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413 of 991 DOCUMENTS

The Edge Singapore

June 10, 2019

Issues: Auditing the auditors

BYLINE: Jeffrey Tan & Benjamin Cher

LENGTH: 3914 words

The spate of corporate scandals in Singapore has left investors such as Jerry Low disgruntled and disillusioned - and
doubtful - about auditors and their work. "They were not able to warn us on Noble [Group's] dire financial situation.
They appeared totally unaware of Midas' fake accounts. They were unsuspecting of Hyflux's unrealistic valuation of
Tuaspring. Auditors' unqualified opinion can no longer be relied upon as an indication that everything is okay in the
listed company," Low tells The Edge Singapore.
"From the investor's perspective, auditors today are acting less like auditors and more like businessmen looking for pat-
ronage," he notes.
Low is not alone in believing that auditors should bear the brunt of the blame when a company goes to the wall. A re-
port by the Association of Chartered Certified Accountants (ACCA) showed that 52% of the Singapore public believe it
is auditors who are responsible for avoiding company failures. This is despite the fact that only 31% of the Singapore
public could accurately identify what an auditor does.
Auditors have privileged access to company management and are able to delve deeper into a company's financials than
most retail investors ever could. As a result, investors have great expectations of them.
"In my opinion, the auditors very often fail in their effort to give comfort to investors that they have revealed all the
pertinent information and those financials are fairly presented," says Michael Dee, a long-time critic of the Singapore
Exchange, Noble and the Securities Investors Association (Singapore).
However, auditing industry professionals to whom The Edge Singapore has spoken have a different take on their role.
They maintain that their job is to carry out a specific scope of work according to recognised accounting standards. In
short, their task is not to look for fraud but to see that companies' financial statements comply with accounting stand-
ards.
"People expect auditors to find all errors, but auditors can never find all errors," a former auditor tells The Edge Singa-
pore. "That's why it is always stated in the financial statements [that] the job of the auditors is not to detect fraud but to
ascertain the reasonableness of the statements."
Another former external auditor laments that audit firms are often caught between a rock and a hard place. He says an
external auditor is very often completely unable to detect efforts, if any, by management to cover up irregularities, de-
spite employing "professional scepticism" while scrutinising the books. "We run audit procedures to meet our audit ob-
jectives to give reasonable assurance that nothing material was missed," he notes. "That is how we answer all those
tricky 'auditor responsibility' questions. [But] if a company hires a good ex-auditor to manage its books, I assure you
that auditors will find absolutely nothing amiss with the books."
There is clearly an expectation gap in what auditors do and what the investing public think they do. This gap is not nec-
essarily a bad thing for the industry, says Chiew Chun Wee, head of policy, Asean and ANZ, ACCA. "The huge expec-
tations the public has is demonstrative of the value [the audit industry] is either delivering or has the potential to deliv-
er."
Indeed, as the economy expands and business models get more complex, the public's expectations of audit professionals
are also going to grow. In the light of all that has gone wrong so far, what needs to change?
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Not finding fraud

