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Lack of Audit Quality Is Alarming

By Curtis C. Verschoor, CMA, CPA
December 1, 2018
1 comments

Recent audit scandals involving Big 4 clients have raised serious questions related to auditor independence and audit quality—or lack thereof.

 

The $625 million damage assessment by the Securities & Exchange Commission (SEC) against PricewaterhouseCoopers LLP (PwC) in the Colonial Bank case has again brought to the forefront concerns over the need to improve audit quality. The amount of damages is one of the largest ever awarded for audit malpractice. Crowe Horwath LLP, Colonial Bank’s internal auditor, previously settled for $60 million, while Deloitte & Touche USA LLP, the auditor of the entity that was the source of some of the fraudulent assets that PwC failed to recognize, settled for approximately $150 million. An attorney for the Federal Deposit Insurance Corporation (FDIC), which had to pay billions to Colonial Bank depositors, stated, “We are pleased that the court recognized there are consequences when an auditor breaches its duty to the investing public.” But that case isn’t the only recent example raising concerns about audit quality.

 

KPMG recently has received negative publicity about ethical missteps and poor audit quality. For instance, the two biggest U.S. proxy advisory firms, Institutional Shareholder Services (ISS) and Glass Lewis, recommended that shareholders of General Electric (GE) vote against its board of directors’ recommendation to reappoint KPMG as auditors for the 110th consecutive year due to “the apparent extent of GE’s previously undisclosed liabilities and accounting issues,” including a surprise charge of $15 billion necessary to bolster GE’s insurance reserves. Although 64.9% of GE shareholders accepted KPMG for reappointment, ISS noted this was only the fifth time in the last 1,500 meetings of S&P 500 companies that an external auditor won less than 90% of the vote.

 

Overseas, KPMG was the external auditor for U.K. construction company Carillion PLC, which collapsed without warning (see “Carillion Failure Raises Questions About Consulting Services,” in the September 2018 Strategic Finance). And KPMG South Africa has faced multiple scandals: It issued a public apology for apparent substandard consulting for the politically connected Gupta family; withdrew a report about South Africa’s tax authority; and gave VBS Mutual Bank an unqualified opinion, the best possible audit outcome, before the financial institution failed. Two KPMG partners resigned after failing to disclose financial interests in VBS, and one of KPMG’s largest clients, the Auditor-General of South Africa, dismissed the firm in the wake of the bank auditing crisis.

 

A discussion of the quality of auditing services that the Big 4 firms provide is contained in a series of Financial Times articles, “The Big Flaw: Auditing in Crisis.” The first story, “UK accountancy watchdog’s competence faces government probe,” notes concerns over whether KPMG, Deloitte, EY, and PwC “are too big to fail, too profit-driven and excessively compliant to managers’ wishes.”

 

The article also states that one of the causes of accounting scandals is the switch in accounting standards from historical cost to emphasis on asset fair value, which gives greater discretion to the judgment of companies’ senior management and finance executives but that apparently hasn’t been matched by increased independent professional skepticism by auditors. Consequently, the story describes the Big 4 firms as “profit-hungry professional services conglomerates that are not that worried about audit quality.” According to the University of Michigan’s Ross School of Business clinical assistant professor Erik Gordon, the biggest professional services firms “have been able to do better with low quality than with high quality work. It’s less expensive and clients, who actually are company management, not the shareholders, seem happy with audits that don’t challenge their view of how well they are performing.”

 

The need for auditors to improve audit quality is also evident in the 2018 Main Street Investor Survey published by the Center for Audit Quality (CAQ), which surveyed 1,100 investment decision makers with assets of $10,000 or more. More than half of investors (52%) had either some or very little confidence in audited financial information released by publicly traded U.S. companies, and only 35% had a great deal or quite a bit of confidence.

 

In the CAQ survey, investors cited a variety of reasons for having a lack of confidence in audited financial information. Management accountants, who have leadership roles that mandate ethical corporate reporting, should be concerned about several of them, such as the top four:

 

  • Companies aren’t trustworthy (28% of respondents);
  • Companies or auditors have conflicts of interest (23%);
  • Negative news heard (11%); and
  • Companies don’t provide enough information (10%).

 

Conversely, the reasons that investors cited for having confidence in audited financial information included the awareness that companies’ reputations are at stake if they get caught doing something wrong or not following best practice (34%) and the idea that auditors provide honest and independent third-party scrutiny (20%).

 

The 2018 CAQ research does have good news for professional services firms that audit publicly traded companies, as 81% of respondents had at least some confidence that audit firms are effective in helping to advance investor protection.

 

Audit firms should reexamine the core reason for their existence and the ethical rationale behind the legislative mandate that all public companies engage their services. Too many professional services firms have expanded their more profitable advisory and consulting practices at the expense of performing high-quality independent audits. Legislators and regulators need to revisit professional ethical standards and consider circumscribing the apparent trend to public accounting firms placing growth and profitability ahead of unbiased service to investors and the public interest.

 

IMA ETHICS HELPLINE

 

For clarification of how the IMA Statement of Ethical Professional Practice applies to your ethical dilemma, contact the IMA Ethics Helpline.

 

In the U.S. or Canada, dial (800) 245-1383. In other countries, dial the AT&T USA Direct Access Number from www.usa.att.com/traveler/index.jsp, then the above number.

 

The IMA Helpline is designed to provide clarification of provisions in the IMA Statement of Ethical Professional Practice, which contains suggestions on how to resolve ethical conflicts. The helpline cannot be considered a hotline to report specific suspected ethical violations.

 

Curtis C. Verschoor, CMA, CPA, is the Emeritus Ledger & Quill Research Professor, School of Accountancy and MIS, and an honorary Senior Wicklander Research Fellow in the Institute for Business and Professional Ethics, both at DePaul University, Chicago. He is also a Research Scholar in the Center for Business Ethics at Bentley University, Waltham, Mass., and Chair-Emeritus of IMA’s Committee on Ethics. Trust Across America—Trust Around the World awarded him a Lifetime Achievement Award in 2016. In 2017, IMA published his book, Curt Verschoor on Ethics. His e-mail address is curtisverschoor@sbcglobal.net.
1 + Show Comments

1 comment.
    Michael Daillak, CPA December 9, 2018 AT 6:00 pm

    The only answer is the SEC in the USA, and its worldwide equivalents, mandating “audit only” firms, rotating clients (and all related files) every three years, with confidential peer-review of the predecessor firm by the successor firm. If you need reasons why, see the 10/06/2008 final-report Advisory Committee on the Auditing Profession, formed by the Treasury Department, especially Section IX, the sole dissenting opinion of Lynn E. Turner, former SEC Chief Accountant.

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