Audit failures

The record of auditors over the last three decades does not
suggest a snarling dog standing guard over the interest of
shareholders and third parties.  There have been too many audit
failures.  This could mean that a bank can fail shortly after
receiving an unqualified opinion from its auditors.  One need
look no further than the hundred of Savings and Loans that
bankrupted even though they were repeatedly given clean bills of
health by prominent accounting firms.

Speaking of prestigious accounting firms, one of them,
Arthur Andersen, is no longer with us.  That’s how enormous that
particular audit failure was.  It sank with a ship called Enron!

If you’re interested in the topic, go on a search engine and
enter audit failures, you’re sure to get numerous examples.

Conflict of interest

There has always been an inherent conflict of interest in
the relation of auditors with their clients.  On the one hand,
the corporation pays the fees, on the other hand, the auditors
need to be independent; they have to inform outside parties (who
rely on them) as to whether the financial picture as reported by
the corporation conforms to reality.  While auditors in general
have succeeded in maintaining their independence, this situation
has been, and continues to be, problematic.  What can be done
about it?

There is a crying need for an outside regulatory agency
which would be completely outside the purview of corporations,
accounting firms, and bodies.  It would hire and pay auditors.
It would ensure that deadlines are reasonable and that fees are
realistic, i.e. not too low in order to attract business.
Finally, it would ensure that audits are properly and competently
conducted.  Of course, all costs will ultimately be recouped from
the corporations.

Value for money auditing (VFM)

For more than three decades, the federal government and the
provincial governments here in Canada have been conducting VFM
audits.  The VFM audits are in addition to the regular financial
audits (the type of audits I have previously described) of
Government Departments, Agencies, and Crown Corporations
(corporations partly or fully owned by the state).

What is a VFM audit?  This type of audit looks at different
government activities and reports upon them.  For instance, the
Auditor General of Canada may audit and report upon food safety
or immigration activities.  I should point out that in a VFM
audit, the auditors do not question management decisions, they
audit them.

One additional consideration; while the audit team is mostly
made out of accountants, more often than not it will include
other professionals; examples:  lawyers, economists, engineers,
geologists (if a mine is being audited), and so on.  These
professionals could be part of the regular staff of the office or
could be hired for this particular audit only.

The system is somewhat different for Crown Corporations.
While I unfortunately no longer remember the details, how they
are audited could be emulated in a VFM audit for corporations in
the private sector.  A wealth of literature exists in the above
mentioned federal and provincial audit offices.

A general example of such an audit in the private sector
follows.

Let us assume that the auditors of a bank have been given a
mandate to carry out VFM audits.  For a given year, they may
decide to audit the computerized systems of this bank.  In the
course of their audit, the auditors discover that a system to
connect the bank with the international banking system was being
developed; this project is two years behind schedule, several
millions over budget, and there is nothing to indicate that it
will ultimately work; yet, management continues to pour money
into it.  The shareholders and other outside parties need to know
about this situation, however, in the course of a regular
financial audit, it will never be audited, and it will remain an
“inside” matter.

Corporations will clamor that VFM audits are costly, time
consuming, and intrusive; they are; but given the complexity of
today’s corporate world, and the sad financial sagas we have
lately faced (the subprime mortgage meltdown and the demise of
investment banks), they are a necessity.

One last word

I cannot help but wonder whether if the above tools* would
have been used by auditors, we could have, at least partly,
avoided the recent financial calamity.

*  The outside regulatory agency mentioned under “conflict of
interest,” and the use of VFM audits.

Source

Wall Street, How It Works and for Whom
Doug Henwood
Verso
New York
1997

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