Integra Audit & Accounting Alert

Wirecard Fraud Raises More Questions From Audit Profession

Credibility suffers in wake of ongoing corporate collapses

The financial collapse of Wirecard, the German payment processing company, is just the latest in an ongoing string of audit failures that continue to plague the accounting profession in the twenty-first century. The repercussions from the fall of American energy giant, Enron, in 2001 brought not only the devastating demise of once venerable and respected accounting firm, Arthur Andersen. Regulatory fallout led to establishment of what some have called the “draconian” Sarbanes-Oxley Act (SOX) in 2002, creating the independent audit watchdog, Public Company Accounting Oversight Board (PCAOB), which has soberly scrutinized audits ever since. Though SOX has been fine-tuned over the years, the law has served to tamp down the frequency of colossal frauds in the United States.

Apparently, the rest of the world did not learn from the painful experience of the Americans. Sure, Germany, responding to Enron, in 2004 set up the Financial Reporting Enforcement Panel (FREP) to check on German companies. However, with only a small number of employees and a limited budget, FREP was severely understaffed for the role it was given. FREP’s involvement was subsequently terminated. This shortcoming sounds akin to the predicament the British found themselves in when multi-national construction company, Carillion, failed. The Financial Reporting Council (FRC) was said to have inadequate powers to perform the needed level of enforcement. Consequently, a robust new agency, Audit, Reporting and Governance Authority (the ARGA), is in the works to take over enforcement from the FRC.

Though Enron, Carillion and Wirecard followed a similar pattern, developing growing issues over about a fifteen-year period from their founding, China’s entry into the dramatic world of corporate accounting scandals materialized in a much shorter time span. Less than three years after incorporation, Luckin Coffee, erstwhile Asian challenger to Starbuck’s, was outed for a massive fabrication of sales, leading to its delisting. Audit issues in Luckin’s case are likely to differ as well. As detailed in the September 2020 Audit & Accounting Alert, China’s closed society has caused problems for international regulators for years.

Without question, these and other financial scandals have given a black eye, rightly or wrongly, to the worldwide accounting profession. There is no simple solution. As soon as new reforms are put in place to counter defalcations, more sophisticated fraudulent techniques enter the scene. Nevertheless, the investing public demands more of auditors. Changes and strict adherence to basic audit techniques need to be addressed on the micro level, while radical transformation of the broader profession must also receive serious debate and action. In America, SOX and the PCAOB took the country a step closer to full government takeover of the audit function. Without effective changes, that last resort may become a reality.

Since Wirecard and Luckin Coffee, as well as a couple of other large companies with recent troubled accounting, were all audited by Ernst & Young, the temptation may be to focus solely on major sanctions directed at this audit firm, similar to the initial fervor that was directed at Arthur Andersen during the Enron crisis. Though the arrogance of Andersen executive partners, and an ineptly misapplied policy to destroy evidentiary papers, played a substantial role in the firm’s fall, the audit quality issues uncovered were not unique to Andersen. In the current Carillion case, KPMG was the external auditor, while Deloitte performed an internal audit function. Also, Pricewaterhouse Coopers (PwC) was in the news in recent years for substandard audit work at failed department store chain, British Home Stores (BHS).

Audit firms and regulators need to revisit audit procedures and standards to restore reliability in the process. Independent verification of cash, such as the $2 billion missing at Wirecard, is one of the most fundamental steps called for in an audit. Whether the result of inexperienced staff, complex technology, the myriad of interconnecting entities, inadequate supervisory oversight, or for other reasons, this monumental misstep need not have happened had appropriately planned and implemented procedures been in place. Even so, in the case of Wirecard, there were plenty of warnings over several years, mainly from the reporting of the Financial Times. Unfortunately, no one was listening.

For Luckin, the presence of voluminous fabricated sales should be the target of strengthened steps developed for the routine audit process. For Enron, unreported debt in related special purpose entities resulted in new requirements and techniques for tracking down and disclosing these questionable accounting approaches, which were designed to use loopholes in rules-based standards to avoid applying common sense principles.

In other cases, difficult to quantify items are subject largely to auditor judgment. In areas such as asset valuation, goodwill, and going concern, standards have already been reevaluated to provide auditors with expanded methods for evaluating and quantifying. Also, often mentioned are a lack of skepticism on the part of auditors, questions of independence from clients, and the earlier mentioned inexperience and inadequate training of the staff performing the crucially basic audit functions.

On the macro level, the accounting profession needs transformation to avoid losing the exclusive audit franchise that has been a hallmark for decades. In the wake of Carillion and other cases, the United Kingdom is in the process of requiring accounting firms to formally separate the audit function from their more lucrative consulting businesses. While 2024 has been set as a deadline, Deloitte announced in September 2020, that the firm has begun the process by establishing an audit governance board for oversight.

Rotation of audit firms by companies is another means of enhancing independence and reducing the pressures from conflicts of interest. Auditor rotation, along with separation of consulting from auditing, have been hotly debated for years in the US. There is no consensus on whether the benefits from these actions outweigh the advantages of familiarity of a company’s operations that comes with longevity, or the ready access to consulting specialists on staff that bring wider understanding of complex issues.

Further details can be found at Wirecard Scandal: Credibility of the entire ecosystem (audit) is under question.
(https://cfo.economictimes.indiatimes.com/news/wirecard-scandal-credibility-of-the-entire-ecosystem-audit-is-under-question-says-shailesh-haribhakti/76845487).