Imagine, as an investor, reading a “clean” audit report where you learn that the auditor receives R60 million in audit fees from the client.
“How much should the investor adjust the client’s earnings per share?” asks Dr Steven Ronald Firer, research fellow at the School of Accountancy, University of the Free State, writing in Accountancy SA.
Firer says since he entered the auditing profession in 1984, “every aspect in the audit environment has been tinkered with − a few more standards here, a bit more oversight there, some additional independence and competition arrangements, a tweak of the professional training curriculum, and a shopping list of extra items that auditors should tick off.”
The Brydon Report, and its call for more tinkering and an attitude of suspicion on the part of auditors, is more of the same adds Firer.
Unconscious bias, more than corruption, is what bedevils the audit profession, adds Firer.
Every accounting scandal since the enactment of the Auditing Profession Act of 2005 is a potent reminder of the profession’s failure to deliver. This piece of legislation was supposed to have solved the problem, but hasn’t. Firer says the next Stenhoff is around the corner. “Yes, I can guarantee that it is.”
“Professor Niamh Brennan of the University College Dublin explains that the real problem is not corruption but unconscious bias, which in my opinion is another term for ‘financial reporting myopia’. Unconscious bias is a deeper, more harmful, but subtle problem within auditing.”
According to the Irish Times, Professor Brennan has been warning of this “unconscious bias” since at least 2003. She references a Harvard Business Review article which found that new requirements demanding auditors to reveal potential conflicts of interest could actually increase bias.
Forced disclosure reduces obligation to act impartially
Why is this? Auditors may feel less duty-bound to be impartial if investors are going to take their statements into account.
“Similar research, carried out by the same group, found that stricter accounting standards would not necessarily prevent auditors from acting according to their own biases,” says the Irish Times article.
The solution she suggests is fixed, limited contract periods during which auditors cannot be fired. All fees and other contractual arrangements would have to be agreed in advance. At the end of the period, the client would be prevented from rehiring the auditor. This would force clients to rotate audit firms. Audit rotation has since been introduced in SA and other countries, but this may not be enough to solve the problem.
Firer goes further, arguing (as we have done here at AW) that we have to change who pays auditor. We have suggested having Independent Regulatory Board for Auditors appoint and remunerate auditors using fees paid by client companies. After all, the audit is a public service, not just to investors, but to all stakeholders and the public at large.
As if we need a reminder why this is now a matter of great urgency, here’s a list of companies accused of accounting impropriety in relatively recent times, just in SA:
- Tongaat Hulett
- Gupta-owned companies
- VBS Bank
- McKinsey & Company
- Construction companies (World Cup 2010)
- Gold Fields
- MMM Global.