This article deals with the public accountancy (audit) profession. It has summed up a review of literature on how public accountancy has emerged as a highly prestigious profession and positioned itself as a critical component of the market economy. Self-regulated, the public accountancy profession earned social appreciation being respectful and compliant with their own prescribed codes of ethics, independence and by achieving professional skills and competence. Public accountancy played its role differently compared to government accounting, education accountancy and non-government accountancy. Governments provided legal and institutional support for creation of professional accountancy bodies by framing rules and acts. The public accountancy profession has also played a crucial role in establishing oversight by reporting to stakeholders which is very important for the investors. It presents the chronology of the state of oversight on the public accounting profession.
Initially, the oversight of audit firms was self-regulatory meaning the institutes elected a council to regulate their Public Accounting practising firms based on certain principles as was the case with the stock exchanges in the pre-demutualisation period. In the post-World War II era the USA became the engine of capitalist development and the Public Accounting profession was positioned as the critical component of the market economy. Financials of listed companies, public entities, banks and financial institutions and other components of financial, capital and bond markets are certified by the public accountants. Public accountancy literature reviews reveal how public accountancy emerged as a highly prestigious profession.
Here are some drawbacks of the accounting profession:
1. Failure of public accounting profession: The public accounting profession with regards to delivering required due diligence in the areas like ethics, independence, dealing with conflicts of interest, maximisation of personal greed and lacking core professional competence, has proven ineffective towards protecting public interest. Consequently, social confidence and public perception regarding their integrity have decreased. After the share market crashes, economic recession and financial scandals, the public accountancy has come under scrutiny. These events dent the profession's right to self-regulation. The era of self regulation needs to diminish and the oversight on the public accounting profession must gain greater recognition. In the Widespread Moral Deficit it was stated: "Accountants held no one to account, governments abandoned their regulatory functions, the media turned cheaters into stars, and a culture of self-righteous mendacity was allowed to flourish as long as the stock prices were high." [Source: Those You Love to Hate - A Look at the Mighty Laid Low - NYT 4/22/2005].
2. Failure of self-regulation: Public accounting professional bodies across the world have failed to bring their members and audit firms under the self-regulatory system. Loopholes in the peer review system possibly explain why the audit profession seemed to believe that peer reviews have limited effects on actual audit quality. These loopholes were brought into focus for the first time by the study of Russell and Armitage in 2006. They identified loopholes within the peer review system that allowed audit firms with defective quality control systems to pass successfully. With a questionnaire, the reviewed firms were asked whether the firms used actions that were defined as potential loopholes. Almost half the audit firms responded that they worked on selected engagement documents before these were submitted to the reviewer. One fifth of the firms were even able to select the engagement subject for review and the majority selected cases with a low risk of receiving negative peer review comments.
3. Whistleblowing from the USA: The USA, as the engine of capitalist development after the World War II, took the lead in the oversight on public accountancy profession. The Securities and Exchange Commission (SEC), Senate Committee, politicians and policy-makers and public interest groups have raised their concern and started chalking out regulation for oversight on the public accountancy profession. Rules and procedures were developed for compliance to deal with the accounting and auditing standard setting, principles of corporate governance, ethics and independence, conflict of interest, separation of statutory audit service from consulting services on tax, human resources, ICT (information and communications technology) and other areas. The public accounting profession gradually has lost its image and prestige.
4. Role of big accounting firms: The big public accounting firms started influencing major government policy decisions, including framing laws to serve their interest, just like syndicates in capturing business. Their diminishing influence on Accounting and Auditing Standards, as well as fiscal and commercial codes in favour of their clients is jeopardising public interest.
Consider the case of Bangladesh. We have the Company Law 1994. The big public accounting firms (in disguise) exert their influence to uphold a provision restricting change of auditors and thus protecting the big accounting firms from losing their big multinational private companies. It is a violation of constitutional rights of the citizens. For example, since the establishment of KAFCO in 1982 the audit firm has not been changed as of today. Same is the case with the Lever Brothers of Bangladesh. Foreign banks also fall in this category. The foreign banks and multinational companies (MNCs) use the same technique in a different way by appointing dummy auditors. They keep their old audit firms in a different capacity. Critics say that public accounting firms in Bangladesh could not attract the international firms' affiliation. On an experimental basis, a few have been associated. However, they (PWC, Ernest & Young and Deloitte) left after having the bitter experience of bad corporate governance within their associate firms regarding disputes on fake partnership deed, partners' involvement in share brokerage business, certification of false financials and keeping the firm within family limit to keep fake financials of the firm.
