A think tank has pointed to deficiencies in how auditors assess firms’ finances and governance, leaving the door open to more Carillion-style business collapses. IPPR researchers warn that a large number of small-scale, silent Carillions are likely happening every year.
Auditors should act as the ‘trusted referees’ of corporate Britain, impartially flagging risky finances, communicating informatively about the state of a business to investors and society, but too often the opposite is the case, according to IPPR. Its report describes an ‘expectation gap’ between what audit does assess, and what it needs to assess to fulfil the expectations of the public and achieve a sound economy. IPPR argues for profound reform of the sector.
The report shows that the way audits are conducted is enabling ‘boom and bust’ cycles, where some businesses are able to present an overly optimistic version of their finances, despite weak financial foundations that eventually lead to business collapses or seriously weakened firms.
IPPR argues that by too often failing to help keep such financial mismanagement at bay, the audit sector is “failing society”. According to the report, audit practices can lead to excessive risk taking and bad investment decisions, all while enabling some bosses, intermediaries and shareholders to get pay-outs. And the costs of business collapse ultimately fall on workers, suppliers and pension holders, with costs for the economy in the billions.
The report argues that in addition to failure to detect fraud or misstatements, it should also be considered an ‘audit failure’ where rules are not technically violated, but it goes unreported that firms are using ‘aggressive accountancy practices’. The report also suggests auditors should also be trusted referees of firms’ governance, climate risks and use of personal data.
Carsten Jung, IPPR senior economist, said: “Auditors should be the gatekeepers helping keep financial mismanagement at bay, yet too often they are failing to do so and are failing society. To meet society’s expectations and needs, there needs to be profound audit sector reform. A well-functioning audit sector should be expected to flag problematic accounting practices and risky business activities before they turn into damaging debacles. However, the current legal set up does not require this from auditors.
“Restore public trust in audit firms is essential for them to become the trusted referees of corporate Britain. With this status gained, it could lead to a virtuous cycle in which trust fosters investment, business development and economic dividends.”
You can download the 30-page paper, The Truth Tellers: Why we need profound audit reform now by Carsten Jung and Shreya Nanda, at: http://www.ippr.org/research/publications/the-truth-tellers.
The UK Government is consulting on audit sector reform.
