Are audits worth the paper they’re written on?

A few weeks ago, I wrote an article about an on-going crisis in business that is being caused by the Big Four accountancy firms. Recent failures of auditors in the UK have left investors like myself with an increasingly strong feeling that the reports we receive are of no real value in determining how a company is truly performing.

An increasing number of auditors also seem to be shirking their responsibility, hiding behind regulators and \’commercial practice\’ to avoid any appearance of producing useless reports or of being held to account because of it. As a private investor who has watched numerous listed companies hit enormous financial landmines after having accounts signed off by the Big Four, I believe that this lack of transparency and accountability is seriously damaging to economy, consumers and investors.

Why poor-quality audits are destroying the markets

It might sound alarmist to some, but as an investor, I rely on board reports and audited accounts to gain an understanding of how a business is operating. If I come to the conclusion that those documents are unreliable, I might consider investments in public markets to be too risky. After all, if I can\’t gain a clear and accurate understanding of a company\’s cashflow and balance sheet, how am I supposed to determine a fair price for it\’s share?

If large quantities of investors take a similar outlook, markets might react in extreme ways – bond costs could rise (because investors would expect a larger premium), investors could avoid publicly listed shares (at least in large companies, because they won\’t trust published documents on their operations), and as a result of all this, tax revenues will be reduced (due to lower trading volumes in public markets).

Can anything be done about this?

To be of any public relevance, auditing surely has to be about delivering accurate, understandable information in a timely manner – not financially engineering \’representations\’ of a company\’s operations. Audited accounts need to reflect the realities of a company\’s financial well-being (or lack of this) to have any meaning at all.

From an accurate audit, I would expect to gain an answer to a range of questions, including, but not limited to;

  1. Has the company generated positive cashflow in the last 12 months?
  2. Has the company paid it\’s suppliers within 30 days (except a small volume of retained costs depending on the industry)?
  3. Has the company made a reasonable effort to meet its pension obligations?
  4. Are the company\’s dividend payments sustainable?
  5. Has the company got the financial and capital resources required to continue operations for a further 12 months?

Without an audit that represents this information, I feel the reputation of auditors will continue to decline and do damage to our economy. Auditors will claim that they add value to their clients through providing a service that is a legal requirement, but to me, this seems like a total cop-out. Surely, a more thorough and credible approach would provide a meaningful answer to the questions above, and go a long way towards reversing the increasing disdain with which many investors currently hold the auditing profession.

 

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