Awolowo, Francis

Garrow, Nigel

Sheffield Hallam University Research Archive

Why Audit will Continue to Fail!AWOLOWO, Francis and GARROW, NigelAvailable from Sheffield Hallam University Research Archive (SHURA) at:http://shura.shu.ac.uk/30129/This document is the author deposited version.  You are advised to consult the publisher's version if you wish to cite from it.Published versionAWOLOWO, Francis and GARROW, Nigel (2022). Why Audit will Continue to Fail! Academia Letters, 5141: 5141. Copyright and re-use policySee http://shura.shu.ac.uk/information.htmlSheffield Hallam University Research Archivehttp://shura.shu.ac.ukACADEMIA LettersWhy Audit will Continue to Fail!Ifedapo Francis Awolowo, Sheffield Hallam UniversityNigel Garrow, Sheffield Hallam UniversityBackgroundThe Wirecard €1.9 billion missing cash and 3.2 billion debt scandals have ignited the conver-sation about audit complacency in the financial reporting process. Financial statement fraud,audit failures and the sudden collapse of companies without any warning signs have increasedin size and occurrence recently, and Wirecard is another example of this. While we were stillanguishing on the Wirecard scandals and the inability of their auditor to pick up this materialfraud, then came Lookers, the UK car dealership company, and the revelation of it overstatingits profitability by £25.5 million (Campbell, 2020).Financial statement fraud is not new. This list is unending when we talk about financialstatement fraud. Management has always deployed different techniques to portray a goodoutlook for their companies through manipulations of financial statements. This can be datedback to the Royal Mail Steam Packet Company scandal of 1931, to Equity Funding scandal1973, down to Polly Peck 1990. Enron happened in 2001, Madoff in 2008, Olympus 2011,Tesco 2014, Toshiba 2015, and Patisserie Valerie in 2018 (Awolowo, 2019).This kind of occurrence is a severe threat to the integrity of financial reporting and corpo-rate governance systems (Hogan, et al., 2008; Smith & Crumbley, 2009; Bhasin, 2013) andoften results in a loss of confidence in the financial reporting process by investors and otherstakeholders (Hogan, et al., 2008; Smith, 2015).The impact of financial statement fraud of any scale is enormous on the stakeholders,and related losses are in billions of dollars. The Association of Certified Fraud ExaminersAcademia Letters, April 2022Corresponding Author: Ifedapo Francis Awolowo, i.f.awolowo@shu.ac.ukCitation: Awolowo, I.F., Garrow, N. (2022). Why Audit will Continue to Fail!. Academia Letters, Article 5141.https://doi.org/10.20935/AL5141.1©2022 by the authors — Open Access — Distributed under CC BY 4.0report to the nation on occupational fraud and abuse (2020) estimated that the median loss tofinancial statement fraud is $954,000.The negative impact of financial statement fraud is not only threatening the going con-cern of the company but also impacting other stakeholders in various ways including, but notlimited to, loss of jobs and pensions, reduction in stock prices and shareholders’ values, andcorporate reputational damage (Colby, 2013). Furthermore, financial statement fraud was asignificant contributor to the global financial crisis of 2008 (Black, 2010). Financial statementfraud threatens both debt and capital markets’ efficiency, liquidity, and safety (Black, 2010).Fraudulent reporting will most likely increase in occurrence due to the global pandemiccaused by COVID19 as companies try to portray a good outlook and, in the process, may“sugarcoat” their annual report.Financial statement fraud is a form of “occupational fraud” (ACFE, 2016), which involvesthe “deliberate misrepresentation of the financial condition of an enterprise accomplishedthrough the intentional misstatement or omission of amounts or disclosures in the financialstatements to deceive financial statement users” (ACFE, 2018).The aftermath of the Enron accounting scandal saw the Chair of the Board and