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Auditors without professional borders

By Malcolm King - posted Wednesday, 4 December 2019


Auditors assure the accuracy of a company's financial records for shareholders, the public and the economy at large. It's a matter of trust.

Yet leaked documents handed to Fairfax Nine by a whistleblower this year, triggered a parliamentary inquiry, (The Regulation of Auditing in Australia), which will hear testimony in 2020, about the cosy relationship between large audit firms and their clients.

The economy relies especially heavily on the exactitude and probity of the 'Big Four' - Deloitte, PwC, EY, and KPMG – as they are the only institutions big enough to audit multinational corporations and government agencies.

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The 2011–12 ASIC audit inspection report found that in 18 per cent of sampled key audit areas, Deloitte, EY, KPMG and PwC had failed to obtain "reasonable assurance" that the financial report as a whole was accurate and free of misstatements.

By the time ASIC released its Audit inspection program report for 2016–17, that number had blown out to 25 per cent.

At the same time, large accounting firms are scaling down their auditing functions to focus more on their profitable advisory-based consultancies.

In the last three financial years, audit revenue at Deloitte dropped from 19.2 per cent to 14.7 per cent. At EY, it fell from 28.1 per cent to 21.7 per cent. At KPMG, revenue dropped from 24 per cent to 21 per cent and at PwC, it slumped from 22.5 per cent to 18.7 per cent.

Across Australia, professional services are the fastest growth areas in accounting. The top 100 companies posted a total revenue of $11.25 billion in the last financial year. That's up ten per cent on the previous year.

The Big Four accounting firms accounted for almost 70 per cent or $7.8 billion of that revenue, thanks to the rivers of cash rolling in from their professional service divisions.

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Last year, finance journalist Richard Brooks wrote in his book, Bean Counters: The triumph of the accountants and how they broke capitalism, that the main focus of these giant accounting firms was not audits but on providing professional services such as financial and IT systems advice.

"It's not really any longer an accountancy profession," Brooks wrote. "It's more a consultancy profession, or it would call itself professional services, with auditing just one of its business lines, and a minority one at that."

In my old home town of Adelaide, the sheer number of current and past tenders awarded to KPMG, makes one wonder whether KMPG works for the state government or vice a versa.

A number of these accounting firms are paid by the state government to provide financial advice and research. Yet much of this research is couched in terms the government of the day wants to hear.

Adelaide's media is littered with reports of highly variable worth by accountancy firms. Most of these reports are PR and marketing exercises.

There is scant mention of exposing bias, fraud and tax evasion and the risks these pose to the economy. In fact, it's hard to ascertain that they were produced by companies dedicated to accounting.

'Eye of the tiger'

Let's travel back in time to 1989. At a large hotel in Dallas, Texas, Jim Edwards, the new head of Arthur Andersen's audit division, walked on stage to the sound of the Survivor's song, 'Eye of the Tiger'blaring over the PA - followed by a tethered snarling, live tiger.

Edwards told his employees they, "require the eyes of a tiger, eyes that seize opportunities, eyes that are focused on the kill."

Arthur Andersen was one of greatest (and most conservative) accounting firms in the world. But in the 1980s, it's corporate culture changed. It morphed from a wise old owl in to a profit-hungry carnivore.

It shackled its fortunes to Enron, a high-flying energy trading company, which undervalued debt while reporting absurdly high profits.

Enron's fall in 2001 took its primary auditing company, Arthur Andersen, with it. It was woefully negligent of its client's true financial position.

Arthur Andersen was found guilty of obstruction of justice, as it had shredded Enron audit documents. Why didn't the auditors hit the alarm button?

As the American writer Upton Sinclair wrote in the 1930s, "It is difficult to get a man to understand something when his salary depends on his not understanding it."

In the lead-up to the GFC in 2008, Lehman Brothers bank had borrowed eye-watering amounts of money to fund its investments in housing-related assets. When the American property market crashed, so did Lehman.

The bank had allegedly removed tens of billions of dollars of fixed income securities from its balance sheet to hide its dire financial situation.

EY had audited Lehman Brothers from 2001 until the bank's bankruptcy in 2008. It had consistently given the 'thumbs up'. EY's audits were useless.

I do not suggest Australian accounting firms are conducting themselves like Arthur Andersen and EY, in those two cases. But when auditors and professional services contractors become 'defacto employees' and their commercial interests are inimical, objectivity and probity may suffer.

The parliamentary inquiry will listen to a number of solutions including introducing legislation to prevent an audit firm offering auditing and consulting services to the same client, imposing a limit on the number of years an auditor can audit a company, and the creation of a separate regulator.

It's a matter of trust.

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About the Author

Malcolm King is a journalist and professional writer. He was an associate director at DEEWR Labour Market Strategy in Canberra and the senior communications strategist at Carnegie Mellon University in Adelaide. He runs a writing business called Republic.

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