THE AUDITING profession is now on the brink of a professional re-engineering. With concepts like, “corporate governance” and “best practices” being raised, the time has come to closely monitor the workings of auditors.

First, let us examine the role of the so-called external auditors who are appointed by shareholders upon being “recommended” by the management. Is it the duty of the external auditor to report on fraud detection? Historically, external auditors have tried to distance themselves from responsibility for fraud detection. But the fact of the matter is that, if gross irregularities are noted, then who is to be blamed.

Take the Enron’s example, Arthur Andersen was not able to report the problem and lately we have a new entry, WorldCom. Andersen can be given a cushion for the Enron case, as the irregularity was complex and required interpretation, but the cushion needs to be taken away with the WorldCom fiasco.

On hearing the $3.8 billion accounting problem, analyst geared themselves for another complex interpretation of the accounting standards and associated regulations. What turned out was a total anti-climax. The problem was not in the standards or regulations but it was in the integrity of the people who ran the show. As the saying goes, “it is never the gun that fires the bullet but the finger that pulls the trigger.”

So we come back to the same old question: Should the auditors’ be audited? Experience shows that all companies “cook” their books, smoothing their earnings, timing their transactions to gain advantage points and taking accounting loopholes to juice out maximum benefit, but these are all done within certain boundaries and standards. A lot of fraudulent financial reporting is probably an exaggeration of previously tolerated practices. Thus the message is let’s not get too far with cooking up of the books. At times the problem lies in the auditors getting too close to the ones they are auditing.

They, therefore, become advocates for their clients rather then independent assessors who, based on their skills and professional judgment, form an opinion about the fairness of the financial statements. Let us be fair about things, external audit is also a business and like other businesses, these firms are constantly seeking profits and a new clientele. An audit firm’s business is divided not only in audits but also tax advisory and corporate consultancy, which at times forms a major component of the total revenue generated by them.

The question as what is the best possible source to find new clients for tax and corporate advisory services. The answer lies in external audit clients. It has been noted that several audit firms are involved, with their audit clients, on tax and corporate matters, so why kill the hen that lays golden eggs. However, all this has changed with the new regulation on corporate governance where audit firms have to keep their consultancy and audit clients separate.

The second dilemma faced by audit firms is the budget factor. With cut-throat competition and an eagerness to maximise profits, audit firms try to chart out an unreasonable audit time and logistical budgets. This allows them to make profit but at the expense of quality. External auditors should realise that completing the audit on time and within budget is desirable but at the expense of missing major audit findings, such as fraud, is a big failure.

Enough has been said about the poor external auditors, who have been constantly facing the firing line since the Enron fiasco. Now let us examine the role of Internal Auditors within the organisation. The internal audit function is defined as, “an independent, objective assurance and consulting activity designed to add value and improve an organisation’s operations. It helps an organisation accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes.”

The function and role of internal audit is defined in its internal audit charter which is governed by the audit committee, which in turn reports to the board of directors. The key of having a successful internal audit lies in its total functional independence. Is it too much to ask? Analysts are skeptical about the views. There are those who talk about the fact that the internal auditors are less independent than external auditors. Why? Because the former is on the direct payroll of the company whereas the latter is on an annual retention basis. On the other hand there are those who view that an Internal Auditor is better placed and has closer link with the management than the External Auditor and thus he may be able to limit the damage, as they would be timely catching the problem. Whatever said and done the conclusion is internal and external auditing goes hand and hand.

The need for a good internal auditing function is proven with the Enron and WorldCom debacles, where questions were raised on the external auditors integrity and professionalism but the internal auditor escaped the wrath. Most large organisations have established an internal audit function. Their staff is highly paid and in the majority of the cases comes from a solid professional background. While the workings of the external auditor of the company are governed by laws and regulations, the internal auditor only has the International Internal Auditing Standards to look into. Furthermore, the external auditors have a regulatory authority. The Institute of Chartered Accountants of Pakistan, (ICAP) which ensures that the procedures of best practices are followed. What lacks in the internal audit function is the missing of a regulatory authority.

While the external audit report of a company, by law, is subjected to submittal requirements to regulatory authorities, like stock exchanges, the SECP etc, the internal audit report is not. Again there is a difference of opinion on this as some professionals view that the Internal Audit Report is confidential and may contain information which may not raise questions on the management’s corporate governance but may divulge information to competitors.

Yet, there are those who believe that there should be some form of reporting on the internal audit function whereby problems are highlighted on a timely basis and thus the damage is limited, if not completely avoided. Hearing both the arguments let us conclude and be fair on the issue, is it not better to be aware of the problem before it turns into another Enron or WorldCom, where at the end of the day not only the shareholders are affected but the employees and the loaning agencies too, not to speak of the investor confidence in the market.

So what should be done? The answer may lie in the following suggestions, which are in no way exhaustive but rather thought triggering:

* For starters, a law has been put forward whereby all listed companies will have an Internal Audit function. An additional clause should be promulgated in the same law whereby copies of the internal audit reports should be submitted to the concerned regulatory authorities. The report may not be in detail so as not to give out confidential company information, but it could be on more or less same pattern as the external audit report.

* The approved internal audit charter of the company should be submitted to regulatory authority.

* The audit committee director should be given complete protection by law to make it difficult for management to do away a particular director in case of disagreements.

* In certain cases, the concerned regulatory authority should reserve the right to appointment an audit director.

The above will not only ensure an effectiveness of the internal audit function but also strengthen his independence.

The time has come for us to look into the aftermath of the crisis that has gripped the corporate world. Nothing much can be done now except to strengthen our defences and be better prepared for any unforeseen eventuality in the future. As the saying goes, “lets not cry over spilt milk”, but rather lets think of ways from which we can avoid spilling the rest of the milk.