Presidentof the American Institute of Certified Public Accountants issued the following joint statement:“Our profession enjoys a sacred public trust and for more than one hundred years has servedthe public interest. Yet, in a short period, the stain from Enron’s collapse has eroded our mostimportant asset: Public Confidence” (Castellano & Melancon, 2002, p. 1).Sadly, for the past 500 years, accounting and auditing concepts have not changed (Sil-verstone, et al., 2012). In this age of information revolution, the accounting profession stillrelies on an audit technique that was utilised before the industrial period. The reliance on thisindustrial age audit technique has resulted in an unrelenting series of embarrassing financialstatement fraud and audit failures.Auditing Profession is in DenialThe auditing profession’s prevailing wisdom is a complete denial of the responsibility to detectfraud in the financial statement. This denial is evident in the International Standard on Au-diting (ISA) 240, which places the responsibility for preventing and detecting fraud solely onthose charged with the management and governance of entities. This denial makes one won-der what auditors’ role is in reducing information asymmetry, which is evident in an agencyrelationship between shareholders and the management (Awolowo, 2019).Nevertheless, this denial has not stopped financial statement fraud from occurring. Neitherhas it prevented the profession from being heavily criticised and questioned by stakeholdersAcademia Letters, April 2022Corresponding Author: Ifedapo Francis Awolowo, i.f.awolowo@shu.ac.ukCitation: Awolowo, I.F., Garrow, N. (2022). Why Audit will Continue to Fail!. Academia Letters, Article 5141.https://doi.org/10.20935/AL5141.2©2022 by the authors — Open Access — Distributed under CC BY 4.0after any revelation of fraudulent financial reporting. The first question the business commu-nity is always quick to ask after any fraudulent financial reporting announcement is who arethe auditors? (Awolowo, et al., 2018)Nowadays, the frequency at which corporate entities collapse because of financial state-ment fraud has raised a serious question on whether the current accounting system of reportingand financial controls is working (Smith & Crumbley, 2009; Garrow, et al., 2019). We wit-nessed Patisserie Valerie’s collapse into administration in early 2019 due to financial statementfraud (Uttley, 2019).Stephen Griggs, a senior managing partner at Deloitte UK, made the following remark inThe Times newspaper on the 2nd of April 2019: “For many years we have talked about therole that auditors play in providing trust and confidence in the capital market. Yet audit hasnot moved with the times. We need to do more to evolve it to meet the expectations of allstakeholders.”The amount of money the Big Four audit firms have paid in fines between mid-2017 andmid-2019 is enormous. If auditors do not have responsibility for detecting fraud in the finan-cial statement, how come they are always quick to be fined by regulators after any revelationof financial statement fraud. Table 1 below shows the fines paid by the Big four audit firms.Academia Letters, April 2022Corresponding Author: Ifedapo Francis Awolowo, i.f.awolowo@shu.ac.ukCitation: Awolowo, I.F., Garrow, N. (2022). Why Audit will Continue to Fail!. Academia Letters, Article 5141.https://doi.org/10.20935/AL5141.3©2022 by the authors — Open Access — Distributed under CC BY 4.0Table 1: Fines paid by BIG FOUR between late 2017 - 2019Another interesting dimension to this is that auditors are usually the first set of people tolose their job after any revelation of fraudulent reporting. Such was Tesco’s case which endedtheir 32 years audit relationship with PWC after the announcement of their accounting scandalin 2014 (Awolowo, et al., 2018). Lookers have equally announced that they are ending theiraudit relationship with Deloitte due to their accounting scandal.In Japan, Olympus changed its auditor from KPMG AZSA LLC