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The assurance companies and investors really need

Corporate scandals and the massive penalties inflicted on big audit firms have affected the credibility of audit opinions. Where to from here?

The assurance given to the public and investors through audit reports by large audit firms has undoubtedly suffered severe damage.

In June, The Guardian reported that fines against accountants more than doubled to a record £32 million (more than R600 million) last year as the Financial Reporting Council cracked down on auditors. 

The number of corporate scandals and massive penalties inflicted on the large audit firms in recent times is increasingly leading to calls for a new way of thinking about the reassurance given through ‘audit opinions’.

Nicolaas van Wyk, CEO of the Southern African Institute for Business Accountants, says there has been a steady decline in the demand for audit services in South Africa over the years.

However, he is not convinced that companies have moved towards having their annual financial statements independently reviewed. The Companies Act allows a company to either have its financial statements audited or independently reviewed.

Most of the companies in SA are ‘owner-managed’ and have opted for compilation reports where a preparer organises the financial information in accordance with the necessary bookkeeping standards.

There is no review or in-depth investigation of the information provided by the business owner, explains Van Wyk.

Businesses cutting costs

Wiehann Olivier, a partner at Mazars, says in a statement that many companies have been trying to “better manage” their expenses given the current state of the local and global economy. Since audit fees make up a significant portion of those expenses they have been focusing specifically on audit fees.

Read: Businesses need to get serious about financial managers

In terms of the act, certain companies have no choice in whether to choose an audit or not. If they have a ‘public interest score’ of more than 350 then the financial statements will need to be audited.

Olivier explains that the score is based on factors such as the number of individuals with beneficial interests (shareholders), turnover for the financial year, third party liability at the end of the financial year and the average number of employees.

Independent reviews

Independent reviews are available to companies with a public interest score of less than 350. If the financial statements have been compiled independently the company can opt for an independent review as opposed to an audit, says Olivier.

An independent review primarily consists of making inquiries of management and others within the company, applying analytical procedures, and evaluating the evidence obtained.

“An audit is a much more in-depth investigation where various techniques are used to obtain the assurance required to enable the auditor to issue an audit opinion,” says Olivier.

Van Wyk observes that given the growing list of corporate scandals, not only in SA, it does appear as if the current “assurance reports” given to investors and shareholders are pretty much futile.

However, in most instances, financial institutions will still insist on audited financial statements when considering financing a company. “They still believe it does something,” says Van Wyk.

He asks if financial institutions or lenders should not rather be focusing on the areas where they run the biggest risk – for example the overvaluation of assets – when making a decision, rather than relying on audited financial statements.

“I believe the world has moved beyond the knee-jerk reaction of having audited statements in order to avoid risks or scandals. We need unique reports for unique problems.”

Technological developments, and specifically the role of artificial intelligence (AI), demand a reinvention of the profession, he says.

The latest trends are in-time audits using AI and more specific risk-driven investigations. An audit is fast becoming a “run of the mill” operation because of AI and the role of robots.

The current acts and the assurance reports that form part of the corporate landscape is becoming outdated in the face of increased automation.

Time for unification?

“It is time for a unification of the audit profession with comprehensive legislation in order for all to incorporate the new way of thinking and the use of technology to approach the market,” says Van Wyk.

Auditors and accountants should understand that they are merely spokes in the wheel of the economy, and not the drivers of the economy.

They should understand what the intent of the business owners is – do they want to grow the business and sell it, or do they want to continue making a living for themselves and their staff?

That understanding, says Van Wyk, will drive the decision as to whether there is a need for an audit, an independent review, or simply a financial statement preparer supported by an internal auditor to ensure that proper controls are in place.

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As forensic accountants we found that most audit opinions for particularly smaller companies are not worth the paper its written on. I don’t agree with the statement that banks prefer audited financial statements. Banks prefer to work with accountants and auditors that the banks have developed a relationship with and where these financial institutions know that they can trust/rely on the information provided. Our office developed a risk analysis tool that we use as basic point of departure to ensure accuracy. Although a review is only limited to the substantive part of an audit, it is still important for accountants to know their clients’ business and in most audit failures where smaller audits are involved the lack of external confirmations seems to be the biggest shortcoming. These things particularly happen where the annual financial statements of body corporates are audited. In these small audits it would seem as if caution is thrown to the wind. I sometimes wonder if the auditor that signed the audit opinion actually read what he/she signed. We did the forensic investigation on 9 body corporates that used the same auditor and management agent. In total just under R25m was lost by people that can’t afford to lose any money as they are pensioners. We only read about the big failures but believe me the failures are across the board. Accountants in general lost their moral compass quite sometime ago and that is in my opinion the primary reason for the failures we are experiencing on a worldwide scale. We need to start seeing ethics and moral values are sharp skills and technical expertise as soft skills. Not the other way around.

Remember that the inherent/strategic flaw is that a Company pays the auditor to find flaws in the Company… this is the most ridiculous system ever in a capitalist society…. SAICA, SAIBA, IRBA etc know this and have zero power to stop it

“ financial institutions or lenders should rather be focusing on the areas where they run the biggest risk – for example the overvaluation of assets“ : when I highlighted to auditors that the asset valuation of one top-40 company is unrealistic (no foreseeable net free cash from the assets), the auditor said that the assumptions underpinning the asset valuation was not in the audit scope! Please bring back common sense, prudence, matching and realistic realisable value limits into auditing

Well said. Agree with all your points.

How did it go so wrong? Having a good understanding of what led to the implosion of SAICA and the once revered CA(SA) certification may prevent such a scandal occurring again.

Bear in mind that SAIBA is a sales-based organisation and that its CEO is talking his book, which mostly involves making a big meal out of very little work.

So what exactly is the role of AI and robots ?

The underlying issues with the accounting industry are a) lots of easy money b) the fiction of independence c) low probability of detection of, and negligible consequences for substandard work and/or unethical behaviour.

Prohibiting indemnity insurance might focus the mind a bit.

Big thumbs up for van Wyk.

IMHO the elimination of SAICA and the IRBA is an absolute minimum requirement for a rebirth of auditing in a more practical, beneficial and cost effective audit process.

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