How to gauge the effectiveness of audits? It is tempting to point to the growing scale of undetected irregularities and outright frauds and conclude that external audits are simply not fit for purpose. Yet there is no objective measure for assessing how much worse things would be without them. What if corporate propriety resided solely in the hands of internal audits, risk and audit committees, and industry and accounting regulators?
Whatever such an evaluation might reveal, it is clear that external audit effectiveness has not kept pace with the growth in size and complexity of entities being audited. The age-old cry of “What were the auditors doing?” remains as pertinent as ever in the context of recent scandals, such as that thrown up by the FBI investigation into FIFA’s suspect payments, or Toshiba’s vast revenue overstatements – both matters of crucial concern to their auditors.
Toshiba’s outgoing president Hisao Tanaka accepted responsibility for the accounting scandal that systematically overstated profits over a six-year period and forced the resignation, in disgrace, of half his board. As he coyly put it: “there is nothing wrong with pursuing profit, but it should be done in line with correct accounting standards.” His auditors, presumably, would agree.
If ever auditors were handed a wake-up call, Toshiba has sounded it: checking accuracy of records is useless without factoring in the culture in which those records are created. Top-down pressure to meet unrealistic targets is a malign influence that nullifies objective reporting. The ex-CEO admits that he instructed management to “use every possible measure to achieve profitability”, and adds that under Toshiba’s corporate culture employees are forbidden to “go against the will of their superiors.”
This is precisely the red flag that auditors perennially miss. Remember WorldCom? Twelve years ago investigators concluded that Bernie Ebbers, the WorldCom CEO, “created, and the Board permitted, a corporate environment in which pressure to meet the numbers was high, departments that served as controls were weak, and the word of senior management was final and not to be challenged”.
The $11 billion fraud was followed by a trial at which Counsel for WorldCom’s investors declared: “That fraud could have been stopped dead in its tracks if Arthur Andersen had been looking to do its job instead of looking to line its pockets.”
Toshiba is merely the latest company to succumb to the “meet-the-numbers” syndrome in which revenues are booked early, costs pushed back, assets overstated and liabilities hidden. Last year Tesco demonstrated how its unique style of revenue recognition was able to achieve huge profit overstatements – and get its auditors removed into the bargain.
Crooked payments undetected
Methods deployed in 2012 by Olympus, the Japanese camera and lens manufacturer, were no less adventurous. Its UK-born CEO Michael Woodford called on the board to explain a number of patently questionable payments, whereupon he was fired. He later claimed that “the core management was rotten and those around them were also contaminated”.
Woodford had queried excessive “advisory” payments by Olympus for its acquisition of a British medical devices firm. These payments amounted to $687 million, or one-third of the entire acquisition cost, compared with norms of 1 to 2 per cent. Would any auditor worthy of the name, confronted by whacking great payments that are clearly not what the records show them to be, follow with a clean opinion?
The Nigerian-focused oil producer Afren, once a stock market darling, has collapsed into acrimonious administration with the loss of £1.6 billion of shareholders’ funds. The Serious Fraud Office is now investigating huge, unauthorised payments siphoned off into offshore companies (a la Olympus) including an undisclosed $17 million paid to its two most senior executives.
While audit methodology fails to reflect the environment in which results are reported, the real question concerns the corporate culture of the audit firm itself, as much as its client.
(No one can accuse me of being less than even-handed. In every ghastly lapse cited above the auditor was – you guessed it – a Big-4 firm.)