to Ernst & Young ShinNihon LLC immediately after Michael Woodford exposed the most prominent corporate scan-dal in Japanese history in 2011 (Aubin & Uranaka, 2011). The same happened to Toshiba,who also changed their auditor from Ernst & Young ShinNihon to PWC Aarata after the com-pany was found overstating its profit by $1.3 billion in a fraud that spans over seven yearsAcademia Letters, April 2022Corresponding Author: Ifedapo Francis Awolowo, i.f.awolowo@shu.ac.ukCitation: Awolowo, I.F., Garrow, N. (2022). Why Audit will Continue to Fail!. Academia Letters, Article 5141.https://doi.org/10.20935/AL5141.4©2022 by the authors — Open Access — Distributed under CC BY 4.0(Inagaki, 2017). The issue then is, if auditors are not responsible for detecting fraud in thefinancial statement as they claimed, how is it that companies are usually quick to end theiraudit relationship after any revelation of fraudulent reporting?This suggests that the business community demands auditors and the accounting profes-sion to improve their fight against financial deception. However, this is somewhat difficultwith the current accounting system and reporting and procedural auditing culture. Hence, theneed for a system shift to forensic accounting.Forensic AccountingACFE defined forensic accounting asthe use of professional accounting skills in matters in-volving potential or actual civil or criminal litigation, including, but not limited to, GenerallyAcceptable Accounting Principle; the determination of lost profit, income, assets, or damages;evaluation of internal controls; fraud; and any other matter involving accounting expertise inthe legal system.Forensic Accounting can simply be put as the use of accounting for legal purposes (Hop-wood, et al., 2012). We defined forensic accounting in the context of financial statements asa high-level validation of financial information through an array of skills involving but notlimited to accounting, auditing, law, criminology, psychology, economics, computer sciencein actual civil or criminal investigation.Joshi (2006), emphasising the relevance of forensic accounting in fraud prevention anddetection, observed that “auditors should be a watchdog and not be the bloodhound.” Thisquote alone makes forensic accounting definition even simpler and helps differentiate a foren-sic accountant from other accountants and auditors. A forensic accountant is a bloodhound ofbookkeeping (Crumbley, 2009).These bloodhounds ‘sniff out’ fraud and criminal transactions in banks, corporate entitiesor from any other organisation’s financial records. They ‘hound’ for the conclusive evidence.External auditors are known to only find deliberate misstatements, but forensic accountantsdeliberately find out misstatements. External auditors look at the numbers, but forensic ac-countants look beyond the numbers (Joshi, 2006). These are some of the attributes that makeforensic accounting relevant in the fight against financial deception.ConclusionOur conclusion is that until present-day auditors are trained in forensic accounting skills,ethics, and principles and start acting like detectives, the way and manner in which fraudAcademia Letters, April 2022Corresponding Author: Ifedapo Francis Awolowo, i.f.awolowo@shu.ac.ukCitation: Awolowo, I.F., Garrow, N. (2022). Why Audit will Continue to Fail!. Academia Letters, Article 5141.https://doi.org/10.20935/AL5141.5©2022 by the authors — Open Access — Distributed under CC BY 4.0is hidden in complex financial transactions will continue to threaten the integrity of financialreporting corporate governance. For the auditing profession to avoid more casualties in termsof audit failures and the corresponding fines that come with it, now is the time to evolve au-dit and embrace forensic accounting and accept fraud detection responsibility in the financialstatement. Until this is done, audit will continue to fail and not too long from now, and itmight become irrelevant to the capital market if the recommendations