KPMG

Article by David Watt and Shahn Bharwani (2011)
Over the last 50 years, we have witnessed fundamental changes to the role of the auditor. Influenced by critical events (e.g. court decisions, corporate failures, economic melt-downs), audit responsibility has evolved from straight-forward error and fraud detection to the provision of more value-added services for clients and regulators; services that include, among others, reporting on internal control deficiencies, identifying business risks and even providing guidance on these risks1. As a result, auditors are now not only expected to be fluent in accounting and reporting standards and requirements, but also in a variety topics ranging from the technological to the legal aspects of business and finance. And, while demand for oversight is nothing new, the pressure on the audit function is increasing, largely as a result of what many regulators, politicians and investors perceive as recent, audit-related corporate failures.
So, what next for the audit profession?
The risks of over regulation
History shows that regulation drives evolution when it comes to the role of the auditor. Although corporate failures like Enron and WorldCom have been few and far between (and in reality resulted more from significant underlying issues – i.e. fraud and collusion – than from their auditors’ perceived malpractice) they have nonetheless been viewed as some of the most pervasive and expensive failures of the century. The knock-on effect has been extensive reform in audit oversight.
What began with the introduction of the Sarbanes Oxley Act ("SOX") and the creation of the Public Company Accounting Oversight Board ("PCAOB") in 2002 has consistently evolved through to present day. Unfortunately, it looks as though these initiatives have done very little to prevent the subsequent failures that have occurred throughout the most recent economic crisis.
Therefore, governments and regulators are once again focusing their attention on this profession and are more closely examining the systemic risk associated with the role of the auditor.
Interestingly, however, one unintended consequence of this renewed scrutiny seems to be increased competition and retaliation between global financial centres. Newly created standards of excellence for regulatory frameworks, which have been designed to manage audit risk and prevent future audit-related failures, will, in practice, restrict auditors from providing audit services to clients that are registered and listed in foreign jurisdictions. Under the "third-country auditor" reforms being put forward by the US, EU and Japanese regulators, any foreign audit firm, or auditor wishing to perform an audit function for regulated entities, will be required to register with and adhere to all regulatory reforms and practices in each respective jurisdiction – a different set of rules for each country. International response to the proposal of these reforms has been far from ideal as it has, unhelpfully, perpetuated further retaliation by other regulators (e.g. "If you won’t let my auditors audit in your country, I won’t let your auditors audit in mine.")
Another risk posed by over-regulation is as a consequence of the unremitting demand for ever more information at greater speed. Financial and corporate transactions have become more voluminous and more complex and the level of detail mandated by filing requirements has also increased. Auditors, therefore, have less time to understand, evaluate and, ultimately, audit the financial information. As a result, audit quality may be affected and this may, in turn, contribute to future corporate failures.
While it may be tempting to make the auditor a scapegoat for the recent financial markets crisis, all parties involved (regulators, governments, corporations) share in the responsibility for these events. All parties are also, therefore, responsible for developing the solutions needed to prevent a similar crisis from happening in the future. If regulation is undertaken for its own sake, we may see knee-jerk reinforcement of outdated elements without the necessary reflection to ensure all regulation is fit for modern purpose. It is my hope that auditors and regulators will work together to find proportionate responses to address the short comings of current regulation, oversight measures and audit assurance.
No matter the shape of new regulations to come, both on local and global levels, and no matter the new demands audit firms face when critical events change the landscape, there is no doubt that the audit profession will continue to adapt, evolve and maintain its status as one of the most reliable and necessary players in the global marketplace.
Questions:
1- Discuss the recent changes in audit regulations since Enron and after the global financial crisis its implications how changes have challenged the audit profession (i.e. challenges, roles and responsibilities)?.
2- How are audit firms responding to the regulatory changes at both global and local levels?.
3- Compare the main reasons behind the failures of both Enron and Lehman Brothers reflecting on the role of auditor in:
a) Detecting fraud and errors.
b) Reporting on business going concern
4- How could Arthur Andersen and Ernst & Young have avoided or minimised the litigation risks relating to Enron and Lehman Brothers?