Over the last couple of decades, a few incidents have acted as big blows to the profession of audit. The jolts include the dissolution in 2001 of Arthur Andersen, which was one of the big five global accounting firms at that time, and recently-declared two years of ban on audits of listed entities across India by Pricewaterhouse Coopers (popularly known as PwC) with substantial amount of financial penalty. In Bangladesh, we also have examples of failure of different magnitude. In the wake of such big shocks, audit professionals must critically look into their own practice models and methodologies with clear objectives to reposition themselves, wherever needed, so that potential disaster can be avoided.
Audit is an organised profession run by professional accountants governed by the rules and guidelines of International Federation of Accountants (IFAC) and various other laws within the country a firm operates in.
The International Standards on Auditing (ISA), promulgated by the IFAC/ IAASB, delineate numerous guidelines for the audit professionals to apply in their audit and similar other engagements. Apart from it, countries in their own jurisdiction make various laws and regulations to regulate the profession and the professionals' activities. In addition, one of the IFAC units, known as International Ethics Standard Board of Accountants (IESBA), has documented Code of Ethics applicable for the professional accountants.
The core of all these is to make sure that accountants while discharging their duties and responsibilities would act and deliver with utmost diligence applying their competence and appropriate skills. Despite having all these regulations in force, people often come across information on the failure of the auditors to conduct their duties as diligently as they are expected to.
ENRON INCIDENT AND CONSEQUENCES: The Enron scandal, publicised in October 2001, eventually led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas, and the de facto dissolution of Arthur Andersen (AA), which was one of the five big audit and accountancy partnerships in the world. In addition, Enron, being the largest bankruptcy reorganisation in American history at that time, was cited as the biggest audit failure.
Enron was formed in 1985 by Kenneth Lay after merging Houston Natural Gas and InterNorth. Several years later, when Jeffrey Skilling was hired, he developed a staff of executives that - by the use of accounting loopholes, special purpose entities, and poor financial reporting - were able to hide billions of dollars in debt from failed deals and projects. Chief Financial Officer Andrew Fastow and other executives not only misled Enron's board of directors and audit committee on high-risk accounting practices, but also pressured Arthur Andersen (the auditor of Enron) to ignore the issues.
The market price of Enron shares per unit soared up to $90.75 in mid-2000 thanks to the unusual effect of the engineered financial information and it again dropped to less than $1.0 by end of November 2001. The US Security and Exchange Commission (SEC) started investigation into the fact and the Huston-based Dynegy wished to purchase Enron at that extreme low price, but the deal naturally failed. Many executives at Enron were indicted for a variety of charges and some were later sentenced to prison. Enron's auditor, Arthur Andersen, was found guilty in a United States District Court of illegally destroying documents relevant to the SEC investigation that voided its license to audit public companies - thereby effectively closing the business.
Audit professionals would pay focus on what's termed as auditor's failure with respect to such an unprecedented corporate damage. Big auditors were blamed for their failure to identify fake and inflated financial information that eventually resulted in loss of millions of dollars in the hands of shareholders. Besides, SEC approached to probe the matters, the respective partner of AA was found to have instructed his office to shred all documents related to Enron audit. So, whatever else the audit firm wished to say in support of its logic, methodologies etc really did not work saving them. The ruling against AA was however overturned at the US Supreme Court later, but AA had lost majority of their customers by that time and had ceased operating. The firm (AA) had to embrace a sad death in 2002 putting thousands of white-collar people workless across the globe.
This unprecedented disaster brought about some discernable changes in the market and these were thought to be inevitable consequences that were visible in terms of:
* Bankruptcy of one of the largest companies in the US;
* Elimination of an accounting firm with working people numbering about 100,000 across the globe;
* Evolving a new law codifying corporate governance rules and many related regulations in the US (one of the fastest enacted laws in the history of USA);
* Almost concremation of Enron and their auditor Arthur Andersen;
SATYAM INCIDENT AND CONSEQUENCES: Satyam Computer Services Limited was incorporated in 1987 as a private limited company in India for providing software development and consultancy services to large corporations. The company was promoted by B Rama Raju and B Ramalinga Raju.
The company over the years became one of the largest technology firms in India until the global recession hit them putting the firm awestruck. In 2009, a scam was made public and it was mentioned that Satyam Chairman Ramalinga Raju had manipulated the accounts in several ways leading to a disaster that he admitted to later. This incident brought about a cyclone of concern and confusion across the globe at large and corporate houses in India in particular. Legal actions, including the arrest of Raju brothers, CFO of Satyam and so on, followed as instant consequences.
But audit professionals' attention got locked elsewhere seeing that PwC, being the very firm that worked as Satyam auditors over the years, failed to detect the fraudulent treatments in the financial statements they audited. Sometime in 2015, the special CBI court held Raju and nine other officials guilty of cheating. Among those held guilty were two former partners at PwC who were engaged in dealing with audits of Satyam financials.
As a listed company, Satyam's case naturally attracted the attention of Security and Exchange Board of India (SEBI). They took several actions that included barring Raju brothers from operating in capital markets. SEBI, after having due process of investigation and related other actions, has barred PwC from audits for two years across India. It also asked two partners and the firms to disgorge about Rs 270 million that includes the revenue they generated from this engagement and a penal interest.
The PwC prefer a stay order from the higher court, but by the time they get a favourable order, if at all, a substantial damage would take place in overall image of the audit profession.
WAKE-UP CALL FOR AUDIT PROFESSIONALS: The methodologies that are prescribed as standards for the audit professionals hardly allow detecting intentional frauds and forgery that might be built into the financial statement under review. In fact, the respective legislation does not necessarily want auditors unveil all these intentional fraudulent treatments in the financial information. However, a sensible audit may act as a critical deterrent for the fraudulent practices/ intentions of the functional managements.
The cases discussed were not just cases of deficiency in knowledge and methodologies. These were more of ethical issues on the part of the functional management of the company and engagement partners of the audit firms. It is natural that functional management would try to take the advantage of their tricky/ engineered accounting practices. So, it may not be of any value if the auditors point their finger at the unscrupulous management, it may be worth repositioning their mindsets while staying in the audit profession. To have ready reference regarding ethical codes, audit firms may consult with the handbook on IESBA Code of Ethics which ICAB has circulated to its members.
Md. Rokonuzzaman, FCA is Partner, ACNABIN.
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