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Separation of audit and advisory functions should be tested

Audit firms need to be kept from getting carried away by ‘opportunities’ and better able to spot red flags.
Capture and scandal: auditors were ‘influenced’ by their clients and ‘started behaving in the same manner’. Image: Shutterstock

The complete separation of audit and advisory services in large audit firms has been hailed as a solution to the corporate and state capture scandals that have decimated public trust in the accounting profession.

This hard line was taken by KPMG chair Wiseman Nkuhlu at a recent Courageous Conversations webinar hosted by the South African Institute of Chartered Accountants (Saica) and the Wiseman Nkuhlu Trust.

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KPMG was embroiled in state-capture and Gupta-linked scandals, and Nkuhlu was brought in to restore the reputation of the firm.

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He says audit firms got carried away by the opportunities that became available to them. They were influenced by the needs of their clients, who wanted to maximise profits, and started behaving in the same manner. At the heart of it all was self-interest and greed.

Flimsy walls

Nkuhlu believes that the so-called Chinese walls (virtual walls that should act as information barriers within an organisation to prevent the exchange of information that could cause conflicts of interest) aren’t effective.

“We need to acknowledge that we have become commercial and driven by profit-maximising and less guided by a commitment to public interest.” Therefore an operational split is necessary, especially within the big four auditing firms. 

The audit profession should however not take all the blame for governance failures in the public and private sectors.

“The experience with the major corporate failures in SA shows that they have lot to do with egoistic and greedy chief executives … Other guardians of governance also have responsibilities, and there needs to be consequences when they fail.”

Read:

But Nkuhlu stands firm on the operational separation of audit and advisory services.

Conversations about non-audit-related work between an audit client and a partner should be banned.

This is to ensure that the auditor is not influenced by any consideration other than to make sure that what they sign off on in terms of the financial statements is true and fair.

The auditor needs to be suspicious, sceptical and independent.

Separation

“Separation has not been tested yet, we should test it. At KPMG we are prepared to test this.”

Nonkululeko Gobodo, CEO and head of leadership consulting at Nkululeko Leadership Consulting, and joint caretaker at the Independent Regulatory Board for Auditors, agrees on the issue of separation.

“I just fail to understand how it is possible that smart people like us have struggled to solve the problem for so long,” she says.

“For me, at the centre of it all is self-interest. It is time that we put aside self-interest, egos and start to collaborate in our financial reporting value chain to solve this problem.

“We have to restore public trust and we have to be committed to that mission because the economy is suffering.”

Read: The bankers, lawyers and liars who enabled state capture (Feb 2020)

Red flags

Gobodo says the profession is fragmented and suffers from “poor audit quality” because of fraudulent schemes and accounting errors.

“I find it hard to believe that we cannot see the red flags and that our internal audit functions are not able to pick up these red flags. I find it hard to believe that no one [in the corporate and state capture scandals] was suspicious or saw something.”

Read: Why did PwC not identify corruption at SAA? (Jul 2020)

She says the profession needs more “discerning” professionals who are able to alert the audit committees.

However, efforts to put a stop to fraudulent schemes have created so much complexity in the financial reporting system it has become “unreal”.

“The very investors we are trying to help find our financial statements meaningless. They need other ways to analyse the statements to make any sense of [them]. We need to find a way of making it simpler.”

Good place to start …

Ajen Sita, CEO of EY Africa, says whether it is separation of functions or a “multi-disciplinary model” the principle that everyone must agree on is greater independence in the audit profession.

“There are many things that we can do very quickly to achieve that, because a complete separation of audit and advisory in the short term can be quite complex.”

Not that it cannot be done, he adds.

One issue that can be addressed immediately, says Sita, is to ensure that none of the audit partners in the firm is remunerated for sales to their audit clients.

He says the issue of greed can be fixed. One way is through improved corporate reporting on company resilience. Merely stating that the company is a going concern is not sufficient. The auditor must spell out why that is the case.

“If we force that kind of disclosure, we will see a far greater understanding of what the true business risks are.”

There also needs to be more emphasis on long term value reporting. In SA things have become about compliance. The rest of the world, particularly in the light of the Covid-19 pandemic, focus on economic recovery, health, social equity and climate change.

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Ultimately it boils down to the integrity of each and every CA. In the past the industry seemed to be more attractive to honest individuals, who were intelligent enough to pass the board exams. Then it started becoming an industry where lots of money could be made and a different breed was attracted. And the more the industry was ringfencing (making it an exclusive club), it opened up more opportunity for a select few who had the brains, but not necessarily the ethical and moral fiber (the same applies to lawyers, medical doctors and even the engineering profession). Will splitting off the added functions auditing firms supply help? I don’t think so. What it will do is to split off the functions where the real money is made and in which businesses are really interested in, leaving behind a company that will add very little of real value. After all, what does an honest set of audited books add to a company’s bottom line? And who will be willing to pay for it – even if it is done with the highest integrity? The functions spun off, will then be where the shenanigans can continue, unabated, without the hindrance of morals and ethics. So, in theory it might solve the trust issue in the auditing world, but it will just move it on to a new industry, stocked with ex-CA’s with shaky morals and ethics. It will also put the auditing industry in the unenviable position to sell something to a company that the company doesn’t want, or wants to pay for. After all, who insisted on the shenanigans in the first place.

The reason the so called “Red Flags” are not picked up by the auditors is because a) most of the time the auditors dont understand the business and dont know where to look” and b) the auditors rely on management to tell them of any irregularities, which of course won’t happen.

End of comments.

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