A ‘bloody’ path to better audits

OPTIMISTICALLY CAUTIOUS
By ERROL OH

COMBINE the idiom “heads will roll” with the phrase “blood in the streets”, and you'll get the gory yet powerful notion of “heads rolling in the streets”.

Audit Oversight Board (AOB) executive chairman Nik Hasyudeen Yusoffused this twice in a media briefing on the board's Annual Report 2011,which was released on Wednesday.

He was referring to the general feeling that there ought to be hefty penalties whenever auditors are found guilty of sub-standard work, particularly when this relates to the financial statements of listed companies.

Indeed, we tend to develop this bloodlust each time a listed company reports financial irregularities. Inevitably, the focus of the flurry of questions will swivel to the company's auditors. If the auditors were doing a good job, how could there be fraud and mismanagement? Where's the warning from the auditors?

And if it were the auditors that had raised the alarm by qualifying the audit opinion on the company's accounts, there would still be room for criticism. How come the auditors didn't detect the hanky-panky earlier on? Sure, they have qualified the latest financial statements, but what about those for the previous years?

In other words, auditors are in the line of fire when listed companies are found to have cooked their books. And by extension, so is the AOB.

Like it or not, the business of auditing companies is measured by failure rather than by success.

Nik Hasyudeen conceded: “Unfortunately for auditors, they are just like pilots. They have to take the planes to the skies and land safely every time. And our job is just like that of the Department of Civil Aviation to make sure that all the planes take off and land safely. People will only remember us when there's a plane crash. But they forget about all the hard work that has been done to create a safe environment for flights.”

Unlike in aviation mishaps, people don't die when a company has financial irregularities. But people can lose their investments in the securities of the company. Creditors may not be able to collect what the company owes them, and employees may end up jobless.

As such, it's not at all unreasonable for stakeholders to expect the AOB to begin imposing sanctions on errant auditors.

The board has already flexed its regulatory muscles when registering auditors, allowing several auditors to be registered for only six months instead of the standard 12 months, issuing warning letters, and attaching additional registration conditions.

In addition, inspection of audit firms is a big part of what the AOB does, and it has asked the firms to come up with remediation plans to address deficiencies uncovered during the inspections. Nik Hasyudeen said the follow-up to these plans was the main thrust of the board's work.

Another threat that the AOB brandishes is the possibility of it publishing inspection reports if the firms fail to take the relevant remedial measures.

Yet, there's nothing like a sanction to show that the board means business. Among the sanctions that the AOB can impose are fines and the removal of an audit licence and/or registration.

Nik Hasyudeen assured that the board would not hesitate to use sanctions when necessary. He explained that it had yet to do so in its brief history the AOB began operations in April 2010 because it could not act retroactively. That is, if an offence occurred before the statutory provisions that support the establishment and operations of the AOB came into force, the board can't penalise the auditors.

But presumably, in the two years after the AOB had been set up, there have been breaches that may lead to sanctions. Nik Hasyudeen refused to confirm this. He would only say that any sanction by the board would have to come at the end of a due process and such a sanction would be made public.

Let's hope this happens soon, because we can tell from findings of the AOB's inspections so far that the audit firms, including the six largest in the country, are far from flawless when it comes to ensuring audit quality.

The AOB or anybody else, for that matter cannot guarantee that every company audit will be perfectly conducted. However, the board can provide some comfort that when the auditors are not up to mark, heads will in fact roll, figuratively speaking, of course.

Executive editor Errol Oh believes in the deterrent power of sanctions, especially among auditors, who rely heavily on their reputation. However, no matter how many heads roll, there will always be black sheep.