Regulation & Standards

Asia’s accounting scandals spur audit reform

Published: Mar 2022

A string of high-profile corporate failures and frauds in Asia has called into question the role of the auditors and prompted calls for the profession to be reformed. This falls in line with a global trend of audit reform and a need to adapt to the changing requirements of corporates.

Justice scales and law books

Corporate collapses, frauds and accounting scandals in Asia have blighted the reputation of the audit profession in recent years and have even threatened to undermine investor confidence in their reporting. High-quality audits have been described by the International Federation of Accountants (IFAC) as the “backbone of the global financial system” and there has been a movement across the globe to reform how they are done. This could have ramifications for companies in Asia – and the overseas markets where they are listed – and how they do their corporate reporting.

There is a long list of high-profile cases in Asia that have spurred the need for audit reform. The pattern seems to go like this: a high-profile collapse, revelation of accounting lapses, ensuing litigation and promises of reform.

Jim Peterson, a lawyer and specialist in corporate financial information and author of Count Down: The Past, Present and Uncertain Future of the Big Four Accounting Firms, says that public outrage over the performance of auditors is cyclical. “When things are cruising along nobody cares,” he says. And then something goes wrong. “Then they look back and say ‘where were the auditors?’,” Peterson says. “Then the bureaucrats and politicians stir the pot, then it calms down until there’s another cycle. These cycles tend to run on a seven to ten year cycle.”

There is currently ongoing litigation related to some of the high-profile scandals. In February, for example, a Goldman Sachs banker was on trial in New York related to 1Malaysia Development Berhad (1MDB) – Malaysia’s sovereign wealth fund – and the alleged embezzlement of billions of dollars. The question of ‘where were the auditors?’ has already been asked in a separate US$5.6bn lawsuit the Malaysian government brought against the partners of KPMG Malaysia. In September 2021 this was settled for US$80m.

In China, the public has also been questioning the role of the auditors in the alleged frauds at companies like Kangde Xin Composite Material Group and Kangmei Pharmaceutical. And when the debt-laden property giant Evergrande defaulted on its bonds, questions were asked about accounting irregularities and why auditors gave the company the all-clear when it was so overstretched. There have been other scandals, such as the fraud at Luckin Coffee, which led to it being delisted in the United States. In August 2021, China’s State Council vowed to improve the oversight of accounting firms and published detailed rules on supervision.

A few months earlier, in January 2021, there was a similar move in Singapore to increase the scrutiny of listed companies. The regulatory unit of the Singapore Exchange (SGX) introduced additional requirements for auditors following some accounting scandals, such as the collapse of oil trader Hin Leong Trading and fraud at another oil trader Hontop Energy.

The listing of companies on foreign exchanges has highlighted shortcomings in the audit process. For Chinese companies, the financial statements – or working papers – are deemed sensitive data and cannot be removed from China. This has been the source of a long-running spat between the US and China because US regulators and liquidators cannot inspect the audits of Chinese companies that are listed in the United States. This puts the large audit firms in a difficult position, caught between the interests of the two countries. It also undermines investor confidence in the US-listed Chinese companies.

Pressure has been increasing, and, in December 2021, the SEC finalised rules that would implement the Holding Foreign Companies Accountable Act. This was introduced in 2020 – under the Trump administration – to enable the inspection of US-listed Chinese companies.

The need for audit reform is not unique to Asian companies, and there is a global movement afoot to bring changes to the way corporate reporting is done. The Public Company Accounting Oversight Board (PCAOB), which is the body that could lead audit reform – for the US and potentially set an example for the rest of the world – has been hampered by difficulties of its own. Matt Kelly, Editor and CEO of Radical Compliance, which provides consulting and commentary on corporate compliance, audit governance and risk management, comments that the regulation of the audit industry has been weak for several years.

He describes the PCAOB as “dysfunctional” and says in the US, “we have not really seen reform – the regulator was a mess”. Part of this mess saw the PCAOB Chair William Duhnke removed from his position by the SEC in June 2021. SEC Chair Gary Gensler said at the time said he was looking forward to set the PCAOB on a “path to better protect investors by ensuring that public company audits are informative, accurate, and independent.” He was not forthcoming about the details of the dismissal, but there were news reports of a toxic culture at PCAOB and a story of Duhnke throwing an empty soda can at another board member.

