Auditors need business acumen

The high-profile collapses of Enron, HIH and WorldCom have shaken investor confidence in the credibility of independent audit processes, and triggered a wave of measures designed to improve audit practice. On 1 July 2006, the first legally enforceable auditing standards in Australia came into force, taking liability away from the civil jurisdiction and imposing criminal sanctions for professionals who breach mandatory requirements. The new standards, together with an industry campaign to better understand what corporate Australia wants from its auditors, will see the profession continue to evolve.

The Australian Auditing and Assurance Standards Board (AUASB) believes the new standards will improve the quality of audited financial reports and consequently, investor confidence. It is the next phase of reform that began with the shift away from self-regulation and the introduction of CLERP 9 in 2004. ‘The move to a core regulatory environment has resulted in substantial changes for practitioners, both in the way they practice and in enforcement,’ says Jessie Wong, audit  and assurance technical adviser with CPA Australia.

Aside from the standards now being legally enforceable, there are some new mandatory requirements, particularly regarding the way an auditor interacts with the auditee. The changes include more onerous documentation procedures, an increased duty on the auditor to communicate matters relating to independence, and greater scrutiny being placed on the entity’s related-party relationships.

One of the potential consequences of the additional requirements and tougher penalties is the threat that some auditors won’t have the resources to cope, and may therefore exit the profession. Wong says this is an outcome the regulatory bodies and the government are trying to avoid, but concedes it is a concern. ‘There are now more requirements, they are more stringent and there are criminal penalties for non-compliance,’ she says. ‘There is an increased demand for training and resources and therefore, more effort required both leading up to and throughout the conduct of the audit.’

Audit has always been regarded as a high-risk activity by professional indemnity insurers. Drew Fenton, co-director of insurance brokers Fenton Green & Co, says that the risk depends largely on the type of client being audited. ‘The publicly listed companies carry the most risk from a professional indemnity perspective,’ he says, ‘because they’re larger and there are many stakeholders who stand to risk losing their money.’

Peter Rashleigh, partner at Phillips Fox, adds that the magnitude of any litigation arising from a professional indemnity claim involving auditors contributes to the risk profile. If a publicly listed company folds, the finger of blame usually gets pointed at the audit firm soon afterwards. ‘One of the risks is that liquidators can access litigation funding for claims against auditors,’ Rashleigh says. ‘There is a potential exposure to a wide range of claimants, in circumstances where there is a limited opportunity for auditors to use disclaimers.’

Rashleigh says litigation of this nature is inherently expensive, involving multiple parties, numerous expert witnesses and large discovery processes to unravel the chain of events.

Auditors are also exposed, due to the possibility of fraudulent management by the entity they are auditing.

Although auditors cannot be expected to prise open every container to verify the assets claimed, they need to be attuned to the fact that all may not be as it appears. ‘The duty to audit includes a duty to have regard to the possibility of fraud,’ Rashleigh says. ‘In the past, the courts have described the role as one of watchdog, not bloodhound. If in the course of a proper audit fraud should have been detected, then the auditor may be liable, depending on the facts of the case,’ he says.

CPA Australia is taking a lead role in addressing, in conjunction with other industry stakeholders, the erosion of investor confidence by conducting research across the whole supply chain of financial information. ‘Audit quality is really affected by two things: the degree of independence of the auditor and how competent they are,’ Wong says. ‘That’s what the study is trying to find out: Does the market think the current pool of auditors in Australia competent? Do they have the business acumen that companies are looking for?’

The aim is to develop a strategy that can be implemented by the government. ‘It’s one of the ways CPA Australia can bring forward the collective members’ voice to the government and lead the way forward in defining the audit profession,’ Wong says.

Reference: August 2006, volume 76:07, p. 64

This page is available online at:
http://www.cpaaustralia.com.au/cps/rde/xchg/cpa/hs.xsl/724_19452_ENA_HTML.htm