Australian Securities and Investment Commission Chairman Greg Medcraft has described as ‘disappointing’ the results of ASIC’s audit inspection report 317 (2011-12 Issued Dec 2102) which shows a decline in audit quality. The audit inspection report identified eight key findings, four on Audit file reviews and four on quality control. What do these findings mean?
Because of the risk of internal manipulation of financial records and because publicly-traded corporations are routinely required to employ outside auditing companies, the integrity of the independent auditing company is vital. Corruption in the auditing process can undermine an entire industry. If the success or failure of a particular industry can have major ramifications for the broader economy, the importance of ensuring the integrity of the auditing process cannot be overstated. The corporate auditing scandal that rocked the United States in 2001 resulted in the collapse of a major energy company, Enron, and the dissolution of a prestigious auditing firm, Arthur Andersen, and shook public confidence in the financial stability of much of corporate America. Whether U.S. Government agencies responsible for oversight of that process had been carrying out their responsibilities was debatable, but, clearly, neither those agencies nor the “independent” auditing firms like Arthur Andersen at the center of the scandal had been immune from ineptitude and corruption.
Similar to the U.S., the British and Australians experienced problems. The Australian agency responsible for oversight of public auditing is the Australian Securities and Investments Commission (ASIC). In its December 2012 Audit Inspection Program Report for 2011-2012 (Report 317), ASIC declared its “disappointment” with the failure of the auditing companies to improve their performance over the preceding year. As the report states,
“Our risk-based reviews have shown an increase in instances where auditors did not perform all of the procedures necessary to obtain reasonable assurance that the audited financial report was not materially misstated.”
Specifically, the commission’s report cites “three broad areas requiring improvement by audit firms:
(a) the sufficiency and appropriateness of audit evidence obtained by the auditor;
(b) the level of professional scepticism exercised by auditors; and
(c) the extent of reliance that can be placed on the work of other auditors and experts.”
The four main “Audit file reviews” specified in the report question the adequacy of audit procedures; the “sufficiency and appropriateness” of the material or evidence utilized in conducting audits; the level of professionalism exercised by the auditors (“professional skepticism”); and the independence of the work performed by the auditors relative to that produced by others. The “Quality control” findings involve “ethical requirements and independence” (i.e., whether individual accountants are rotated in and out of particular projects in order to ensure they don’t “go native” and develop personal relationships with officers of the companies they are auditing), “engagement performance” (following-up on reviews and audits to determine whether corrective measures have been adopted), “Human resources” (ensuring internal quality control measures are in place at the company being audited), and “Monitoring” (ensuring that internal quality controls are in place at the independent auditing firm).
The ASIC report is concerned that independent auditing companies are failing to police themselves and adopt consistent practices designed to prevent improper relationships and subpar auditing practices from taking root and undermining the financial integrity of the client corporations.