In the US, so far changes have not occurred: “They are not really doing a good job of reform of audits because the regulators have been dysfunctional. The action is definitely coming out of the UK,” says Kelly. “The UK is well ahead of the curve,” he adds.

For those in Asia – and the rest of the world – who have been calling for audit reform, the UK offers a beacon of light as it has gone through an exhaustive consultation process and has offered a number of proposals.

To stand up to a big organisation you have to be big yourself or you could be cowed.

Kevin Dancey, CEO, International Federation of Accountants

Following the corporate collapses of Carillion, Patisserie Valerie and Thomas Cook, in the UK people also asked ‘where were the auditors?’ In response, in March 2021, the UK’s Department for Business Energy and Industrial Strategy (BEIS) announced it was launching a consultation to reform the UK’s audit and governance regime.

The BEIS proposals build on recommendations of previous reviews – led by Donald Brydon, John Kingman and the Competition Markets Authority – and include requiring large audit firms to use ‘challenger’ firms to do a substantial part of the audit and putting a cap on the market share of large firms. Also, a new regulator would be introduced with powers to split the audit and non-audit functions of accountancy firms to reduce the risk of conflicts of interest.

On the issue of whether the Big Four accounting firms need to be broken up, Kevin Dancey, CEO of IFAC, says the companies being audited are large – with large extensive operations around the world – and the scale of the audit firm has to match. Also, points out Dancey, “To stand up to a big organisation you have to be big yourself or you could be cowed.” Peterson agrees that the ‘challenger’ audit firms would be unable to take up the degree and quantity of work that would be necessary.

There is an issue with non-audit services and the perception that this could impact the independence of the audit firm. Dancey says that an audit-only firm would not be able to attract the right people to do a high-quality audit. “The audit firm needs to bring in expertise in other areas as well – such as tax – and you can do that within the multidisciplinary firm,” says Dancey.

When asked to comment on the global trend of audit reform, Dancey says, “I think the journey of audit is always how we can do better,” he says, adding that the world is evolving and the profession is always looking to make the process more efficient for all stakeholders. “At IFAC we always look at it through an audit quality lens,” he says, explaining that he takes a step back and questions if any reforms will enhance audit quality or not – a different approach from those who focus on competition. IFAC has outlined the five factors it believes are necessary for a high-quality audit. These are the right process, the right people, the right governance, the right regulation and the right measurement.

On the question of how the audit process could be better, Peterson questions whether the way they are currently done has lost their usefulness to companies. He argues that the idea of a ‘true and fair view’ opinion has lost its value. He says that audit committees and chief financial officers would rather spend their money on a more nuanced and bespoke report that goes into detail on particular countries or departments, for example. “There are regulatory and political constraints on the firms being able to do that,” Peterson says.

Also, he notes in a journal article, that the pass/fail nature of audits is too simplistic and inadequate. This is something that Kelly raises: “Audit inspections are difficult for readers to use. The audit committees do not really know what an audit inspection is telling them.”

If the needs of companies in this respect are already complex, they are set to become even more so. The expectations of what corporations need to report is evolving and Dancey sees a growth in the demand for corporate reporting on environmental, social and governance issues (ESG). He says attention needs to be paid to the sustainability issues – “Sustainability is real and coming to a company near you – avoid this at your peril,” he says. “The treasurers and CFOs of the world cannot treat this in siloes.” They need to have an integrated approach in their company so senior management and boards can make good decisions. Also, they need to have the right reporting in an integrated and responsible way, says Dancey.

This points to a change in skills that will be needed in the future. In the UK’s Brydon report there is the idea of a new professional designation of a ‘corporate auditor’, who could provide multi-disciplinary services across what a corporate requires. This could involve a range of subject matter expertise that will be needed from the profession in areas such as the environment and cyber-security.

In terms of the skillsets needed for this, Dancey comments that accountants are well placed to take this up because of their expertise in quantifying information and corporate reporting. With ESG reporting, for example, Dancey says “Professional accountants have the skills to deal with these issues,” says Dancey.

While accountants may not be well versed in these other areas at the moment, Dancey comments this is why multi-disciplinary firms are important because they can draw on experience of others with different subject matter expertise.

These are just some of the issues that the audit profession is grappling with, both in Asia and other regions in the world. As it addresses the failures of the past, it also needs to look to the future and accommodate the evolving needs of corporates, and also move beyond the cycle of public outrage of people asking where they were.

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