On the face of it, an auditor's job is to ensure that a company's financial statements represent a true and fair view of the
company's financial performance and position, free from any material bias or error. If the audit uncovers financial fraud,
the auditor is expected to report it. This also means the auditor does not expect to purposefully sniff out financial fraud.
"What the auditor is expected to do, and is already doing, is to minimise the risk of material misstatements arising from
fraud and error," says El'fred Boo, associate professor of accounting at Nanyang Business School (NBS). "The auditor
is required by the professional standard to assess risks, including fraud risks. If there is fraud, and to the extent that it
results in a material misstatement, the auditor is expected to be able to detect the material misstatement when appropri-
ate audit procedures are performed."
In fact, auditing has not been the primary way of uncovering fraud. In a study by the Association of Certified Fraud
Examiners, nearly half of fraud cases are detected by a whistleblower. An internal audit catches fraud 16% of the time;
a management review does it only one-tenth of the time. Only 8% of fraud cases were detected by an external audit.
Indeed, an audit may not even be as thorough as a layman expects it to be. As the former external auditor puts it, an
audit may include just three out of 10 subsidiaries that a company owns, should they contribute a significant portion of
the company's revenue. Another issue is what counts as "material" to the company. In a company that generates hun-
dreds of millions of dollars in revenue, a few thousand dollars that may have been accounted for wrongly would not be
obvious in the broader scheme of things, and therefore could be considered as immaterial by the auditor.
Still, auditors are expected to employ professional scepticism on the job, says Boo. "Even if the auditor is happy with
the management's integrity based on past dealings, [he] nevertheless still needs to watch out for potential misstatements
due to fraud," he explains. "This is important to the auditor, as [his] role is to ascertain the rigour of information pre-
sented to [him] and disclosed by the company. An auditor will need to question and pursue the matter until it clears his
significant doubts."
Says ACCA's Chiew: "It doesn't mean that you assume the management is out to defraud you. But [do] not let past ex-
perience persuade you that the management is always good and great."
Expectation versus reality
On the ground, insiders tell The Edge Singapore there is pressure to not look too thoroughly at figures in order to get the
job done on time. "Sometimes you do find things, but because of the pressure of finishing the job, you just leave it," a
former auditor says.
He also says that, between the time he joined the internal audit department at a Big Four firm and the time he left, half
his department had resigned. Yet, the number of projects the department handled remained the same. And the firm con-
tinued to hunt for new prospects. He has doubts the remaining employees are able to maintain the quality of their work.
There is also the practice of having less experienced, junior auditors handle most of the work while the senior partners
and managers sign off on the reports.
"The work doesn't happen at the senior level. It's at the lowest level - they are the ones seeing the documents and mak-
ing the initial decisions," says Carl Jenkins, global leader, governance, risk, investigations and disputes at corporate
investigations and risk consulting firm Kroll. "A lot of young people fresh out of school are assigned to large companies
to do the work. Right off the bat the question is: Are they trained? And are they supervised properly? In an audit firm
[where] you have 25-year-olds supervising 21-year-olds, there is no depth of experience."
Compounding the issue is how some firms are promoting employees, even if it is not justified, as a way to retain them.
One former external auditor tells of juniors who were bumped up even though their work was not up to scratch, as the
firm scrambled to cope with the turnover rate. However, the former auditor noted that the senior partners did send back
substandard work, even if they were on a tight deadline.
Then, there is the cultural factor. Auditors are expected to challenge company management on their findings, and it may
be that some are reluctant to question older people.
Nevertheless, firms have to stress to their employees that it is ultimately about doing the right thing, says ACCA's
Chiew. "It is public interest that we are protecting," he says. "It is not to finish everything in the quickest possible man-
ner. The auditors' responsibility is to make sure that the job is done well and they will take the time they need to do
that."
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Issues: Auditing the auditors The Edge Singapore June 10, 2019

