Who audits the auditors?

There is a well-known joke in accountancy circles: why did the auditor cross the road?


Because he looked in the file and that’s what they did last year.

It may be only a joke, but it conveys some of the cynicism which has come to surround the audit process. As questions are raised in political and business circles about the auditing of Ireland’s banks, there is a growing perception that sticking to a tried formula without really attempting to test the financial health of business seems to have become the norm.

The audit is supposed to provide extra protection for shareholders and stakeholders in a company. But the failure of the auditors of Ireland’s bank storing alarm bells over the past few years is shining a spotlight on the profession and the audit process.

In their own defence, auditors say there is a basic misunderstanding - an ‘expectation gap’ - about the role of the audit. Chartered Accounts Ireland (CAI), which represents auditors, said it was not the role of the audit to assess a company’s ethics or business strategy.

It said audit requirements were set by the International Financial Reporting Standards (IFRS), not by some local standards committee. It also said the role of the audit was being assessed globally in the wake of the financial crisis, and was part of a wider debate.

CAI may have a point, but auditors look set to feel the heat for some time to come. The body’s Chartered Accountants Regulatory Board (Carb) has appointed John Purcell, a former comptroller and auditor general, as special investigator. He will look into the role that certain CAI members may have played at the now-nationalised Anglo Irish Bank.

Purcell will also examine the performance of Ernst&Young as auditor to the bank in recent years. The same accountancy firm has been hired to investigate any former malpractice at Irish Nationwide, an appointment which has attracted some criticism.

Finance minister Brian Lenihan, has indicated that the wider banking inquiry will look at the part played by the auditors to Anglo Irish Bank and Irish Nationwide. It is also possible that legal action could be taken against auditors by shareholders or others.

There is no limit on the liability of auditors in Ireland, so this possibility is a serious concern - not just for the Irish accountancy offices, but for the international parent companies as well.

One audit source spoke of the venom levelled at the audit profession on RTE’s Frontline programme last week. ‘‘It is very hard to defend yourself against that sort of comment," he said.

However, it is not just members of the public who feel auditors have a case to answer. Senior and experienced accountants also feel that some extraordinary practices at banks went unnoticed.

‘‘Professionals would look at some of the things that have gone on in the last while and say ‘what the heck was going on with the auditors?’, a senior accountant said.

‘‘A class action would be a concern for them in the background, and they possibly feel a bit exposed. There would be a feeling that relationships between auditors and their clients are far too close. We’re in a reasonably small pool here."

There has long been concern that too much audit work in Ireland is divided among a small number of firms, with most of the big accounts going to the so-called ‘Big 4’ of Ernst & Young, Deloitte, KPMG and PricewaterhouseCoopers.

However, Aidan Lambe, director of technical policy of CAI, said there was no indication at this stage that auditors would face any financial liability.

‘‘Obviously auditors in this jurisdiction are operating in an environment of totally unlimited liability, and that is an issue which we continue to be concerned about," said Lambe. ‘‘They’re not only liable for losses which they may have been responsible for, but also losses of others.

‘‘Any time a professional signs off a public document, of course there is a certain amount of exposure to liability. While there are being questions asked, there is nothing specific to suggest that auditors haven’t performed in accordance with their legal and professional obligations."

Lambe said there was often a public misconception about the scope of an audit.

‘‘An audit opinion is based on whether the numbers give a true and fair view," he said. ‘‘It is not a comment on the business behaviour or ethical behaviour of company directors.

It is carried out with a specific purpose in mind. Maybe there is a misunderstanding that it does much more."

He said that debate was taking place internationally on the role of auditors.

‘‘The audit of financial institutions is not just being looked at here," he said. ‘‘It has been looked at most recently in Britain. The conclusion there seems to have been there is no systemic failure in the audit process, but they’re asking if the audit process is useful, and can it be made more useful in the future."

Eamonn Walsh, professor of accounting at University College Dublin, said it was wrong to jump to the conclusion that there were serious flaws in the audit process.

‘‘It is difficult from the outside to know, at the moment, whether the auditors actually missed something or alternatively were subjected to management which ran rings around them," Walsh said. ‘‘I don’t know the correct answer to that.

‘‘I think it is complete nonsense to say we need to invest lots more social resources in audit, unless evidence emerges from the Anglo Irish investigation which suggests there were serious deficiencies on the part of the auditors. But we don’t know that yet. If we’re looking for villains, auditors are probably a long way down the list."

Accountants are naturally slow to criticise fellow practitioners. Few wanted to blame others in the past, but there is a growing acceptance that things will have to change in future.

Peter Carroll, managing partner of accountancy firm BDO, said there was a fear that a lack of balance could enter the debate, focusing too much on the role of one group.

However, he said that the Financial Regulator, bank management, the investor relations community and auditors had all played a role in what happened at Ireland’s banks.

He said changes were needed.

‘‘There’s a huge responsibility to carrying out the audit of a bank, and it’s only become more onerous, given the level of complexity of transactions," Carroll said. ‘‘Auditors being left just to interface with an audit committee or management isn’t enough, given the importance of financial institutions within the economy.

‘‘There is a real challenge if you’re an audit engagement partner and you’re going to an audit committee which comprises non-executive directors, who in certain institutions may be long, long standing. They’re there to challenge management, but they may be former management.

‘‘Being able to go to regulator management and have a very broad strategic discussion about the risks that institutions might have can only be helpful. I would ask that everybody at the table chip in, in terms of openness to change."

The Irish Auditing and Accounting Supervisory Authority oversees the profession, and it is watching closely how CAI and other agencies deal with the fallout from Anglo Irish Bank and the banking crisis. It is seeking the implementation of EU recommendations which would lead to a more direct role in monitoring the work of auditors of listed companies.

The anger surrounding the failures at Anglo and other banks is unlikely to cool in coming months.

The European Commission has just announced that it is to publish a green paper on the role of auditors that will investigate the concentration of business in the audit market among a small number of firms, and the implications of that for financial stability.

This usually low-key profession can expect to be in the spotlight for some time.