Accountancy and Law Column; Failure of Auditing to Deliver Accountability


Prem Sikka

Professor of Accounting

University of Essex

(Published in The Herald, 4 August 2003)


 After the Enron and WorlCom Scandals, the US secured a criminal conviction of Arthur Andersen. This was followed by the Sarbanes-Oxley Act, independent regulation of auditors and forcing company executives to accept personal responsibility for the credibility of annual accounts. The Securities & Exchange Commission (SEC) forced hundreds of companies to revise their accounts and also prosecuted some company executives and their advisers.

 In typical fashion, British corporate interests stymied the debate by claiming that ‘it couldn’t happen here’ even though it has and will. Instead of reforming accountancy and auditing practices, the Department of Trade and Industry (DTI) stirred apathy by appointing artificial reviews of accountancy regulation to ensure that no change took place because the accountancy interests do not want any. This exercise in impression management follows the usual pattern of cover-up, silence and obfuscation. The 1990s collapse of the Bank of Credit and Commerce International (BCCI), Polly Peck, Levitt and Resort Hotels resulted in loss of jobs, homes, savings, bank deposits and savings, but none have been subjected to an independent investigation. Reports on Queens Moat Houses and Transtec are yet to be published. Ministers continue to resist calls for an independent investigation of the auditing industry. Accountancy firms continue to act as advisers to companies and their executives and then pretend to audit the very transactions that they helped to create.

 British businesses spend over one billion pounds a year on compulsory audits. Yet they deliver precious little, other than a fat fee for accountancy firms. Contemporary company audits are a creature of the late nineteenth and early twentieth centuries. At that time large scale multinational companies were virtually unknown. Electronic money transfers did not exist. Complex financial products, such as derivatives, options and various hedges had not been developed. Ex-post audits were conducted to assure the public that auditors had verified the existence of assets and liabilities. Today’s environment is far removed from that. Yet no questions have been raised about the ability of conventional audits to deliver anything.

 The closure of the fraud-ridden BCCI showed that multinational banks are incapable of being audited even by the world’s largest accountancy firms. In a world of instantaneous transfers of money, ex-post audits cannot verify much. Even if they can, much of the money has already flown and cannot be recovered to protect depositors and savers. Paradoxically, as companies have become large, global and complex, auditors have reduced the number of transactions that they examine. This helps to increase firm profitability, but is sold to the public as some kind of a scientific sample-based audit. Auditors effectively play Russian roulette with the lives of stakeholders.

 Rather than producing things, many companies now speculate on the stock and financial markets. They place clever bets to manage or transfer risks. Money itself has become a commodity. Values of many hedge funds, derivatives and options are dependent upon uncertain future events. The collapse of the Long Term Capital Management (LTCM) showed that even the economics Nobel Prize winners cannot anticipate the future events and calculate the value of these products. LTCM had to be bailed out by the Federal Reserve with $3.5 billion of taxpayer’s monies.  The same products also played a major part in the troubles at Enron, NatWest Markets, Sumitomo, Barings, Allied Irish Banks, and other cases. Company auditors are certainly no Nobel Prize winners. They cannot verify the value of financial markets and cannot outguess future market conditions to attest any numbers dreamt up by company directors. Yet audit reports remain silent about such difficulties and aren’t worth the paper they are written on.

 Conventional audits are costly and deliver little protection to stakeholders. A major debate about the limits and value of company audits is long overdue. They need to be replaced by new institutional structures that enable stakeholders to continuously monitor large businesses.