Why Society Believes That Audit Failure Has a Cure

PART 2 of A Letter to My Profession V: THERE IS NO CURE FOR AUDIT FAILURE

Audit failure is an inconvenient conversation but which we cannot avoid.? As a learning society, we need to be confident to confront its realities. Scapegoating of auditors only gives a temporary absolution that is soon shattered by shrill wrangles over another corporate collapse in which audit failure is, again, a suspect.? With that bias we ignore the larger fundamental reasons why audit fails and make policies and rules that only touch on superficial factors.?

Audits have been failing for as long as we have done them.? Yet, society is conditioned to believe and hope that audit failure has a cure.? This forlorn hope for audit failure cure is engendered by the appeasing response of auditors and regulators when something goes wrong: we shall make sure it does not happen again, we shall do something to “prevent” a repeat.? That response is effectively a promise that canalizes into the prospect of assured curing of audit failure. ?Unfortunately, that stale response has elevated to an institutional overcommitment and has created false expectations, leading to a broader audit expectation gap.? The overcommitment is supported by rules and regulations that promise to fix what is wrong with auditing and prevent future audit failures.? For example, when the British Government launched “audit regime overhaul to help restore trust in big business” the stated objective is that “the reforms to improve the audit regime and corporate transparency will help “prevent” sudden large-scale collapses like Carillion and BHS, which hurt countless small businesses and led to job losses.”? Notice the word “prevent” and the nonexistent hope that it communicates.? And it alludes to job security; given that job and/or job security is the “grand cultural purpose of life” (Jacobs, 2004)[1] in Western societies, a promise woven into it would only resonate and instill in the psyche of society. The grand cultural purpose of life in a society has always been viewed as a righteous justification for doing anything, according to Jacobs; so, steeping new rules in job security makes the message more acceptable, irrespective of whether it is the best option for society.? Unfortunately, abstract rules and regulations are not aware of what is wrong with audit and so cannot in/by themselves do anything about it just by being rules in the book of law.? But like a desperate sick and hungry person, society, in the din of the angst of the markets, is vulnerable to hunger bias and would uncritically be acceptive to the empty promise that audit failure has a cure and become unwittingly tolerant of overbroad rules.

Sometimes stakeholders in the market are ignorant of the relative orbits in gatekeeping in the financial reporting value chain. They wrongly believe that the auditor is the absolute gatekeeper, an untenable position for the auditor in our contemporary audit/gatekeeping geography. From this absolutist perspective the public believes that the auditor has an overarching role in governance, operations, and financial reporting gatekeeping. So, when things go wrong in operations and corporate governance they blame the auditor, with implicit bias.

Constituencies inspiring the sentiment of overbroad auditor responsibilities also include the accounting clerisy whose authoritative writings contain presumptive statements that impress on the market incorrect beliefs about auditor’s duties.? For example, auditing standards recognize the distinct responsibilities of auditors and management thus: “the auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud … Management is responsible for adopting sound accounting policies and for establishing and maintaining internal control that will, among other things, initiate, record, process, and report transactions (as well as events and conditions) consistent with management's assertions embodied in the financial statements. The financial statements are management's responsibility … The entity's transactions and the related assets, liabilities, and equity are within the direct knowledge and control of management.”[2] ?But a number of accounting and auditing literature dealing with the duties of auditors have misconceptions that I believe are, perhaps, dictional errors, or they are pacifying tones evoked by the din of audit failures and consequent rules that frame the duties of an auditor broadly.? ??An example of what might be a dictional error, in my opinion, is seen in the intellectually brilliant/stimulating work of Shaub and Braun (2014),[3] ?in a contributory article to a book on accounting for the public interest, where they stated that “the auditor’s duty is not just to detect material misstatement, but to be part of the process that helps prevent it by ensuring that audit clients have adequate internal controls and by reporting significant deficiencies to the company’s board.”? We see sentiments like this all over accounting and auditing literature. The phrase “prevent it by ensuring that audit clients have adequate internal controls” suggests duties that are clearly not in the traditional functions of an auditor and would make stakeholders tend to hold the auditor accountable for what was not his duty – the auditor cannot compel management to implement particular controls, for example. Such statements also disregard the structure of our audit culture in which auditing is largely historical and so has no chance to “prevent” in the sense used by the authors, namely, to “keep (something) from happening or arising.”? The frequent promise to prevent failure is representative of the sentiment of the profession. Audit firms may not have said it outrightly, but all of us communicate to the clients and the markets with gratuitous thematics that send the subliminal message that the audit function is an absolute gatekeeper and that our services would help prevent audit failure.? That putative role of absolute gatekeeper is taken seriously by the market and stakeholders who now insist that it should be instantiated as a cure for audit failure.

