Why Financial Audits as So Corrupt to be Useless

Executive Summary

• Financial auditing firms have been pretending that their signature means the company is not cheating on its accounting.
• Repeated control failures demonstrate this is false.

Introduction

The following is an essential quotation regarding the reality of financial audits.

External auditors look at a company’s financial statements and a small amount of underlying transactions in order to issue a report that the financial statements are properly presented. (It’s really a check of math and application of accounting rules.) The financial statement audits aren’t designed to detect fraud, and so they almost never do.

External auditors look at a company’s financial statements and a small amount of underlying transactions in order to issue a report that the financial statements are properly presented. (It’s really a check of math and application of accounting rules.) The financial statement audits aren’t designed to detect fraud, and so they almost never do.

In theory, the work of internal audit should help give greater confidence in the accuracy of the financial statements. In reality, you have question how likely it is that problems identified by internal audit will be corrected if upper management is against the corrections. (Why would they be against corrections? They might negatively impact the planned financial statements.

If you read Extraordinary Circumstances: The Journey of a Corporate Whistleblower, you get a feel for the unenviable position internal auditors are in. The author, Cynthia Cooper, was the head of internal audit at WorldCom. She and her team uncovered some irregularities in the company’s numbers, and the minute they tried to look into them further, upper level executives told her to stop, or else.

Yet I have to ask: If the auditing is so much better post-Sarbanes-Oxley, why has financial statement fraud NOT decreased? Why aren’t audits doing more to protect shareholders? It’s clear that audits are no more effective than they were pre-Sarbanes-Oxley. – Sequence Inc

The Negative Impact of Highlighting Accounting Flaws

Seventeen years late, auditors find themselves punished for following that law—not by the authorities, but by the market, according to a study of 13 years’ worth of data from 358 US audit firms. On average, auditors saw a 2.2% drop in their client growth for each flaw they highlighted, while their revenue grew 8% less than competitors who didn’t flag those flaws, according to the paper by University of Arkansas academics Elizabeth Cowle and Stephen Rowe. Seventeen years late, auditors find themselves punished for following that law—not by the authorities, but by the market, according to a study of 13 years’ worth of data from 358 US audit firms. On average, auditors saw a 2.2% drop in their client growth for each flaw they highlighted, while their revenue grew 8% less than competitors who didn’t flag those flaws, according to the paper by University of Arkansas academics Elizabeth Cowle and Stephen Rowe. As such, auditors are incentivized not to declare clients’ internal weaknesses, since businesses “appear to avoid association with auditors that have a history of being critical of their other clients,” the authors write. Almost half the companies analyzed were part of the “Big 4” accounting giants (KPMG, Ernst & Young, Deloitte and PricewaterhouseCoopers, or PwC). – Quartz

The Uselessness of Auditing Boards

The Big Four accounting firms bungled 31% of the most recent US audits analyzed by their quasi-governmental watchdog, the Public Company Accounting Oversight Board (PCAOB). Yet despite the abysmal findings, the oversight board—which the US government empowers to police the audit firms—has rarely taken action against them. The Big Four accounting firms bungled 31% of the most recent US audits analyzed by their quasi-governmental watchdog, the Public Company Accounting Oversight Board (PCAOB). Yet despite the abysmal findings, the oversight board—which the US government empowers to police the audit firms—has rarely taken action against them. Since it began its work, PCAOB has issued just $6.5 million in fines on the Big Four, according to POGO. That’s far short of the maximum total penalties the oversight board could have demanded the firms pay—some $1.6 billion, POGO calculates. While the Big Four failed to properly audit their clients in 31.1% of cases examined by the PCAOB since 2009, the PCAOB has only disciplined them in 6.6% of those cases, including in actions also taken by the Securities and Exchange Commission (SEC), according to POGO data. (The SEC oversees the PCAOB and sometimes takes on high-profile cases involving auditors.) John Coffee, director of the Center on Corporate Governance at Columbia Law School, told POGO that the fines levied against the Big Four were “trivial.”

“We have a watchdog who is not watching,” he said. “We have a watchdog who looks increasingly like a lapdog.”

Of the four firms, only Deloitte provided a comment to POGO on its investigation, saying it was “proud of the high quality audits” it performs, and that it was making “large investments” to drive technological innovation and improve its employees’ skillsets. – Quarts

Conclusion

Audits are simply a way to obtain a rubber stamp from an entity with credibility. The executives of the audited company control the auditors. When there is a conflict, the auditors do not alert authorities, they exit the account, and leave the account to be transferred to a new auditor, which must then relearn the issues. The auditors have no fiduciary duty to any anyone but the executives that approve their invoices.

References

https://qz.com/1701404/walmart-allegedly-created-fictitious-chinese-jv-to-avoid-us-tax/

https://qz.com/1705744/big-four-accounting-firms-are-bungling-a-third-of-us-audits/

https://qz.com/1686648/accounting-firms-lose-work-when-they-hold-clients-accountable/

*http://www.sequenceinc.com/fraudfiles/2008/11/audits-are-near-worthless/