Auditing: should it be about rules, or people?

10 Dec 2020

Warren Kelly

Freelance writer

Are the public's expectations of auditors realistic and fair? A recent SAICA webcast called for a bigger focus on the integrity of business people themselves.

A recent webinar explored the current status quo around the public’s expectations of auditors and whether those standards are realistic and fair. In preventing fraud, the panellists highlighted the need to give more weight to the ‘who’ rather than the ‘what’ in the process.
 
Titled How things have changed, the webinar was hosted by Investec and the South African Institute of Chartered Accountants (SAICA) as part of its CA of the Future series.
 
The call to focus on the integrity of those involved in any business dealing was made in recognition of how difficult it has become for auditors to pick up fraud in today’s convoluted, rules-based accounting framework. Indeed, the instances where a set of audited financial statements is dangerously detached from the reality of the business in question, are rising.
 
When shareholder value is destroyed as a result of gross accounting misrepresentations, should the auditors be held solely responsible for not denuding the fraud earlier? And, more importantly, does the notable rise in corporate South Africa accounting skulduggery point to a bigger, systemic problem with how business, and the auditing thereof, is being conducted?   

Assurances – reasonable doesn’t mean absolute

Every set of audited financial statements comes with a ‘reasonable assurance’ stamp. Its definition is as follows:
 
Reasonable assurance is a high level of assurance regarding material misstatements, but not an absolute one. Reasonable assurance includes the understanding that there is a remote likelihood that material misstatements will not be prevented or detected on a timely basis.
 
It could be argued that, in recent times, all financial statement stakeholders have taken ‘reasonable’ to mean ‘absolute’. This was largely the consensus during the webinar.
 
While there was some disagreement between the panellists about whether the public needed education around the role and responsibilities of an auditor, and whether they would accept such instruction, there was a broad acceptance that auditors today face a number of significant challenges that need to be addressed.

State of the auditing profession

What follows are the summarised thoughts of each panellist during the webinar, putting into context the bigger dilemmas faced by auditors and their clients in the pursuit of producing financial statements that truly reflect the financial position of the business in question.   
 
Nonkululeko Gobodo, CEO at Nkululeko Leadership Consulting, lamented the proliferating and overly technical accounting statements that are absorbing precious businesses resources. The technicality has seen her lose faith in what she sees on an income statement or balance sheet, preferring to look at cash flow metrics instead.
 
When asked about the culpability of auditors when fraud arises, she stressed that the executives of the business needed to take greater responsibility.
 
Stephen Koseff, former CEO of Investec Group, talked trusting your gut instinct when dealing with shifty characters about how the ‘who’ used to be more important than the ‘what’ when doing business. He said that ‘principles are better than rules’ and that we should value ‘substance over form’, reiterating that there will always be people smart enough to circumvent the rules.
 
He underscored that open cultures, for both auditor and corporate alike, are paramount in detecting and rooting out nefarious behaviour.
 
Nkateko Mathebula, Founder of Kaytee Professional Services, had sympathy for the technicality of today’s accounting standards, noting the changing paradigm of what it means to be a successful business as the catalyst. But she echoed the sentiments that fraud can take time to uncover.
 
She also drew attention to the lack of purposeful skills transfer to black female CA(SA)s in particular. In the same vein, she stressed the need to be transparent with any aspiring auditor about the role and responsibility of their profession.  
 
Divyesh Joshi, General Manager of Finance at MTN South Africa, was firm that the changes in accounting standards are in reaction to a rapidly changing business environment, citing the obsolescence of the discounted cash flow (DCF) model, long a favoured tool of CAs, when trying to value the high-flying tech unicorns (eg Tesla, Airbnb and Uber).
 
He agreed that uncovering mastermind fraud schemes is difficult, especially when so many young auditors have yet to acquire the business acumen necessary to spot concealed irregularities. But he also said that sometimes auditors miss obvious malfeasance, and they must account for those instances.  
 
READ MORE: Wirecard: Tarnished turtlenecks and lessons in fraud

What needs to change?

Winston Churchill once said that, “If you make 10,000 regulations, you destroy all respect for the law.”
 
What he’s really saying is that with too many rules, the perceived need to exercise human judgement – which is far more cognitively taxing than just overlaying a rule – is diminished.
 
Regulation, by its very nature, is reactionary. Something bad happens and we make a rule that prevents it from happening again. The problem is that there will always be people capable and determined enough to find a loophole through which they can defraud others.
 
The lesson? In the business world, including the auditing profession, an overreliance on regulation is making us more vulnerable to fraud, the damages of which are insidious and far reaching.
 
And at the end of the day, it’s the people involved who perpetrate fraud. So, instead of tirelessly crafting what will inevitably be porous defences, why not upweight the importance of the human element in trying to prevent or uncover fakery?

Tips for auditors and corporates

Based on the insights of the panellists during the webinar, here are a few ways in which that could be achieved:
 
For auditors:
  • Reopen debate around taking a principles- rather than rules-based approach to auditing.
  • Empower employees to ask hard questions when auditing and support them when needed.
  • Educate employees on the human behaviour that is most often associated with fraud.
  • Find substance, account for it and explain it.
 
For corporates:
  • Give more weight to principles and integrity when hiring top executives.
  • Design and implement management KPIs that are agnostic to creative accounting.
  • Work to create an open culture that rewards those who voice their concerns.
  • Empower people to use their judgement rather than relying solely on rules.
Imagining a world in which corporate fraud doesn’t exist is fanciful. But that doesn’t mean we should stop striving for it. To be sure, rules are necessary and those who work to craft them are doing difficult and valuable work.
 
However, human judgement is a powerful tool in detecting fraud and it must not be allowed to rest on the belief that rules alone are enough. 
  • Disclaimer

    Focus and its related content is for informational purposes only. The opinions featured on the site are not to be considered as the opinions of Investec and do not constitute financial or other advice. The information presented is subject to completion, revision, verification and amendment.

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