Why Do Auditors Produce Skewed Client Audits?

It is widely accepted that accountancy is a career that requires significant and specialised technical competence. To succeed enough to be placed on a team auditing some of the biggest organisations in the country necessitates exceptional skill in the area.

So why then do such high-level auditors share the responsibility for such catastrophic failures as the collapses of long established businesses including Carillion and Thomas Cook?

Why bad audits matter:

The failures of the audit industry matter because they have far-reaching consequences. Auditors’ failure to flag problems led to the high-profile collapses of Thomas Cook, Patisserie Valerie, and Carillion.

Carillion’s collapse alone left 2,400 people without jobs and cost the taxpayer £148m.  Thomas Cook’s demise cost 9,000 jobs and left 150,000 British holidaymakers stranded abroad. At the same time, the company’s top directors were raking in the cash – being paid a combined total of £20m since 2014.

How can anyone be expected to trust company audits when those conducting them are approving huge corporate bonuses while the company heads for the cliff edge?

Unfortunately, these poor quality audits are not isolated cases. During 2020 the Financial Reporting Council (FRC) found that one third of the company audits assessed in its latest review fell short of industry standards, requiring more than ‘limited improvements’ to reach the expected quality. The previous year, the rate of reviewed audits falling below standard was one in four.

Why Unconscious Bias is important:

The common view of accountancy as a purely rational, objective practice is inaccurate, and obscures the ways in which bias can enter the process and skew results.

As Bazerman, Loewenstein, and Moore wrote in the Harvard Business Review almost twenty years ago, ‘bias thrives wherever there is the possibility of interpreting information in different ways.’ And while many see accounting as solely an objective numbers game, the process of auditing is largely about interpretation. For example, it is up to an auditor to decide whether to identify a particular outgoing as an investment or expense, a decision which influences the overall picture created by the audit.

So while it is often assumed that failures in accounting are the result of corruption and intentionally unethical behaviour, the truth is that most are down to unintentionally biased interpretation of data. In this way, even the most honest of auditors may end up producing an inaccurate picture of a company’s finances and misleading clients, regulators, and stakeholders.

Biases that play a role:

When it comes to the ways unconscious bias affects audit findings, a number of different biases can come into play.

At the top of the list is Self-Serving Bias. Studies have shown that given the same information, different people will come to different conclusions – ones that favour themselves and their interests. Audit companies can receive millions of pounds of fees per year from a client for their auditing and related consulting services.

This is a major income stream the auditor doesn’t want to risk losing, so if presenting a positive picture of the company’s accounts is more likely to keep the client happy, an auditor is likely to provide one. This happens because companies are in the position of hiring and firing auditors, and can (and do) choose them based on how they believe they will interpret certain subjective aspects of their accounts. 

Closely related to this is Confirmation Bias, where a person unintentionally exaggerates the importance of facts that support views they already hold (or wish to believe) and discounts or downplays the facts that contradict them. If an auditor is consciously or unconsciously looking to ensure their client is happy with their results, they risk producing an audit that does not provide a complete picture of their client’s financial position. Though it initially looks like the path of least resistance, this ultimately does the client a disservice, as they are not given the opportunity to identify or mitigate risks. It could also be a criminal offence.

Unfortunately, legal measures punishing accountants for poor audits are limited in their ability to act as a deterrent, as not only is wrongdoing often unintentional and unconscious, but the bias causing it also acts to downplay the potential repercussions of producing a sub-standard audit.

Optimism Bias refers to the tendency to overestimate the likelihood of positive outcomes and underestimate the likelihood of negative ones. If an audit company is producing an audit for an important client, the potential negative consequences of an inadequate audit (such as industry backlash, criminal charges etc.) seem small and far away in comparison to the immediate results of the client’s reaction to the report provided.

It's also important to remember that people are more willing to harm strangers than those they know, something that is even more pronounced when the known individual is a client providing their company with an ongoing source of income. If an auditor has questions about a potentially problematic piece of accounting, they are in the position of deciding whether to risk harming their client by challenging it, or harming the companies’ stakeholders – strangers – by not speaking out.

Choosing the former may be the more ethical choice, but it is also the more personally precarious one, as it risks the auditors being dropped by their client in favour of a company more eager to provide a pleasing outlook. The previously mentioned report from the FRC states that auditors not challenging their clients was one of the failures they credited with the poor results of their assessment. 

