Radio National program on failures of the audit profession

Radio National is the earnest national public radio service in Australia. They recently ran an hour program on the audit profession and this blog and my views particularly on China got a mention.

You can find the program here - and it is worthwhile listening.

Of course if you think that an hour talking about accountants is marginally less interesting that listening to paint dry then you might skip it along with the rest of this post.

Whatever you can find a reasonable review at Francine McKenna's excellent if polemical blog.

I appear after Carson Block just after 41 minutes... I am there as much as anything because I offer a (limited) defense of the auditors which Francine McKenna (who was given the last word) dismisses pretty harshly. The limits were edited out of the show in part because I named certain institutions as corrupt and Radio National did not want to be sued and in part because it was useful for the show to have someone (anyone) on it willing to defend what looks to be indefensible.

Here without the editing is my limited defense of auditors.

Audit is a process which is designed to catch fraud. Any defense that says that audit is not meant to catch fraud is of course nonsense.

The process involves among other things checking that a sample of transactions actually occurred and are accounted for correctly. So you look at individual transactions flowing in-and-out of the bank and check them against bank statements. You check the end balance of key items (receivables, inventory and especially cash).

If an audit is done properly (and that usually involves a competent partner and a group of competent juniors following boring rule-driven process) it will detect almost all major frauds. Competent audit may miss small scale embezzlement but will not miss wholesale fictional accounts.

The bulk of major frauds and almost all of the Chinese frauds would have been detected by proper process.

However now and again you find a really sophisticated fraud which fools that process. In China the main way of fooling the process is to have the bank in the the fraud and have the bank provide accounting statements that match the fraudulent transactions. Of course the criminal firm will also need the customers to be in on the fraud (and say to verify receivables in random checks).

In other words a fraud that fools the process needs to embed itself into a well-controlled fraudulent network. It needs to be elaborate and well constructed.

In that case - and only in that case - I am willing to offer the auditor a free pass. The auditor might have done their job properly and not detected fraud.

I think there are two Chinese frauds that meet this test. The first is China Media Express where I think it entirely possible that Deloitte did their job properly and did not detect the fraud. The other is Longtop (which was also audited by Deloitte). In both cases the customers (advertising agencies and banks) were in on the scam and the banks provided false statements to verify cash flows and cash balances.

And that is the extent of my limited defense of the auditors.




John