External auditors – “arrogant beyond their competence”

Anyone who has paid close attention to my writing and ranting over the years may have gleaned that I have great respect for good internal auditors, none whatsoever for the poor ones, and a mixture of concern, irritation and anger over the conduct of the external audit profession.

External auditors, particularly the Big Four, are addicted to a seriously flawed business model that serves their clients, the shareholders, and wider society desperately poorly, but happens to enrich the partners. This blog post explains the root of my disenchantment, the time I spent as a trainee accountant with a firm that was then one of the Big Eight, now Big Four after various mergers and the collapse in disgrace of Arthur Andersen.

This all happened in the 1980s and there’s little chance of being sued but I will just list what I witnessed, without naming names. Sadly the problems are not historical. If anything they are worse now. I regularly came into contact with the external auditors later in my career. I remained unimpressed. Norman Marks, who was chief audit executive at major global corporations for more than 20 years summed up the problem pithily in 2010 (see comment 3 in the linked article). Marks’ verdict exactly matches my own experience.

“Management is often able to hide fraudulent transactions or estimates from the auditors. This is an inherent risk. The staff who actually talk to the accountants and others involved in day-to-day activities are junior and inexperienced. The partners and managers are, in general, not as proficient as they believe they are. Most internal auditors would join me in assessing the external audit partners and senior managers as arrogant beyond their competence.”

Here is my list of external audit misconduct, all of which I witnessed at first hand.

* Auditors approved an inadequate set of accounts that had been drawn up for a client by a different department of the same firm. Then, when the client announced it was going to launch on the Stock Exchange, senior people frantically tried to cover the tracks before the independent accountants got their hands on the books. There was also one manager equally frantically trying to preserve the paper trail so he wouldn’t take the career-ending rap for the whole thing.

* A partner ordered a team to stay on a client’s site for a few days longer than necessary when there was no work to do, so the firm could keep charging the client. A side benefit was that the audit team could keep claiming lucrative expenses, to be charged to the client – obviously.

* Auditors ignored a company buying back its own shares rather than checking to see whether it had done so legally. When I queried the legality the response was “It could be illegal? Really? Don’t worry. Just approve it.”

* An audit manager allowed a client to record the purchases of some vehicles from the manufacturer in the following year. But they’d been delivered, and sold on at the very end of the previous year. The sales were recorded on the last day of the year. That meant the revenue looked like pure profit. “They can’t do that” I said. “Don’t worry” I was told. “Just approve it.”

* An audit manager took an audit team out on a Friday jolly to do a wages spot check at a client, conveniently located close to a decent pub that did very good meals. The team was staffed of people at a loose end in the office and who wanted a lengthy pub lunch at the client’s expense. The client went bust a few months later, with everyone losing their jobs.

* I was told by an audit team leader that he hadn’t had to touch his salary for months because he was raking in so much on expenses.

* A partner called in the audit team to tell us that the agreed audit fee with the client had been frozen at the previous year’s level, so it was a cut in real terms. We’d therefore have to do less work than last year if we were to make a profit. We would report that internal control had improved, so we could justify doing less checking. The audit team leader chipped in, “but we already know internal control has got worse, so we should be doing more work”. The partner replied, “you don’t understand – you MUST report that internal control has improved”.

* On my very first day on a client site after completing the graduate induction course I was told to check out the client’s internal control system. I was handed a large sheet with a complex flowchart of organisational responsibilities. “Go to the accounts department and find someone who will look at it. Ask them if anything has changed since last year.” I was incredulous but I did what I was told. I found someone who was willing to talk to me. I asked if anything had changed. He looked at me as if I was an idiot, glanced at the chart and said “Naw, nothing has changed.” I reported back. “Good” said the audit team leader. “Internal control is the same as last year.” This was for a multinational company, one of Scotland’s largest. I would not have had a clue if I was being lied to, which may well have been why I was sent.

The Post Office’s external auditors, Ernst & Young (up to the end of July 2018), are hardly the prime suspects in the Post Office’s Horizon IT scandal. However, the external auditors’ business model makes them far too dependent on client executives, and far too willing to miss or overlook obvious problems. This is an issue that governments do not seem willing to address.

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