Two Sides to Every Coin

February 15, 2019 Off By Robert

Company auditors have a very difficult job. They’re supposed to check a company’s accounts to make sure, amongst other things, that they’re free from material misstatement. The starting point of most audits is they’re given, usually by senior management, information such as a trial balance and other schedules.

If the same senior management who give the auditors information are perpetrating a fraud, uncovering said fact by the auditors will be difficult, especially as the senior managers are likely to be very knowledgeable and experienced.

There have been some well publicised frauds recently, one being Patisserie Valerie. In this case we know so far there were thousands of fake transactions and millions of pounds of hidden debt. The public outcry has been understandably loud and it has also highlighted a continuing debate of what should be expected from the audit process. A useful quote from a judge in a court case on the subject was “He is a watch-dog, but not a bloodhound”. This court case happened 122 years ago in 1896. Billy the Kid had been dead for 15 years at the time.

On the other side of the coin the audit profession sometimes doesn’t help itself. There are numerous examples of miscreant behaviour. Here are a few.

• KMPG, who were Carillion’s former auditors, are facing a new investigation for allegedly providing the regulator (who’s investigating the collapse of Carillion) with back-dated, i.e. fake, documents. KPMG, in their defence, did originally self-report their concerns to the regulator.

• Grant Thornton, who were until recently Patisserie Valerie’s auditors, paid a fine last year of £3.5 million. The report described one of their offices as having widespread and serious inadequacies in the control environment over the period.

• Again Grant Thornton but this time they were described in 2017 as showing a lack of professional competence and due care in an audit. They were fined £3.0 million by the audit regulator and two weeks ago a court in Essex ordered them to pay their ex-audit client £21 million in damages

I last worked as an external auditor 20 years ago and, despite new regulations since then, nothing’s really changed. Making the penalties for financial wrongdoing as severe as they are in the US doesn’t seem to work. The US is home to the biggest frauds in history, Enron ($78bn), Bernie Madoff ($65bn), Cendant ($19bn) and Worldcom ($billions) to name a few.

Regulators will continue to develop new rules and regulations but I don’t think they’ll ever find a solution to prevent new accounting scandals, human nature being as it is. I also believe the vast majority of audits are done well and I’m fairly confident that more frauds are discovered through the external audit process than those which aren’t. I can’t say for sure as we don’t hear about any audit “success” stories, only the audit failures. This doesn’t in any way excuse the few poor quality audits that have been reported and the sometimes dire consequences that follow.