Conflict of interest
The biggest issue facing the auditing industry today is conflict of interest, which critics say have resulted in firms being
unable or unwilling to find faults.
In the case of Noble's troubles, critics point to the failure of the commodity trader's auditor to question what appeared to
be outrageous valuations. For instance, the value of the company's 14% stake in Yancoal Australia, at 50 times market
price, was grossly overstated, in Dee's view. "Now, how does an auditor sign off on that?" he says, referring to EY
(Singapore), which had its audit of Noble's financial statements from 2012 to 2016 reviewed by regulators.
PwC was subsequently brought in as the special auditor take another look at Noble's books. But Dee then accuses the
firm of failing to question whether the company's commodity contracts were genuine. "Who looks at the contracts and
asks if they are real? Why are we letting someone value something that hasn't happened? Who reviews the judgement
on the price and value in the contract?" he asks.
Audit firms are profit-driven entities and are compensated for their audit services. One industry insider tells The Edge
Singapore that this has resulted in a company putting undue pressure on its audit firm to act in its favour. An external
auditor who was attached to a mid-sized audit firm for three years is sceptical about how independent external auditors
can truly be, given that their fees are being paid for by the companies. "I question the true independence of external au-
ditors if they are hired by shareholders, who are also members of the board of directors," he says.
"The auditors are paid by their clients; there is pressure on audit fees," says Kroll's Jenkins. He cites the example of
Enron, the largest client of accounting firm Arthur Andersen. The firm, which was indicted for its criminal involvement
in covering up billions of dollars in losses at the energy company, collapsed a year after Enron did.
"Do you go back to the client when you see something wrong and say 'stop', knowing full well that the client will blow
up? Or will you try to bend over backwards to find a way to make something work? Unfortunately, in that situation,
they bent over backwards to make something work."
The failure of Enron led to the enactment of the Sarbanes-Oxley Act in the US. This effectively legislates independence
by prohibiting auditors from offering services to their clients apart from audit.
Yet, in the interest of growth, firms here are consultancies that sell a wide-ranging host of other advisory services, albeit
through affiliate firms, in a bid to maintain a firewall between the business units. Consulting services generate higher
fees than audit, notes Mak Yuen Teen, associate professor of accounting, NUS Business School. "The lessons of Enron
are long forgotten and today, the situation is worse than before Enron," laments Mak.
He adds that he often hears of audit partners defending the interests of their clients, such as opposing certain regulations
that may result in higher compliance costs. "Why do they see it as their business to argue on behalf of their clients if
they are supposed to be independent?"
Auditors may also be forced to take on engagements that may be risky, for profit. "This is where commercial considera-
tions may trump the spirit of professional standards," Mak points out. "One only needs to observe the fact that no matter
how bad or risky a client is, there will always be some audit firm that is willing to accept it as a client. I have not seen
any listed companies here failing to find a replacement auditor. Some change auditor every year, or nearly every year.
These high-risk clients just keep going down the list until they find a firm willing to risk its reputation for the fees."
Who is responsible?
Auditors today have an increasingly tough job, according to industry practitioners, as technology and new business
models make accounting more complex. At the same time, various accounting treatments, particularly those that require
the exercise of professional judgement - such as revenue recognition and fair valuation - are making the audit more
complex, says NBS's Boo. Moreover, not all clients are cooperative, and the information given could be "sketchy or
messy", he adds.
Given the challenges in getting a true and fair view of any company's balance sheet, the former external auditor says he
finds it hard to believe any financial statements put out by companies and auditors. He left an audit firm for an internal
audit role, as he believes he would be able to institute controls to prevent such accounting mistakes and lapses and
fraud.
Ong Hwee Li, CEO of corporate finance services firm SAC Capital, says auditors should be held responsible for not
calling out wrong accounting treatments made by the client. Using the example of Hyflux, he says the auditor should
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have made a stand to classify the perpetual instruments as debt. "The auditor cannot just follow what the client thinks is
the right treatment."
