Australia: Audit Failures Not The Major Reason For Corporate Collapses
Last Updated: 11 November 2002

Reform of the auditing profession alone is unlikely to solve the problem of corporate misconduct, nor is it likely to prevent corporate collapses, says Alison Lansley, a corporate partner at Mallesons Stephens Jaques.

"Auditors are not the gatekeepers of corporate crime, nor are they responsible for the success or failure of the company’s business operations and management," says Ms Lansley. "They perform very specific statutory duties, primarily aimed at providing a form of check of the company’s annual and half year financial reports to shareholders aimed at ensuring that they provide a "true and fair" view of the company’s financial position.

Ms Lansley’s comments on the CLERP 9 proposals for auditing reform appear in a 25-page paper on "Future directions for auditing in Australia" published this week in a thematic issue of the University of New South Wales Law Journal on "Contemporary Issues in Corporate Governance".

The CLERP 9 issues paper was released by the Australian Government on 18 September 2002 in response to the perceived need for corporate governance reform in the light of the series of recent corporate collapses. The list of Australian corporate collapses in the past two years includes Pasminco, Ansett, One Tel, Impulse Airlines, Harris Scarfe, and HIH Holdings, while the US giants include Enron and WorldCom.

A major problem with the CLERP 9 paper is that it reinforces the audit "expectation gap" – the gap between society’s expectations of auditors and the reality of their obligations. Most of the CLERP 9 proposals are about audit reform, whereas in reality auditors do not guarantee the accuracy of financial information. They are required only to exercise a reasonable degree of skill and care regarding the company’s compliance with accounting standards, and to ensure that the financial reports give a "true and fair" view of the company’s financial position and performance.

The auditor’s role in scrutinising annual and half-year reports has at least three limitations. First, the reports are historical, and do not predict the future - as such, they are only but one tool among several that investors and their advisers need in

order to make informed investment decisions about companies. Second, the auditor looks only at the accuracy of the company’s financial records, and does not consider

other data relevant to the company’s performance. In addition, the role of the auditor does not extend into what is probably the most important area of disclosure – continuous disclosure.

The CLERP 9 paper puts forward recommendations covering matters such as auditor independence, disclosure of non-audit services, an expanded role for the Financial Reporting Council, reform of the Auditing and Assurance Standards Board, and amendments to the ASX Listing Rules.

However, Ms Lansley says there is a risk that these measures will be largely ineffective. This is because, rather than waiting for the causes of the recent collapses to be properly established (eg through the forthcoming Royal Commission report on the collapse of HIH), the Government has leapt straight into assuming that most, if not all, the blame lies with the auditors.

There is a danger, therefore, that the CLERP 9 proposals will give investors false comfort that the audit changes proposed will prevent future corporate collapses.

Ms Lansley cites recent studies that show that audit failures were not the cause, or even a substantial cause, of corporate collapses – rather, in many cases the collapses arose because of "a failure of boards of directors to comply with national and international best practice guidelines and standards on corporate governance".

The Horwath (NSW) report, for example, showed that, amongst Australia’s top 250 companies, 73 companies had corporate governance structures that were deficient, 108 followed standards that were generally good, and only 9 demonstrated standards that were outstanding.

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