession and the public alike since the last century, e.g., the auditors' assurance meant that the accounts were fraud free Cadbury said audit report was one of the cornerstones of governance. This is the only interaction between users and the profession.
Other jurisdictions' have redrafted the report in plain English, and expressly brought out their (and directors') responsibilities under suitable headings and greatly succeeded in reducing the 'gap' at no extra cost.
Mentioning the implications of audit on test basis would further reduce the gap substantially. The Chartered Institute of Management Accountants (CIMA), (UK), in its paper issued on 23 July 2002, recommends that a statement describing the limitations of audit concepts such as materiality and judgment should be included as an appendix to the audit report. (Recommendation 6.1, CIMA Review of Auditor Independence).
The 'gap' relating to their responsibility in relation to detection of fraud is likely to vanish in the US at least. Price water house Coopers, the biggest audit firm, have already stated publicly that auditors must accept more responsibility for finding fraud. (How Audits Must Change, Kris Frieswick, 1 July 2003,CFO P).
Moreover, as recommended by the Panel of 2000 on Audit Effectiveness, the auditors in the US may soon be required to use forensic techniques in every audit. (Of course, doing as above would increase the audit fee, which should cause no concern to the profession.)
Randomly selected auditors' reports are reproduced below. Extract from UK auditors' report: We also report to you if, in our opinion, the Directors' report is not consistent with the financial statements.
We read the other information contained in the Annual Report and consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the financial statements. The other information comprises only the directors' report, the message from the chairman, and the 'corporate governance' statement.
We review whether the 'corporate governance' statement reflects the company's compliance with the seven provisions of the combined code specified for our review by the listing rules, and we report if it does not.
Extract from auditors' report, New Zealand: We have conducted our audit. We planned and performed our audit so as to give reasonable assurance that the financial statements are free from material misstatements, whether caused by fraud or error...
Extract from Australia's auditors' report: At the date of this Statement there are reasonable grounds to believe that...will be able to pay its debts as and when they become due and payable.
Extract from Swedish auditors' report: As a basis for my (our) opinion concerning discharge from liability, I (we) examined significant decisions, actions taken and circumstances of the company in order to be able to determine the liability, if any, to the company of any board member or the managing director. I (We) also examined whether any board member or the managing director has, in any other way, acted in contravention of the Companies Act, the Annual Accounts Act or the Articles of Association.
These reports show that to change the IFAC prescribed auditors' report is not being heretic. Pakistan also may change the report, for example, as under: "We have audited the financial statements of XXX on pages. The financial statements, that is, the balance sheet, profit and loss account, cash flow and the changes in equity together with notes provide information about the financial position of XXX at... and of its financial performance and cash flow for the year then ended.
Directors' responsibilities: The company directors are responsible for the preparation and presentation of financial statements, which give a true and fair view of the financial position of the company and of the financial performance, cash flows and changes in equity;
Directors' declaration: The directors have declared that * the financial statements prepared by them present a true and fair view of the state of affairs of the company;
* accounting policies adopted by them accord with the industry practice, are consistently applied and estimates made are prudent in their best judgment;
* company to their best judgment shall remain a going concern during the next year;
* proper internal control measures to safeguard assets are in place; and,
* as set out in the requisite statement in the annual report, the company has complied with the practices of corporate governance, as detailed in the listing regulations.
Responsibilities:
* We are responsible for expressing an independent opinion on the financial statements presented by the directors and reporting our opinion to you.
* We read the other information contained in the Annual Report and consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the financial statements. The other information comprises only the directors report, the message from the chairman, and the corporate governance statement.
* We review whether the Corporate Governance statement reflects the Company's compliance with the provisions detailed in the listing regulations and we report if it does not. Basis of opinion: existing with following change -- (II) ... the financial statements are free from material misstatements, whether caused by fraud or error.
Unqualified/qualified opinion- existing but the word 'respectively' in paragraph 3(c) of opinion is not correct and should be deleted. There is unanimity in every jurisdiction that to stem the unethical lapses profession's self-regulation must end.
Nick Land, Chairman, Ernst and Young, (UK), admits it is in the interests of the profession, that the profession is seen to be well-regulated. "The word 'self-regulation' is an oxymoron in today's environment, because even if it does work, no one believes you anyhow;' adds Land.
The self-regulation has ended in most countries. It has ended in the US about which Turley of Ernst & Young, US, said, "The move from self-regulation to being a regulated business by the Private Company Accounting Oversight Board (PCAOB) is actually the right thing to do".
PCAOB's remit includes inspections of the largest accounting firms with more than 100 public clients every year and other firms once every three years (which might possibly lead to a second opinion on audit decisions) (How Audits Must Change, Kris Frieswick, 1 July 2003,CFO).
The UK has established a joint monitoring unit, which makes about 1000 audit visits each year of audit firms and its entire regulatory process- activities and decisions - is subject to independent scrutiny by the UK Department of Trade and Industry (that regulates the profession there.)
Canada also has established in 2002 an independent public accountability board (CPAB), with seven members out of boards' 11 members not being from the chartered accountancy profession, to review the country's major auditing firms each year and impose sanctions when they fail to comply.
Ms Liesel Knorr, former technical director, IASB and now Secretary-General of the German Accounting Standards Committee, said: "Unless there is proper oversight soon, European accounts will in future be full of what she calls "IAS-lite", meaning that they will pretend to obey international rules but in fact will not. The European Federation of Accountants favour an oversight mechanism that, like Canada, has the majority of non- members from the profession.
Ireland has about legislated an independent board of 7 members with only 2 members from the profession to review published accounts. The European Federation of Accountants declared it "supports the organization of a robust oversight of the audit profession in the public interest and that oversight is also a necessity at the level of the IFAC." (FEE Fact Sheet, Public Oversight of the Audit Profession).
In this part of the world, Sri Lanka has an independent statutory overseeing body with extensive enforcing powers, which reports to the parliament through the minister.
The research in post-Enron period at Vanderbilt University's Owen Graduate School of Management has shown that the profession also has the Achilles' heel. They would not hold their own when alternatives become available- the audit firms would still produce inaccurate audit opinions to benefit a big client - if they think they can get away with it, (They Might be Giants, John Goff, CFO P).
The world has grown complex and the Victorian ideal of doing right is no more a part of culture and the audit professionals are a part of their culture. We know when thorns are scattered, it is imprudent to go barefoot. Supervision by an external body is the only way to translate professional ethics into behaviour.
Also Rene Ricol, IFAC President, also is very clear that to restore public trust "the profession must accept independent oversight of (its) work", as also the "shared regulation of auditors of listed companies, divided between the profession's national organisations and independent supervisory bodies."(Audit Requires Massive Reform, 22 Nov. 2002, CFO P).