But the fault-finding should really begin with a company's management, says Daniel Bens, professor of accounting and
control at INSEAD. "Whenever we see these failures, we have a tendency to point the finger at the auditors. And some-
times they are to be blamed. But the finger has to be first pointed at the management because they are the ones respon-
sible for putting together the financial statements," he says.
Bens argues that auditors are only responsible for uncovering financial fraud if they detect hints of it. Other stakeholders
have their roles to play: Shareholders are responsible for electing a competent board of directors, who are in turn re-
sponsible for keeping checks on the senior management and choosing a qualified auditor.
"The first line of defence is those who are charged with governance. It falls squarely on them," says Kon Yin Tong,
president of the Institute of Singapore Chartered Accountants. "They are all part of the [financial reporting] ecosystem.
It is very difficult to sit down across the table to say that, in this case [the blame lies with the] auditors; in that case, [it is
with] the management. In all cases, everyone should take a fair share of the blame." He adds that if the auditors have
been following accounting and auditing standards, the scrutiny should then shift to the standards - whether they are "ap-
propriate" and "robust".
Industry reform
So, should it be the auditor's responsibility to detect fraud? This would make their job even more onerous and result in
the ballooning of audit fees and compliance costs, industry observers say. And even if the role were to change, it would
still be difficult to find fraud. The perpetrators of a crime would be careful "not to leave any trail", Boo points out. And
they would most likely collude with others to subvert internal controls. "As an outside party who visits the company a
few times at most in a year, the auditor is an unlikely candidate to detect fraud. Even a discovery of fraud by accident
ranks higher [in probability] than [discovery by] external auditors," he says.
Preventing corporate fraud from getting out of hand and eroding faith in the market would need a reform of the audit
industry in several ways.
The key is to ensure true impartiality in the audit process. "The auditors are paid by companies that they are supposed to
be auditing. There is a structural incentive for not being too hard on clients for fear of losing them," Dee says.
One way is to have an independent escrow authority handle the negotiations and payments and define the auditing
scope. An industry insider proposes a "pool" of audit fees that every company pays into and which is managed by a cen-
tral regulatory authority. Audit reports should then be sent to this central regulatory authority. "This way, the audit firm
is not at the mercy of the client," he says.
By taking that paying relationship out, auditors can fully play their role with true independence, notes ACCA's Chiew.
"It could be the stock exchange or a state-owned body that collects the fees, based on market cap, and it allocates them
to the [audit] firms. You won't have the perception that they are beholden to their clients [then]," he says.
A rotation of auditors would also be a good way to ensure that clients and auditors maintain a professional working rela-
tionship. Currently, only audit partners need to be rotated rather than firms. This could be a way for auditors to remain
impartial, according to former external auditors and industry observers.
Secondly, there needs to be stricter enforcement and actual penalties for auditors that have plainly been negligent, or
criminal, in their tasks. This would fall within the purview of the regulators. In the UK, for instance, the Financial Re-
porting Council has meted out tens of millions of pounds in fines on Big Four firms, following numerous audit lapses
and scandals.
Investor Low agrees. "No SGX-listed companies' auditors have been penalised in recent years, despite multiple corpo-
rate frauds and failures," he says. "After Hyflux and Noble, audit opinion no longer matters."
Says Dee: "There is no procedure for bondholders or investors to hold auditors accountable for the reports they gave
that stated that the financials were fine. The auditors are able to hide behind certain rules and practices and absolve
themselves of responsibilities - by saying they relied on management's judgement without testing the judgement inde-
pendently."
Consequently, the market regulator needs to be independent of the operator and its commercial interests. "The organisa-
tional structure of SGX is to be a profit-making enterprise. But if you regulate aggressively, and other [jurisdictions] are
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less aggressive, [companies] won't list on your exchange," Dee says. "In my view, the regulatory regime was weakened
to have more commercial success. I am hopeful that a separation of the regulatory function in SGX would lead to a bet-
ter outcome."
Thirdly, since the uncovering of fraud in most of the cases is a result of whistleblowing, perhaps there should be a whis-