of the Brydon reportare implemented.Academia Letters, April 2022Corresponding Author: Ifedapo Francis Awolowo, i.f.awolowo@shu.ac.ukCitation: Awolowo, I.F., Garrow, N. (2022). Why Audit will Continue to Fail!. Academia Letters, Article 5141.https://doi.org/10.20935/AL5141.6©2022 by the authors — Open Access — Distributed under CC BY 4.0ReferencesACFE, 2018. Report To The Nations On Occupational Fraud and Abuse, Austin: Associationof Certified Fraud Examiners.ACFE, A. o. C. F. E., 2016. Fraud Examiners Manual. International ed. Texas: ACFE.Aubin, D. & Uranaka, T., 2011. Analysis: Olympus scandal puts auditors under scrutiny.Reuters, 10 November.Awolowo, I. F., 2019. Financial Statement Fraud: The Need for a Paradigm Shift. Sheffield:Sheffield Hallam University.Awolowo, I. F., Garrow, N., Clark, M. & Chan, D., 2018. Accounting Scandals: BeyondCorporate Governance. Journal of Modern Accounting and Auditing, 14(8), pp. 399-407.Bhasin, M., 2013. An Emperical Investigation Of The Relevant Skills Of Forensic Accoun-tants: Experience Of A Developing Economy. European Journal of Accounting Auditingand Finance Research, 1(2), pp. 11-52.Black, W. K., 2010. Epidemics of Control Fraud lead to Recurrent, Intensifying Bubbles andCrises. Working Paper, University of Missouri-Kansas City.Campbell, P., 2020. Lookers reveals £46m loss after fraud investigation. [Online] Availableat: https://www.ft.com/content/3e860970-215b-45e7-a9d9-bc3dd1decdc6 [Accessed 30January 2021].Castellano, J. G. & Melancon, B. C., 2002. AICPA Statement on New Auditor Indepen-dence Position. [Online] Available at: http://www.accountingweb.com/practice/practice-excellence/aicpa-statement-on-new-auditor-independence-position [Accessed 4 July 2016].Colby, E. E., 2013. Financial statement fraud, Part 1. CGA Journal, pp. 1-5.Crumbley, L. D., 2009. So What Is Forensic Accounting?. Accounting, Behaviour and Or-ganization.Garrow, N., Awolowo, I. F. & Growe, G., 2019. Annual Report: Fact or Friction. Journal ofLeadership, Accountability and Ethics, 16(1), pp. 21-26.Hogan, C. E., Rezaee, Z., Riley, R. A. & Velury, U. K., 2008. Financial Statement Fraud:Insights from the Academic Literature. Auditing: A Journal of Practice & Theory, 27(2),Academia Letters, April 2022Corresponding Author: Ifedapo Francis Awolowo, i.f.awolowo@shu.ac.ukCitation: Awolowo, I.F., Garrow, N. (2022). Why Audit will Continue to Fail!. Academia Letters, Article 5141.https://doi.org/10.20935/AL5141.7©2022 by the authors — Open Access — Distributed under CC BY 4.0pp. 231-252.Hopwood, W. S., Leiner, J. J. & Young, G. R., 2012. Forensic Accounting and Fraud Exam-ination. 2nd ed. New York: McGraw-Hill.Inagaki, K., 2017. Brave is the auditor that takes on Toshiba’s accounts. [Online] Avail-able at: https://www.ft.com/content/d5709622-2ef8-11e7-9555-23ef563ecf9a [Accessed29 September 2018].Joshi, M., 2006. What is Forensic Accounting?[Online] [Accessed 21 August 2014].Silverstone, H., Sheetz, M., Pedneault, S. & Rudewicz, F., 2012. Forensic Accounting AndFraud Investigation For Non-Experts. 3rd ed. New Jersey: John Wiley & Sons Publishing.Smith, S. & Crumbley, L., 2009. Defining a Forensic Audit. Journal of Digital Forensics,Security and Law, 4(1), pp. 61-80.Smith, G., 2015. Toshiba just lost its CEO to a huge accounting scandal. [Online] Availableat: http://fortune.com/2015 [Accessed 2 November 2015].Uttley, H., 2019. Accounting scandal at Patisserie Valerie is even worse than we feared, cafechain owner admits.[Online] [Accessed 20 January 2019].Academia Letters, April 2022Corresponding Author: Ifedapo Francis Awolowo, i.f.awolowo@shu.ac.ukCitation: Awolowo, I.F., Garrow, N. (2022). Why Audit will Continue to Fail!. Academia Letters, Article 5141.https://doi.org/10.20935/AL5141.8©2022 by the authors — Open Access — Distributed under CC BY 4.0

Why Audit will Continue to Fail!

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Why Audit will Continue to Fail!

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