5. Accounting scandals: A series of accounting scandals took place in different parts of the world, including Bangladesh. These scandals resulted in losses to the economy and led to the recession. We in Bangladesh have experienced the share market crash in 2010 and also banking scams. Politicians and other policy-makers became alert after each scandal about a trend of violation of self-regulatory code of conduct among public accounting firms. Allegations began to surface that a fierce competition among firms for clients became more intense and vicious. Critics claim the size of the firm does not matter when it comes to earning a client. Bangladeshi firms started paying bribes to the clients to win audit assignments at higher figures than professional service fees.
6. Economic impact of accounting scandals: New York State Office of the State Comptroller study (2003) reports a sustained 20 per cent decline in stock market wealth ultimately reduces the GDP (gross domestic product) by 0.4 per cent after one year, 0.8 per cent after two years, 1.0 per cent after three years, and 2.1 per cent after ten years. The declines in GDP occur because of reduced consumption spending (with the reduction in personal wealth) and less investment (with rise in the cost of capital) (Brookings Institution "Cooking the Books: The Cost to the Economy"). As the financial markets deteriorated with continued news of corporate scandals and accounting irregularities through early 2002, the brief's authors sought to estimate how much the scandals contributed to a decline in wealth, and in turn, economic output. The decline caused by the scandals would be part of the much larger decline in wealth-and reduction in GDP-arising from the financial markets' decline from its 2000 peak. Brookings authors then estimated that the range of the economic impact of scandals could vary in the first year from a lower limit of $21 billion, or 0.2 per cent of the GDP, to an upper limit of $50 billion or 0.48 per cent of the GDP. Enron Wasn't Just Enron: Enron Corporation, Arthur Andersen, Enron's law firm, investment bankers, countries with Enron operations like Argentina, Mozambique, India, Poland, companies in other countries like Shell, BP, Mobil and Total collapsed with their stakeholders. Adverse economic consequence was huge (Source: Ethics in Organisations - Learning From Enron).
7. Market consequences of misreporting: As is the case with the political/regulatory system, markets have their own mechanisms for penalising and hence deterring harmful behaviour that does not meet accepted standards. While the political/regulatory response to the scandals of 2001-02 garnered considerably more press attention, the market response was substantial. It included enormous damages awards under civil litigation, reputation effects, and bankruptcy. Furthermore, markets are adaptive mechanisms, and learn from past events, even though many of the likely market changes in response to the scandals were pre-empted by legislation.
8. Taking over from standard setting to independent body: In the public interest, the policy-makers took initiatives for oversight on public accounting profession by creating an independent regulator like the public oversight Board in the USA. The standard setting process was taken over by separate independent bodies to monitor the public accounting practitioners. Reform of the professional accounting bodies took place under gun from the regulators of the market and the USA took lead.
9. Conflict of interest and separation of statutory audit and other professional services: Restrictions are imposed on the public accounting firms with regards to statutory audit tax, consulting, system design, ICT, human resources and any other consulting services, as well as the employment of relatives and former employees of the auditor firm in the client companies. The SOX (Sarbanes-Oxley) has sharpened this separation to get rid of this conflicting situation. The SOX requires the auditor of subsidiary companies outside the USA to get listed with the stock exchanges under the jurisdiction where the parent company is located. For example, an auditor of Bangladesh subsidiary of a foreign parent company listed with the US stock exchange needs to meet eligibility criterion under the PCAOB - prescribed rules of that stock exchange.
10. Impact of SOX on the public accounting profession: SOX and PCAOB (Public Company Accounting Oversight Board) have changed the landscape of public accounting profession. Conflicts of interest, partner rotation, employment of relatives, separation of audit consulting and taxation services, including any other consulting services, have been prohibited. Starting from the USA all other market economy countries have followed and others are set to follow the process of the creation of oversight bodies to oversee and control professional accounting bodies solely run by the elected council members. The public accounting firms earlier considered the watchdog on management of publicly listed and public interest entities from the stakeholder side and the government is now put under surveillance by another watchdog in a different name in different countries. The self regulatory regime of public accounting profession must shift to oversight bodies under the defined professional code of conduct, conflict of interest regulation, and a firewall between audit and non-audit services. In accepting audit assignments the audit firm partners are to be careful about whether they have any share holding with the aforementioned client, in case of bank audit the auditor cannot be a borrower of that bank, auditor cannot be a director of a stock brokerage firm or merchant bank along with his family members and partners. Like the BSEC (Bangladesh Securities and Exchange Commission), central bank, insurance regulator, BTRC, BERC, UGC, Drug Administration, and other regulators, including Proposed Financial Reporting Council, shall do surveillance on the ICAB (Institute of Chartered Accountants of Bangladesh) and ICMAB (Institute of Cost and Accounting Management of Bangladesh) the same way the other countries practise.