tleblowing policy here to encourage reporting without the fear of repercussions. In the US, for instance, there are laws
to protect whistleblowers, who also receive a portion of the financial penalties that are levied on the companies after
wrongdoing is proven.
Unfortunately, the experience with whistleblowing in Asia so far has not encouraging. "The majority reaction is: 'Who
is making this claim? We want to know who is turning against us,'" says Tadashi Kageyama, regional managing director
at Kroll Asia-Pacific.
Fourth, companies need to shore up their internal audit processes to provide the checks and balances needed to uncover
and prevent fraud. Internal audit would then become the first line of defence, even before external auditors come in to
verify their work.
Finally, it is down to investors to familiarise themselves with the company they own and its financials, and hold the
management accountable. - With additional reporting by Trinity Chua and Pauline Wong
Detecting fraud in a company
As obvious as it may seem, the first step in detecting fraud in a company is to compare the numbers, says Carl Jenkins,
global leader, governance, risk, investigations and disputes at corporate investigations and risk consulting firm Kroll. He
recommends taking a good look at trends, comparing the performance of a company with its peers in the industry and
examining the financials of each subsidiary of a company, right down to the individual office.
"You look for trends and you also look at the industry [the company] is in," says Jenkins. An underperformance or out-
performance may be an anomaly or attributed to a bad deal, but it is something to look at. "The next thing we might
look at is whether there are any large compensation changes or arrangements in the company," he adds.
While higher sales should drive higher compensations, one might find that costs of sales are going up because some-
body is giving big discounts to increase sales numbers, Jenkins notes. This issue of assumptions also extends to new
acquisitions in markets the company has not been in before, with headquarters and subsidiaries being on a different page
when recognising revenue or profit. In such cases, looking closely at all the books instead of only a "sample" makes a
difference.
Jenkins recalls his experience when he was an auditor looking at the books of an insurance company in the US. "I see
stationery and supplies for an office somewhere in the Midwest, and it was US$200,000 when it used to be US$10,000,"
he says. It might not have been obvious at the company level. "But I pointed it out. [And it turned out that] there was
somebody embezzling funds using that account."
Vendors should also be scrutinised, he adds, for conflict of interest, or fake invoices and round-tripping. Auditors tend
to only check that purchase and delivery orders match invoices. "I was working with a Dutch company and they had set
up these fake vendors. If you looked in the phone book or called them, they didn't exist," says Jenkins.
With growing complexity in business models, technology is also coming into play. "With the help of computers and
artificial intelligence [AI], auditors are able to audit the whole population of transactions. This will increase the chances
of detecting material misstatements that may be due to fraud," says Wang Jiwei, associate professor of accounting
(practice) at the Singapore Management University.
Start-ups and large corporations are now looking to produce AI solutions to detect fraud internally. Payment systems
company ACI Worldwide, for instance, is building a data model for indicators of fraud.
"The indicators that stand out tend to be breaches of policy. [The person who commits fraud] - whether they are dis-
gruntled or believe they are owed something or [need] access to funds - tests the waters. They test to find out if what
they know about vulnerabilities is true; they test the boundaries. They try things that are minor, to build up knowledge
and confidence," says Giselle Lindley, principal fraud consultant at ACI Worldwide.
AI start-up Datavisor has sold applications to combat internal fraud. "Our systems are being used to target internal fraud
similar to what happened at Wells Fargo & Co when they were aggressively expanding customers," says Xie Yinglian,
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CEO and co-founder. "Sales agents' performance [was based on the number of] new applications. Some agents brought
in customers not qualified for the accounts, but packaged them to help them qualify, [a form of] internal fraud."
She adds: "It is very hard to manually sift through things to look for fraud. You need an advanced algorithm to look
across the data, and correlation to identify that."
Ultimately, the best teacher is experience. "Very rarely is there fraud or an issue that we haven't seen before. The num-
bers and the people might be different, but the [bare facts are the same]," says Jenkins. "Unfortunately, learning from
past mistakes is hard, as companies often do not want to go public when fraud has been discovered internally." - By
Jeffrey Tan & Benjamin Cher

