Auditors are supposed be the most conservative form of humanity on earth. For the most part, members of audit teams are. They are organized, tactful, punctual and thorough, well…sort of.

Audit standards, on the other hand are broad and roomy. Professional judgment is applied during audits which poses risks for investors and regulators who rely on audit results. Audit managers are charged (by audit partners) to determine if an anomaly is an anomaly or something bigger.

If professional judgment warrants further investigation, the audit team digs deeper than the customary statistical sampling of accounts and transactions. But only a little…

If you dig a six foot hole, you might find two bodies. If you dig a little deeper, you might find forty more.

The discovery of even the suspicion of fraud is enough to convene a meeting of the risk committee to discuss the prospect of how to proceed carefully in completing the audit in an ethical manner without digging the wrong hole and without subjecting the firm to financial and/or reputational liability. Risk will communicate its position to the partners committee.

A dominating topic of the discussion among partners also involves withdrawing from the engagement and losing a valuable client. Audit partners have capital accounts built up over years of service to the firm. How do they minimize risk? The partner who covers the engagement is often asked questions about how well they know the management and if the partner ever questioned management’s integrity.

Sometimes, the discovery of questionable personal information related to a control person at the client between periods can lead to conflict or even a withdrawal. For example, if the controller or CFO becomes the subject of any litigation during the year, this can cause the risk committee to recommend withdrawal of all audit opinions and termination of the engagement.

Call the lawyers

The other topic usually raised is the malpractice policy. Audit malpractice insurance is expensive and represents a large expense for the firm. Like most insurance companies, policies are rarely renewed after a storm and in the audit profession, there aren’t many alternatives when looking for a new underwriter.

Counsel is summoned to review the policy. This is an expensive review and an even more expensive legal assessment. For a small to medium sized firm, can be cost prohibitive. Counsel will ask the firm how valuable the client is. Is it worth it to proceed at the prospect of peril? What about large accounting firms? What’s the cost of doing business?

Faced with the prospect of a withdrawal from a lucrative engagement, the auditor makes a difficult decision. How far do we dig and in what direction? The decision to proceed is wrought with mine fields. A withdrawal could mean financial difficulty for a smaller firm. These decisions represent serious conflicts of interests when the outcome is weighed with financial gain.

Large firms can afford to proceed and take risks. They are layered with separation of duties, committees and compartmentalization which can act as exculpatory mechanisms during liability discovery and assessment.

Professional Negligence

The suspicion of fraud can lead to a disagreement between the client and the auditor. The disagreement is detailed in a report and is transmitted to the client. The client can respond and remediation can be proposed by the client. Auditor Independence hangs in a delicate balance when a remediation is discussed. What if a private discussion leads to a private resolution?

For publicly traded companies whose securities are subject to tight disclosure regulation, a disagreement should be filed with the regulator which becomes public information in most jurisdictions. Disagreements, assuming they are reconcilable, are resolved between large complex enterprises and large accounting firms but this is a whole different topic altogether.

The largest accounting firms often have a long standing history of reappointment for annual and quarterly audits. After all, there are only four of them. Reappointments are by proxy at the annual shareholders meeting and the proxies are like congressional or parliamentary legislature; stuffed with many other considerations on the agenda.

If an auditor digs too deep and finds the wrong evidence, they must file a disagreement and resign as the auditor. They stand to not only lose the client but also run the risk of being viewed as a bloodhound and not a watchdog. At least they get to keep the malpractice policy. If they don’t dig deep enough, it can be proven that the auditor was negligent in its professional duties. See FDIC vs. PwC.

We all seem to work for the insurance companies. Auditors are especially susceptible to the temptation of arbitraging audit malpractice risk but at what cost?

In the end, its always the investors who lose. It’s the employees who must file for unemployment. It’s the taxpayers who foot the bill when it all goes wrong. It’s the average person who’s fiat currency is debased when central banks print money to bail out the materialization of systemic risk.

About Auditchain:

Auditchain is the founding member of the DCARPE Alliance Association and is leading the development of the world’s first Decentralized Continuous Audit & Reporting Protocol Ecosystem for digital asset and enterprise assurance and disclosure. Auditchain is developing a layer 2 public blockchain ecosystem populated with CPAs and Chartered Accountants who externally validate enterprise system and controls and financial condition on a continuous basis and in near real time. The DCARPE Explorer is a subscription based public block explorer that renders financial statements and audit analytics in real time to subscribers.