Audits must be founded on independence and skepticism

PCAOB chair, Jim Doty's June 2, 2011  speech, "Rethinking the Relevance, Credibility and Transparency of Audits is a must read for auditors.

Mr. Doty’s identified a number of important challenges to the auditing profession.

He’s concerned about auditor independence, auditor skepticism, whether auditors communicate effectively, the need to bring more transparency about how audits are conducted and how the PCAOB inspection process works.

As my blog on Going from the Big 8 to the Big 0?? pointed out, the issue of independence is fundamental to an effective auditing system if it is to bring real accountability to stakeholders (creditors, shareholders, future shareholders, taxpayers, the public). So is the issue of professional skepticism.

Mr. Doty cited the inherent conflict that exists when audit firms are hired by the company to be audited. Mr. Doty said, “Auditors are, after all, paid by the clients they are charged with policing. As in other professions, auditors want to advance in their chosen profession which often means keeping the client happy and growing their business.”

To address some of these concerns, the PCAOB is considering several approaches:

• Discussing changes to the auditor’s report to better communicate what auditors actually do.
• Determining whether mandatory auditor rotation would help address the problems caused by the need to keep clients happy.
• Providing more context about the PCAOB inspection process and results to audit committees.
• Considering a requirement that engagement partners sign audit reports with their own name in addition to the firm’s name.

These are good first steps, but they also do not address the work auditors should be doing to find the real problems that may exist in the financial statements. Many of the traditional audit procedures are old and obsolete. Finding fraud depends on professional skepticism, but it must go far beyond examining documents and assess the substance of the underlying transaction(s).

I like Mr. Doty’s willingness to begin assessing the challenges and seeking to bring about change.