Positive Steps:

Thankfully, there are positive steps being taken to prevent disasters like the Thomas Cook collapse from happening in the future. The Financial Reporting Council have told the UK’s ‘big four’ accounting firms (KPMG, EY, PwC and Deloitte) that they must ensure their audit divisions are ring-fenced from their consultancy units by 2024, the intention being to reduce the incentive for auditors to provide a rose-tinted view of a company’s finances in order to keep them happy and sell add-on services.

The FRC have set 22 specific principles for effective separation of the two areas, including the requirement that the companies’ audit arms operate a separate profit and loss account from the rest of the business. They must also have a separate board to provide more independent oversight of audit practices.

However, it’s important that the industry is proactive in taking the steps needed to improve audits without waiting for regulatory bodies to impose new rules. Auditors need to agree and implement clear professional boundaries both in their own work and across the industry.

Effort should be made to follow best practice at all times, and comply with all existing regulations by choice, rather than waiting for the report that finds one third of your company’s audits sub-par.

Auditing companies should consider appointing an independent expert to objectively assess and approve the process of their audits, as well as sign off on all findings and recommendations. To remove as much bias as possible, this should be a completely independent auditor – NOT a non-executive director, who, despite having a non-executive role, still has a personal interest in the company’s business running smoothly. Having an independent expert to oversee audits and candidly question both auditing company and client will mitigate auditors’ biases and ensure the final audit is rigorous, accurate, and as objective as possible.

On an individual level, training auditors in Emotional Intelligence can make all the difference. David Rule, executive director of supervision at the FRC, stated that firms need to support a “culture of challenge,” to ensure audits are up to standard. Emotional Intelligence training teaches how to create and maintain high-trust relationships with colleagues and clients that allow for honest, candid communication without risk of damaging that relationship.

Emotionally Intelligent auditors are equipped to establish clear parameters for how their relationship with a client will develop in the event that their audit shows significant risks or opportunities.

Emotional Intelligence helps auditors understand the difference between an enjoyable relationship with another individual (for example, a representative from a client company), and a healthy, productive relationship between organisations that each have corporate responsibilities to fulfil. While it may be easier to ensure a comfortable relationship with another person through people-pleasing and avoiding difficult conversations, this only does both organisations a disservice. Appeasing and individual or group should never come at the expense of accurate, data-driven information reporting. Within a high-trust relationship, difficult times and difficult conversations can be dealt with in a productive, collaborative manner that invites positive change.

Three key Emotional Intelligence competencies for auditors:

• Reality Testing – This refers to the ability (and willingness) to remain as objective as possible in any given situation, to not be steered by opinion, hunches, or external pressures. High competency in reality testing allows an auditor to interpret the facts without being influenced by how their client may react to certain outcomes.
  

• Problem Solving
  While it may be a skill prized in many areas, problem solving in Emotional Intelligence refers to the ability to correctly identify and solve even complex problems that involve emotions, whether those of a colleague, client, or even yourself.
  
  One area where this is particularly helpful is communication. Though auditing is heavily numbers-based, on occasions it may not be the numbers that are causing problems – it may be the way these numbers are being presented or understood. This competency allows the individual to identify the best way to communicate with others to clarify information or invite collaborative thinking.
  

• Assertiveness
  It is always important to have the ability to stand your ground when needed. It’s also important to clearly understand the difference between assertiveness and aggression. Being able to use the right level of assertiveness at the right time, in a high trust relationship, allows both auditors and their clients to ask each other tough questions, challenge assumptions, and ensure candid communication.

The catastrophic failures of Thomas Cook and Carillion were caused by a number of factors, and preventing such collapses happening again will require changes in a similarly broad range of areas. Regulatory change, such as the new instruction that large firms separate their auditing and consulting branches, will play their part. But if the auditing sector is to see any significant change in the quality of audits produced (reflected in the reports from the FRC), it needs to be proactive in changing the attitudes that let biases fester and hide problems in the name of keeping clients happy.

A commitment to Emotional Intelligence values of high-trust relationships, candid communication, and personal accountability will begin to build a culture where obstacles are identified and dealt with long before thousands of holidaymakers find themselves stranded on foreign shores.

If you would like to explore further how world-class Emotional Intelligence training can boost quality, productivity, and value, why not get in touch to discuss how Summit’s individually-tailored courses can benefit your organisation?

https://www.summittraining.co.uk/organisational-learning/unconscious-bias-training/