By Owen Mavengere
THERE are very few incidences that shake the public’s confidence and perception of the audit profession the way “sudden” corporate failures do. Sudden, meaning incidences that have no warning or any extenuating unforeseen circumstances, for an example Covid-19. The public struggles to comprehend how an entity can collapse after an audit. This brings them to question the value of auditors, their purpose, whether they can be trusted and so on.
Research done on this has pointed to what is termed the audit expectation gap, i.e. audit performance versus public expectation. A lot of reference was made to the work done internationally, by the International Federation of Accountants (Ifac) and the International Auditing and Assurance Standards Board (IAASB).
Through Statutory Instrument 41 of 2019, the Public Accountants and Auditors Board (PAAB) prescribed international standards for the Zimbabwean market, therefore international developments are quite relevant to this market.
Purpose and types of audit
Let us start by defining the various types of audit, which depending on the particular source range from three to more than nine. For the purposes of this article I will limit to financial statements audit, internal audit and forensic audit.
- Financial statements audit
This is the most common type of audit that the public is aware of, and largest source of the gap. The auditors, usually external, come in primarily to look at an entity’s financial statements and express an opinion on whether the numbers being reported by and large represent the actual financial performance for a defined period and the financial position at a given date.
Usually an independent external auditor is appointed to perform the audit. The purpose of having external auditors come in is to provide confidence to the users of the financial statements that the financials have been independently verified and thus are more likely to be free from erroneous or deliberate misrepresentation.
Users of financials e.g. lenders, investors, other creditors, employees, tax authorities and so on need to have comfort over the figures. Interestingly, there has been a lot of complexity on this front for both the auditors and preparers of financials over the past two to three years in Zimbabwe due to our own unique challenges, and this will be touched on in another publication in the near future.
- Internal audit
According to Ifac, internal audit functions include, amongst other things, examining, evaluating and monitoring the adequacy and effectiveness of internal control. The internal audit can be from within the organisation, in such a case usually report to the board for example through the audit committee.
- Forensic audit
This type of audit is usually meant to gather data for use in a court of law. It involves a degree of investigation to uncover and unearth evidence that is admissible in court, hence its infamy. Usually there is a lot of discomfort and a deal of unease that surrounds this process due to the likelihood of criminal proceedings.
Corporate failures, who to blame?
Now that we got the definitions out of the way, and apologies, I got carried away with those. I would like to go back to the purpose of the article on expectations of audit regarding corporate failures and scandals.The IAASB summary document of September 2020 listed the following:
- Toshiba Corporation (2015), Japan — Overstated operating profits by more than $1.2 billion in a scandal that spanned seven years.
- Carillion (2018), UK — The company’s collapse left £2 billion (US$2,7 billion) owed to its suppliers and £2,6 billion (US$3,5 billion) in pension liabilities.
- Luckin Coffee (2019), China — Fraudulently inflated sales by 2,1 billion yuan (over US$300 million).
- Steinhoff International Holdings NV (2017), South Africa — A fraud investigation uncovered billions of dollars of fictitious/irregular transactions.
The few examples above show that these issues are global. Now to the question on who is responsible for corporate failures, this can be a bit controversial and I shall not apportion blame to a single player but reiterate thatall parties in the whole reporting and governance system has a role to play i.e. auditors, employees, management, audit committee, board etc. The panacea in my view would simply be ethics, but these are often found to be lacking particularly in the huge fraud related scandals.
The audit function’s response
The audit function justifiably or unjustifiably still finds itself having to answer for all of the short-comings with questions like, how did the auditors fail to pick up the error or fraud?
The IAASB already made changes to the communication done by auditors (auditor reporting standards). Some of the changes include detailing key audit matters and the name of the engagement partner.
Other changes include information on going concern such as roles of management and the auditor and a section on the material uncertainty related to going concern if necessary. Details on the auditor’s responsibility and functions of an audit are disclosed.
In addition to the above, there is still further work being done which will assist on multiple fronts, to lower the expectation gap, as the public further understands the function of audit.
The audit function must progress and advance to meet the reasonable expectations of the public. Lastly, the audit performed must be beyond reproach. This will significantly cover the gap as defined by ACCA in May 2019.
Proposals and actions, from Ifac, IAASB, Professional Accountancy Organisations(PAOs), regulators and other key stakeholders include: –
- New international audit quality management standards were issued and are effective December 15, 2022.
- Continuous professional learning and development for audit professionals. For example, locally PAOs such as Icaz have entered into partnerships with bodies that focus on forensic accounting to develop its members.
- Revisions to the International Code of Ethics for Professional Accountants (including International Independence Standards). This was also prescribed locally by PAAB through Statutory Instrument 41 of 2019.
- Leaning on experts or having multiple disciplines in the audit firms e.g. forensic specialists and IT experts.
- Communicating with the public on the function and purpose of an audit, while concurrently making strides to meet some of the expectations that can be reasonably met.
- The directors confirm their responsibility for the internal control environment under which the financials under audit were produced. This adoption of responsibilities ensures that the organisation fully embrace their role in integrity reporting.
- Integrated Sustainability Reporting (ESG/value reporting/impact reporting) is taking root and auditors focus on providing assurance on integrated information which is non-financial, will have a positive impact as this gives the auditor information beyond just figures. This will assist the auditor, and indeed the user of the information to gain better insight into the operations and future of the company under review.
- Mavengere is the technical manager at the Institute of Chartered Accountants of Zimbabwe (Icaz), which is the largest and longest standing PAO in Zimbabwe, having been established on 11 January 1918, and is a body corporate incorporated under the Chartered Accountants Act [Chapter 27:02]. Icaz provides leadership on the development, promotion, and improvement of the accountancy profession focusing in the areas of accounting education, assurance, good governance practices and leadership and organizational excellence. — firstname.lastname@example.org or twitter: @OwenMavengere.