Have giant corporations outgrown the ability of even the largest audit firms to report safely on their accounts? Complexity, geographical reach, exponential growth in the number and size of transactions leave auditors struggling to do justice to their authentication processes. The greater the size of the client entity, the more that can go wrong. This correlates with a liability exposure out of proportion to both culpability and the resources needed to survive an unimaginable level of claims.
Although this risk has been staring auditors in the face for years, it has been met by a steadfast reluctance to come up with a more secure auditing paradigm. How can auditors raise their game while the cards are so stacked against them?
A wake-up call for auditors.
For a start, they must test management’s assumptions more boldly. I remember when even going concern was just ‘assumed’ rather than tested – until so many companies turned out to be ‘gone’ concerns. A wake-up call for auditors.
Preparers are not auditors
It is tempting for auditors themselves to fall for an assumption: that accounts are fine as long as they are compliant with treatments prescribed by standard-setters. They may all be members of the same profession, but they wear very different hats. Accountants as preparers are slaves to rules governing treatment and presentation, but auditors have a higher calling. For auditors, all the semantic nit-picking is a distraction, an obstacle to be overcome, rather than a consuming objective.
Even the new Chairman of IASB finds it remarkable that supposedly compatible standards can cause one and the same asset to be differently classified. Software, for example, is a tangible asset under UK GAAP but is an intangible under IFRS.
Take share-based payments. The notion that these are somehow a cost to the company, rather than a note-worthy dilution of existing holdings, has led to a maze of unfathomable and illogical accounting strictures that leave most auditors dumbfounded. Until rulemakers are forced to get a proper job auditors are obliged to check compliance, but they should never lose sight of the fact that compliance was never a problem for Lehman Brothers, nor Enron, nor the Greek government’s application for Eurozone membership.
Auditors must return to the watchwords of reliability, prudence and substance over form, depite the fact that the latest IASB Framework has deleted them all. Instead we have ‘faithfully represented’ because, they say, this is what they really meant all along.
Compliance alone is never enough
Compliance, if you can understand what you are complying with, should be a ‘given’, not the main objective. All the cerebral scribblings in the world can never vouchsafe the true and fair imprimatur. That is the auditors’ preserve. But the tide is against you: derivatives and other fraud-prone devices are again on the march; Sarbanes-Oxley safeguards are in retreat; prudence itself has become an anachronism.
I repeat: focus on assumptions. Management’s own assessment of covenant headroom assumes income flows, contract renewals, asset sales and funding availability. They may be over-optimistic? Debt and mortgage valuations are based on assumptions about borrowers’ solvency. Reliable? Marking current assets to wobbly market valuations assumes that the unrealised profits are real. But are they?
Maybe it’s time to question everything. There are no safe assumptions and it’s your head on the block.