Scandals erode confidence in auditors

Audit failures raise questions on credibility of company financial reports.

The scandals involving companies that have come to the fore in recent times have fuelled debates on several matters regarding corporate governance.

Of these, the debate on the credibility of the audit practices as well as the pros and cons of auditor rotation is one which has received extensive deliberation.

The essence of the long-standing debate is whether the mandatory periodic rotation of external financial auditors would strengthen the buffer between them and their corporate clients and lead to better audits.

Well documented failures have led to the erosion of public confidence in audits resulting in a need for relevant authorities to consider increased scrutiny for audit practices, specifically imposing limits for audit tenures.

America’s Sarbanes-Oaxley Act of 2002, which imposed enhanced corporate governance standards for US public companies in the wake of major corporate accounting scandals, was the contemporary standard setter.

Its recommendations and trail of thought have been adapted world over.
In sub-Saharan Africa, South Africa’s King III Report on corporate governance notably stands out as one of the most rigorous corporate governance requirements.

The basic notion behind the call for auditor rotation is the view that a prolonged relationship between an auditor and a client may erode the auditor’s professional scepticism which would undermine the audit process.

In reviewing the corporate governance shenanigans of the recent past, the role of an auditor and the assurance given by audit firms becomes an important focus point.

The central role of the external auditor aside; to express an opinion on whether an entity’s financial statements are free of material misstatements, other considerations, subjective as they may be, are indeed noteworthy.

The expectations gap, the discrepancy between what investors expect and what auditors do, is vital to the rotation quandary.

While audit firms attempt to close the gap by educating the public on their actual role, the boilerplate language and general reference to the risk of material misstatement whether due to fraud or error essentially limit the auditor’s culpability.

In addition to their current opinion declaration many investment practitioners are of the view that auditors should identify their clients’ key risks as well as highlight areas that could possibly have questionable estimates made by management additionally made available in the annual audit reports accompanying financial statements as they are in security offerings information memoranda.

At first glance, the intention of mandating auditor rotation seems noble.

It would enable an external their opinion to be scrutinised by the subsequent auditor.

This would bring in an additional buffer to the process and framework.