LOAD-DATE: June 12, 2019

LANGUAGE: ENGLISH

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414 of 991 DOCUMENTS

The Edge Singapore

June 10, 2019

Edgewise: Auditing the auditors

LENGTH: 837 words

Audit firms have been in the crosshairs of investors and regulators in recent years, and little wonder.
There has been a spate of corporate scandals over the last couple of years, for reasons ranging from poor financial man-
agement and excessive valuations of assets, to outright theft and fraud. Each of the scandals emerged despite their fi-
nancial statements having being given the all-clear by auditors for years. They have left scores of retail investors out of
pocket and many wondering about the effectiveness and reliability of auditors.
There is apparently a disconnect between what auditors do and what people expect them to do. In a survey by the Asso-
ciation of Chartered Certified Accountants, more than half of the respondents believes that auditors are responsible for
avoiding company failures.
This has been commonly referred to as the "expectation gap" by industry practitioners, who assert that failure to detect
fraud is not simply "an audit issue". Indeed, the task of the auditor is specifically not to look for fraud, but to see that
companies comply with accounting standards. They argue that it should be a combination of efforts by the company's
management and directors, and internal controls, as well as shareholders, who should be on the lookout for hanky-
panky.
Indeed, in a study conducted by the Association of Certified Fraud Examiners, a non-profit organisation based in Texas,
only 8% of the fraud cases detected in Asia-Pacific are flagged by external auditors. A management review detected
10% of the cases, while internal audit uncovered 16%. Most of the cases, or 47%, were as a result of a tip-off, likely by
a whistleblower.
Yet, surely retail investors should be able to rely on the professional opinions of auditors, who have privileged access to
companies' management and financial statements, and who have been paid to ensure that their reports are a reasonable
representation of the companies' financial positions?
But perhaps that in itself is the biggest problem. Audit firms are engaged and compensated for an audit job by the com-
pany whose books they are meant to scrutinise with a degree of impartiality and "professional scepticism". However, in
interviews with industry insiders, The Edge Singapore found that in practice, the payment of audit fees can be used to
pressure auditors to conduct an audit in a company's favour.
To be fair, audit firms are commercially driven. But there are ways to eliminate conflict of interest, such as having audit
fees pooled or paid into escrow and administered by a third-party authority.
And if, for instance, a company's management is intent on defrauding investors, it would be hard for an audit team that
works with material provided by the company to uncover it.
Whatever the case, the scandals have been damaging not just for the audit industry, but also the market as a whole, as
investors have lost faith in auditors. As such, there needs to be more effective oversight as well as actual penalties for
auditors found to have been negligent. In the UK, for instance, the Financial Reporting Council, as the country's ac-
counting watchdog, has opened a full review into KPMG after the Big Four firm audited the books of a number of com-
panies that subsequently collapsed. In the last six months alone, more than £20 million ($35 million) in fines have been
levied on it by the FRC.
To be sure, there have been efforts here to improve accountability. The market regulator, the Singapore Exchange Regu-
lation (SGX RegCo), plans to require companies to appoint a second auditor to review books that have already been
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Edgewise: Auditing the auditors The Edge Singapore June 10, 2019

signed off on. In fact, it has already ordered some companies such as SBI Offshore, which entered into a questionable
property sale, to appoint a special auditor and report the findings directly to SGX RegCo.
Our reporters were unable to get audit firms to comment for this story, the common response being that it would be in-
appropriate for auditors to comment on their peers' and their work.
Yet, SGX Regco's proposal to require companies to appoint a second auditor to review books that have already been
signed off on is effectively having one auditor comment on another's work.
In the case of Noble Group, its external auditor EY signed off the accounts and stood by it even under regulatory scruti-
ny. PwC, which was later brought in as special auditor to take another look, came to the same conclusions despite there
being concerns over how the commodity trader's assets were valued. For instance, Noble's earnings for FY2016 took
into account some US$126 million in unrealised gains on assets, whose valuations were determined by the company
itself. "[The auditors] basically nailed their colours to the mast," said SGX RegCo CEO Tan Boon Gin.
Ultimately, as the economy expands and new business models emerge, the audit profession will become more challeng-
ing. The public's expectations of it will also grow. As this happens, so should the level of accountability in the industry.
The integrity of our markets depends on it.

LOAD-DATE: June 12, 2019

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