Paralyzed by egregious audit failures and beleaguered by the magisterial, sometimes gratuitous and intemperate, criticisms of regulators, judges, lawmakers, the media, the public and the markets, the profession remains passively acceptive of wrong notions of auditor responsibilities.? The result is that the society’s belief in cure for audit failure is entrenched while the auditor is made the scapegoat for everything that is wrong with governance, operations and control in organizations, even for things that happen when he is not supposed to be at the gate.? The truth is that the auditor is only a relative gatekeeper, only concerned with filtering information in the stewardship report of the agents (Board and management) to ensure that the information that gets to the principal is true and fair.? Beyond that, the auditor is not a gatekeeper filtering operational policies, processes, procedures and flow of goods and services in and out of the organization. It is in these orbits of gatekeeping that most of the furtive inefficiencies, errors and irregularities that cause business failure happen,?and are sometimes actively hidden from the auditor who is not present.?

The auditor’s relationship with executive functions in organizations is only as a bystander – there is nothing in the current structure of our audit culture and traditions that assigns executive function to the remit of audit; without such executive roles the auditor does not have structural authority to prevent errors and irregularities from happening.? The significance of the regulatory notion that “the entity's transactions … are within the direct knowledge and control of management” (PCAOB)[4] seem unremarked in our audit society.? The significance of this regulatory provision is that the auditor should not be held accountable for failure of transactions, policies, processes, and procedures that are within the inalienable direct control of management. ?For example, it is the duty of management to ensure that “controls are working,” while the duty of the auditor is to ensure that “controls worked in the period under review” to increase the chance that errors have been highlighted and eliminated in the agent’s stewardship reports going to the principal. ?The execution of management’s duty is designed and expected to be synchronous, and continuous, with transactions; the auditor’s duty is traditionally historical with specific periodicity.? Any executive managerial duty assigned to the auditor would require synchronous presence to perform.? That is not consistent with our audit traditions – the auditor, whether internal or external, is never a synchronous resident gatekeeper functionally.? That the auditor is an absolute gatekeeper in governance is a long-held incorrect belief that needs to be changed in the audit failure conversation.

The salient resonance of the promise by auditors, accounting clerisy and government rule-making agencies to prevent audit failure affirms the society’s incorrect belief that audit failure has a cure; it entrenches that false belief in the doxastic state of the market.? As an overhyped overcommitment, it is easy to believe.? Psychologist and Nobel Laurette Daniel Kahneman (2011)[5] explains why it is easy to be taken by such promises:

“a reliable way to make people believe in falsehoods is frequent repetition, because familiarity is not easily distinguished from truth.”

Accurate belief about auditor’s responsibilities and audit failures, informed by reason, will help adjust the public expectation of audit and reduce the tendency to convict the innocent [auditor] just for being a bystander when organizations fail.

To be sure, the audit franchise could be renegotiated with society to expand audit responsibilities without setting unattainable audit goals with overbroad rules.? It can be done on more convenient terms and there are many options to do so.? Nevertheless, there will always be audit failures – the profession must find a good way to communicate that to society.

The accounting/auditing profession should not be promoting the notion that audit failure can be prevented.? The demerit of that promise is that it is misleading the public to the belief that audit failure has a cure while breaching the very essence of accounting/audit which is to “… to locate, pursue, determine, assure and preserve truth and fairness …,” (Ekeigwe, 2023).[6]? According to Baroness Onora O'Neill, CBE, (2009),[7]? “a good auditor is one who secures or increases trust, and we want, or in many circumstances require, audit because we want and need trust … Forms of audit that encourage trust in the untrustworthy are, it seems to me, uncontroversially, not worth having.”? The promise of a cure for audit failure is untrustworthy; the profession should, therefore, stop suggesting it to the market.

In the next section I will be thinking upon the causes of audit failure and what can be done to improve audit and reduce failure to the strictly residual.

REFERENCES:

[1] Jacobs, J. (2004). Dark age ahead. Toronto, ON: Random House Canada.

[2] AS 1001: Responsibilities and Functions of the Independent Auditor | PCAOB (pcaobus.org), https://pcaobus.org/oversight/standards/auditing-standards/details/AS1001.

[3] Shaub, Michael & Braun, Robert. (2014). Call of Duty: A Framework for Auditors’ Ethical Decisions.? In Mintz, Steven. Ed. (2014). Accounting for the Public Interest: Perspectives on Accountability, Professionalism and Role in Society. 10.1007/978-94-007-7082-9. Pp. 3-25.

[4] AS 1001: Responsibilities and Functions of the Independent Auditor | PCAOB (pcaobus.org), https://pcaobus.org/oversight/standards/auditing-standards/details/AS1001.

[5] Kahneman, D. (2013). Thinking, fast and slow. New York, NY: Farrar, Straus and Giroux.

[6] Ekeigwe, C. (2023). Why and How Auditors Must Change: Shifting the Doxastic State of the Profession. Presentation to the ISACA Ottawa Valley Chapter, Canada, June 23, 2023.

[7] Onora O'Neill, CBE, O. (2009). Trust, Trustworthiness and Audit. Retrieved April 25, 2021, from https://www.gresham.ac.uk/lecture/transcript/print/what-makes-a-good-auditor-trust-trustworthiness-and-audit/

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