Greater expectations for auditors

Greater expectations for auditors

Over the past year, there have been a number of high-profile business failures, most notably FTX and Silicon Valley Bank (SVB). These failures have put auditors in the crosshairs of both regulators and the public.

SVB collapsed in March as interest rate rises by the Federal Reserve negatively impacted the value of their long-term treasury bond-heavy investment portfolio. This led to large mark-to-market losses, venture capital clients withdrawing deposits thereby forcing SVB to sell assets at losses and triggering a run on the bank.

SVB’s auditor KPMG is facing a lawsuit alongside the bank’s underwriters. The lawsuit claims that KPMG misrepresented the strength of the company’s balance sheet, liquidity and position in the market. It also claims that KPMG concealed the size of the risks facing SVB and failed to identify the risks associated with the bank’s declining deposits.

Last year the auditors of FTX came under the spotlight. FTX’s 2021 financial results had been audited by Prager Metis, however, a report published in May 2022 from the Public Company Accounting Oversight Board (PCAOB) found deficiencies across all four audits conducted by Prager Metis.

There has long been an expectations gap between what the public believe auditors do and what their role actually is. The auditor’s report is on the ‘truth and fairness’ of the financial statements and whether they have ‘been prepared in accordance with the relevant accounting practices, reporting standards and legal frameworks.’ A “going concern” opinion is based on whether issues affecting the audited company are deemed material at the time. That has a degree of subjectivity.

Audits can be valuable tools for companies and investors but they do not act as standalone solutions. Credit Suisse’s auditor PwC did identify material weaknesses in the bank’s internal controls over financial reporting; that did not prevent the bank having to be bought by UBS in an emergency rescue.

The public assumes that auditors should be able to catch all material weakness, as well as any potential fraud, regardless of the quality of information available and economic dynamics changing after an audit is completed. This view has become increasingly prominent with the more recent rise of retail investors and use of social media, meaning that more people are likely to be impacted and interested when a company fails. This has brought much higher profile to failures like SVB.

An increase of interest in the public eye may increase pressure on authorities to introduce higher fines and penalties. In 2020/21, UK accountancy firms were fined a record £46.5m.

Changing disclosure standards incorporating climate change and biodiversity as well as increasing data automation are also adding to overall engagement risk.

A review of 134 carbon-intensive companies by Carbon Tracker group found that 98% failed to provide evidence that their financial statements had taken into account the effects of climate-related matters. Out of the audit reports reviewed, 96% did not adequately show whether auditors considered the impact of climate issues when auditing these firms.

As scrutiny rises for auditors and other advisors, professional services firms should ensure that they are protected against errors, omissions and accusations of negligence in a rapidly changing environment. 

If you would like to discuss this article or your insurance requirements for an accountancy firm, please contact Charles Tanham.