11. Legal challenge for creating an oversight body: In many countries the creation of watchdogs for the watchdogs was challenged in the court by the public accounting firms which was denied by the highest court of the country. For example, the Free Enterprise Foundation challenged the formation of the Public Accounting Oversight Board in the USA but the Supreme Court awarded verdict against this challenge. This rejection by the Supreme Court has become a demoralising case reference to countries where public accounting firms were preparing for legal action against the proposed oversight bodies.
12. Updates on institutionalisation of oversight bodies: Obviously, the USA took the lead in the era after Enron collapse and demise of Arthur Anderson, one of the big five, after the enactment of SOX and establishment of PCAOB (Public Company Accounting Oversight Board) which is now doing surveillance on the public accounting firms and profession in parallel to Securities and Exchange Commission. Most of the West European countries, including Scandinavian ones, made quick response to such changes and the countries of East Asia adopted these. The Mediterranean and European countries also responded to the establishment of oversight bodies for watching watchdogs of public accounting profession. In the South Asian region, Bangladesh is poised to become the first country to respond to the call for watching the watchdogs of public accounting profession. This is going to happen, albeit belatedly, as the draft of the Financial Reporting Bill has been approved and the Financial Reporting Council is on the anvil.
1. Impose Punishment: If we are going to consider the corporation to be a person and give it the same kinds of rights and freedoms that are extended to the individual, perhaps it is time to revise the methods by which we hold the corporate "person" accountable. We should impose the same kind of punishment that we have introduced for individuals. If a corporation is convicted in the courts for the violation of a law, we should curtail its freedom to conduct business for a certain period of time. In the event of repeating offences, the penalties should be increased. In those instances, where a corporation badly violates public trust, it should cease to exist. The corporate charter should be revoked, the assets seized and the corporation dissolved.
2. Implementation of Financial Reporting Act and Financial Reporting Council: The government of Bangladesh should form a taskforce stipulating a time limit to make rules and regulations i.e. Standard Operating Procedure and rules of business to function and activate Financial Reporting Act and Financial Reporting Council without any further delay to stop the rot damaging for operation of efficient financial and capital markets.
3. No objection on auditor appointment: Before issuing no objection certificates to the appointment of public accounting firms as auditors, the BSEC, the central bank and relevant regulators must mandatorily take a declaration in an appropriate form that the partner of an audit firm (or his close relative as defined by the central bank in case of a bank director) has no shareholding in the listed entities, borrowings, directorship (sponsor or nominated). Original copy of the partnership deed of the firm, certified by the ICAB and RJSC (Registrar of Joint Stock Companies) should be submitted.
4. Separate auditor for statutory, branch and incentive audit: In the case of a Bank audit, statutory auditors should not be allowed to audit the Export Incentives Audit because of logistical constraints and time limit. A separate auditor should be appointed to audit bank branches. Specific terms of reference for statutory Audit and Export Incentive Audit need to be put in place as recommended by the audit committee. They must be approved by the Board and then be forwarded to the central bank for information.
5. Standard methodology for evaluation of public accounting firms: Central bank, BSEC and other regulators must work out methodology for evaluating the institutional, intellectual, ICT and logistical capacity of public accounting firms also counting audit failures on a yearly basis to determine who can handle what volume of clients. Currently the central bank has a three-year term while BSEC and other regulators do not have such practices. The partnership deed, registered with RJSCF (Registrar of Joint Stock Companies and Firms), of public accounting firms is like that of a memorandum and article of association of public and private limited companies and should be submitted to the Bangladesh Bank for scrutiny by the bank for transparency. This would give an indication as to who can do what.
6. Signing the audit report: Critics argue that currently audit reports are signed in the name of a firm which is ridiculous and unacceptable as it creates confusion in terms of legality and is also against the requirements of BSEC. There is an ample scope for forgery of a signature. There is a requirement that a signing partner must put his name below his signature which is not followed in most reports. To have a check on this kind of forgery, the ICAB, while issuing a practising licence to a public accountant, should preserve specimen signature cards mandatorily similar to how banks keep their customers' specimen signatures. The regulators should also maintain specimen signatures of public accounting firms to stop forgery in audit report signing. There are many instances where audit reports are signed by the manager and students which clients cannot detect. However, as per mandate, the audit report can be signed only by a partner.
7. Limit on bank audit and listed entity: Critics argue that there should be a maximum limit for audit of complex and economically sensitive clients like banks, FIs (financial institutions) and listed companies in a particular year. For example, a public accounting firm accepts an assignment beyond their capacity and at the end they cannot deliver the reliable and quality service depending on lesser/inexperienced staff. The central bank, BSEC and other regulators can establish a monitoring process over the issue to avert the possible scams. Critics also argue that currently more than 90 per cent of the listed companies are audited by public accounting firms which do not possess the required institutional capacity.
Dr. Jamaluddin Ahmed is an FCA and Vice-President of Bangladesh Economic Association.