How auditors can close the great expectation gap

There is a false perception that the future of the audit industry hangs in the balance. Whenever there’s a corporate failure of any kind, a lot of questions are posed by government and the wider public: ‘Where were the auditors? What were they doing when this outcome was under their very eyes?’ I believe there is more accountability that must be applied across the audit ecosystem, than just focusing on the auditor.

Yes, there has been a raft of indiscretions over the past decade and, in some cases, flagrant criminal activity. The question should be whether, given the scope of the audit process, these could have been picked up? The public and investment community remain unclear as to where the role of the audit ends, and the ‘investment story’ of the business’ management begins.

This expectation gap has undoubtedly tarnished the audit profession - an industry critical to South Africa’s investment reputation. My question is, in these corporate failures where were the rest of the management team, who in general are highly qualified and experienced professionals, and how could all the governance of these large, well-established businesses have been placed with a single person? The audit firm is only the third layer of defence: following the board of directors and audit committee, which includes internal auditors. In some cases the audit committees were well respected and highly regarded – but it was still insufficient to identify the deceit and manipulation of information.

Auditors spend a limited amount of time, normally once a year. Furthermore, they perform work within a scope set out by the auditing standards and apply a ‘materiality’ threshold to calculate sample sizes and assess errors, all of this of course based on the perceived risk associated with the audit client.

Even though anything auditors fail to pick up would in fact either be as a result of actions performed by management or a failure of controls put in place by management, the negative reputational impact is more severs for auditors than for the responsible management. The public has come to focus its entire disapproval on the auditor, without analysing what drives the numbers and what the role of the auditor is. This is arguably because the appointment of an auditor is a mandatory requirement and consequently it is an easy target.

The public and investment community expects so much more from the annual audit than it is able to deliver in its current format. Put another way, the expectation gap is the difference between what the profession thinks an audit is—and does—and what everyone else thinks. And those gaps differ for every player—management, the audit committee, regulators, the investment community. There are a number of people on boards of directors and audit committees who don’t have a clear understanding of the role of an auditor. Audit committees today are not entirely made up of qualified chartered accountants with audit experience. They consist of a variety of people of different backgrounds, skills and expertise—all of which you of course want and need on an audit committee.

One problem concerns the communication vehicle we have – the auditor’s report. I would suggest that the expectation gap comes down to people not reading the audit report which is actually quite clear about what auditors do and don’t do. Its weakness is that it’s generic, the same every time and not really looked at. The general perception is that the audit is some kind of general insurance policy against a corporate failure and the want is for auditors to audit a range of management issues like KPI’s not currently covered.

begs the question of whether auditors remain relevant to certain stakeholders if they cannot – in a financially viable format - provide that kind of guarantee. Investors are looking for information beyond the audited financial statements and entertain the idea that there’s been some auditor oversight in compiling this information. So, when there’s a corporate failure it leads to a real public concern about the role of auditors who were thought to be involved in all the reporting.

Much of management’s story uses numbers that are audited, but whose ‘story’ goes well beyond the audited numbers, and with which auditors are not involved to a great extent.

Is the audit going far enough? Is it covering enough of the information? Yes, auditors could do more, but there are two barriers. One is cost and the second is that the standards aren’t there to really go beyond the safe harbour auditors have within existing standards. Every time a business asks the auditor to do something, the auditor would expect to be remunerated for that. Already in the UK auditors are using an expanded report, and this has still not necessarily closed the expectation gap.

Therefore, auditors need to extend the usefulness of an audit. Technology could narrow the expectation gap in time. With technology, an audit may be able to look at 100% of transactions to search for anomalies. That’s a huge difference that would probably close at least some of the expectation gap but more is needed to align all parties and restore the confidence not only in the auditing profession but in corporate South Africa and our investment reputation.

14/06/2022