Checking the accounts: Who checks the checkers do the right thing?

A sword of Damocles hangs over the checkers of company accounts. The once comfortable world of auditing lies in disarray.

The four largest UK Auditing firms face constant and widespread distrust. There’s concern about the quality of their checking and reporting standards. Nor are the numerous smaller audit firms immune to the same criticism.

The Big Four

Ramping up the reputation damage to the world of Auditing, comes a tin- eared response from the head of Grant Thornton. In a meeting with MPs probing what went wrong with several major audits, David Dunkley boss of Grant Thornton declared auditors are not meant to uncover or detect fraud:

“We are not doing what the market thinks. We are not looking for fraud and we are not looking at the future and we are not giving a statement that the accounts are correct.”

Such self-serving testimony drew the ire of MPs. Labour MP Peter Kyle for instance demanded:

“What is the point of audit in the first place? If I was chair of a company, why would I hire you? It’s like being principal of a school and not being able to trust Ofsted when it comes and does an inspection.”

Dunkley’s statement was strongly contradicted by the Financial Reporting Council’s outgoing chief, Stephen Haddrill:

“Auditors are clearly responsible for spotting fraud.”

It’s time to re-write the definition of what’s a quality audit check. That includes what clients get for their money. There’s been a decade of unrelenting bad news about the auditing profession. Checking on the checkers is mainly absent. Criticism from various professional bodies, politicians, and the government can no longer be brushed aside.

The latest action by KPMG to separate auditing from its lucrative consulting work looks what it is. Namely, a blatant attempt to deflect larger forces pressing for more substantial change.

Similarly “firing” “unprofitable clients” because these might lead to large fines for poor quality work, won’t fend off major change. According to one well-placed critic these tactics are:

“…an attempt by the big four to use their power to object to serious audit reforms…”
Atul Shah, professor of accounting at City University

Nor is the bad news about auditing confined to Western nations. China too suffers from a series of billion dollar corporate scandals. Its auditing firms have not delivered in terms of quality of work.

For example an investigation into the company Kangde Xin, for example, found inflated profits of nearly $2bn spanning several years. Concerns about how the profession of account checkers operates therefore run both wide and deep. In particular, important issues arise for ethical business leaders. Are they for instance, enough engaged with the auditing work under their watch?

Failure to detect fraud, or to challenge the viability of some companies through audit work may pose an important ethical dilemma for business leaders:

“When it comes to audits, how effective is my moral compass?”

Do business leaders understand the ethical dimensions posed by auditing work? To be even more explicit they need to ask:

“What is the quality and ethics of the work done by our auditors?”
“Does our auditing service provide strong ethical leadership to its employees?”

Obtaining answers to both questions depends on understanding the prevailing culture of the audit firm. Yet there’s little such information available. Despite individual audit firms boasting about “integrity”, “transparency”, or “independent monitoring”, we have little solid data to support their performance claims in practice.

A Black Box

For ethical business leaders, auditing can seem a black box. From this dark container spew complex checking reports meant to help in judging and running a business. Too often though, such outputs prove arcane and neither supportive nor revealing. Ethical leaders need to avoid becoming enmeshed in the technology of audit, with its endless columns, notes and esoteric definitions such as “materiality”. Instead business leaders will find it more sensible to delve into the prevailing tone at the top of the audit firm.

Tone at the top inspires employees to copy the behavior of role models, such as ethical leaders. This is why the Grant Thornton’s leader’s dismissal of any responsibility for fraud detection proved both divisive and further undermining of auditing’s reputation. Like wisps of smoke, ethical leadership descends from the highest level of management down to influencing supervisors and ultimately employees. This process is important, because:

“…by setting the tone at the top , ethical leaders can influence the operating behavior of not only management but also of those employees making the day to day decisions and journal entries like assistant controllers or accountants.”
J. Taylor Morris, The impact of authentic leadership and ethical firm culture on audit behavior, Journal of Behavior Studies September 2014

Limited research on the audit function and ethical leadership suggests that the latter does affect what happens inside that black box of accountants’ decision making. The continued existence of the black box means business leaders mainly rely on their paid professionals, such as the Chief Financial Officer, to provide assurance about reporting decisions.

Depending on the strength of the compliance function for example, different ethical standards may affect the recording and interpretation of some journal entries.

A focus on Quality

Of the many steps needed to reform the world of the checkers, one of the most important will be reviving a passion for quality. Attacks from all directions have highlighted a failure to sound the alarm bells about the financial stability of companies.

For example, recent high profile failures include the unexpected demise of Corillion, the Patisserie Valerie debacle, and the belated black hole revelation in the Tesco Accounts. These can only partly be blamed on technical glitches. In the case of Patisserie Valarie, the interim accounts reported it was “a reliable growth machine, with 99 per cent of new cafés profitable within a year of opening. ” Yet not long after, the chain of restaurants turned out to have a £40m gap in its finances. Where were the checkers? No wonder the Serious Fraud Office is now investigating, along with regulators.

There is also a common failure by the independent account checkers to question or directly challenge business leaders. Doing so takes a certain amount of courage since these are paying customers. Why do the checkers find it so hard to pursue a fundamental issue such as:

“Is your business sufficiently sound and viable? 

In theory, auditors already ask this question as part of their normal work. In practice, many stay almost silent or duck the issue entirely for fear of biting the hand that feeds them. So predictably it produced headlines when Grant Thornton recently announced it was withdrawing from checking the books of Sports Direct over concerns about a sudden €674 million (£605 million) Belgian tax bill.

Another feature of quality involves the ability of auditors to detect or at least point up fraud. To identify such problems, ethical business leaders often rely on both their internal professionals and their less involved external auditors.

Bring on the change

Structural changes therefore seem destined to hit the audit profession sooner rather than later. So the ability to manage change should now be high on the agenda of most audit firms.

Achieving culture change within these firms though, may require specialist help. For example, coaching to understand how to provoke shifts in individual behavior, or ways to provoke wider culture change.  Help may include:

  • Guiding audit leaders to review their moral compass
  • Assisting audit leaders on altering a firm’s culture
  • Providing learning space for exploring new forms of behavior
  • Help with building and managing teams
  • Coaching audit leaders to relate more effectively with their clients.

More generally, business leaders may also benefit from support to make more sense of the ethical dimensions of audit work. For instance, to raise their awareness of the vulnerability of auditing to ethical issues, such as uncovering hidden bias, or the mistreatment of certain items in the accounting system.

To sum up: ethical business leaders need to view auditing not as a black box, but as area of possible ethical attention.

Andrew Leigh is a joint founder of Maynard Leigh Associates Associates

Sources

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