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Audit can never be zero-risk because auditors are human too

A leading Dutch academic has criticised the way auditors are being treated by politicians and the media and suggests that regulators are adopting the wrong approach to tackling the issues of audit quality

In his inaugural speech at Nyenrode Business University in the Netherlands, Professor Olof Bik says that auditors of failed companies are being blamed for everything when the question should be not only where was the auditor, but also where was the accounting department of the audited company, management, the internal auditor, the audit committee? “All parties need to play their role.”

He argues that there is an interdependence between financial reporting quality and audit quality which means that if financial reporting quality pre-audit is high, then the auditor is unlikely to detect errors and adjustments – but that doesn’t mean the audit serves no purpose or that the auditor has not added value to or performed a high quality audit. This is the “preventive” effect of the audit.

And he challenges the auditing profession to choose financial reporting quality as its compass for audit quality, which is in line with expectations stakeholders and society have of the auditor.

Auditing is an economic service which leads to the joint production of reliable corporate information. “In [the] case of a financial reporting quality issue or failure,” he suggests, “of course it also casts a slur on the work of the auditor – but the auditor would also have a better story to tell: the reality that financial reporting quality – and thus also financial reporting issues and failures – is a joint responsibility of at least a number of parties in the entire financial reporting and assurance supply chain…”

Nevertheless, when the Dutch regulator reveals that its inspectors have found issues in 45% of the audits reviewed (regardless of size and irrespective of any real economic significance in financial reporting quality), “the public narrative is that 45% of audits fail”. That, he says, is complete nonsense.

According to Bik’s research, the professional behaviour of auditors – including theirjudgment and decision-making, professional scepticism, and interaction with their clients and their audit teams – determines the quality of an audit.

“So, if there is an audit quality problem, we need to realise that auditors are human too – really – and thus, that there is no such thing as zero risk in conducting audit work.

“It is possible that such risks can never be fully addressed through regulation and professional intervention alone. These could even lead to unintended consequences.”

Yet there is currently an increasing focus on culture and behaviour as tools of good corporate governance and internal control. This is reflected in the auditing profession where audit firm leaders, standard-setters and oversight bodies increasingly promote “quality-oriented culture”  as the “catch-all resolve to restore public trust in the profession”.

Bik warns that this focus is a risk since it is not governance policies alone that drive  and control behaviour. “Rather, it is the most mundane of everyday activities and occurrences that have normative behavioural meaning,” he says. “Auditors in practice interpret those signals to infer what is really valued within the organisation – which in turns guides their behaviour.”

He adds that audit partner performance evaluations in recent years have become more formalised and granular and are now real drivers of audit quality. As an example, he points to the fact that these days audit partners who continue to perform below par are asked to leave and resign from the partnership.

Bik says that when it comes to audit reform, government departments, regulators, politicians and the press would do well to take more account of academic research than they do now. They tend to assume that because one auditors fails, all auditors fail. This leads to “ill-informed public policy making if the morning paper is the only thing politicians read…”.

So, for example, Dutch audit firms have recently been made to implement some form of audit quality penalty for their audit partners, a legal requirement that is leading to unintended consequences. “The audit firms now signal to their audit partners that delivering a high-quality audit is an option. If you don’t want to, you simply forgo a bonus or accept a penalty.”

Bik believes that implementing such untested measures is dangerous, particularly in a profession “in which the judgment and decision-making and behaviour of the individual professional are so central”.

”That is not what you want. There is no such thing as a zero-risk game, Things that go wrong often happen in the same way as things that go right. Incidents may happen that are beyond management’s control.

“The answer to the question, ‘What should stand-setters do differently after having read your research?’ could also be ‘Stand your ground. Current policy is right, no change needed.’”


Originally published in Economia on 22 November 2019.