CAN AUDITING PREVENT FUTURE GLOBAL FINANCIAL CRISES?
After the breakdown of the worldwide economy in 2007 and 2008 had led many researchers to doubt concerning what the particular explanation for the crisis was. Many came up with points like free market, excessive risk-taking, etc as reasons behind global economic turmoil. While none of them found that auditing was a root explanation for the financial crisis.
Why is auditing important?
Auditing provides credibility to companies’ financial statements and is therefore absolutely fundamental to the success of the capital market. If you’re thinking of shopping for a business, buying shares of stock during a corporation, or lending money to an organization, you’d wish to understand that the numbers within the company’s financial statements are legitimate. Auditors create value by serving as an independent, third-party that rigorously examines management’s assertions within the financial statements and allows you to understand whether these assertions are often trusted. If investors and creditors have no way of knowing whether or not they will trust companies’ financial information, they go to be hesitant to require an edge or lend money to firms – this will cause markets to grind to a halt.
Enron could also be an excellent example of what happens when the numbers within the financial statements cannot be trusted. Investors lost billions of dollars when it had been discovered the Enron’s financial statements were fraudulent. an accurate audit could have detected this much earlier and mitigated the damage, but Enron’s auditor didn’t do its duty and was subsequently indicted for its role within the affair.
Excessive risk-taking and thus the worldwide financial crisis; Where do auditors come in?
The financial crisis has shown clearly that excessive risk-taking is extremely harmful to the health of the worldwide financial economy and it’s time that auditors got to re-examine how they assess risks. This recent financial crisis which may only be compared thereto to the good depression of the 1930s shows how banks failed miserably in monitoring and assessing risks. Excessive lending to bank customers who couldn’t pay back the borrowed amount caused liquidity in banks to dry up and escalated the financial crisis.
Whether proper internal auditing could prevent this recent financial crisis or mitigate future occurrences of such an economic downturn?
According to a report published by the worldwide Audit Information Network (GAIN) in 2009, the impact of the worldwide financial crisis on many organizations around the world necessitated some research to live to the extent to which the crisis has impacted internal audit activities. Mindful of the above, the Institute of Internal Auditors (IIA) and IIA Research Foundation (IIARF) surveyed early March 2009 asking participants — mostly CAEs — specific questions regarding the overall impact of the economic slowdown on their organizations and, subsequently, their overall internal audit efforts. An analysis of the survey uncovered five key findings:
1. The economic recession has impacted not only organizations but their respective internal audit activities also.
2. Internal audit activities are shifting risks that gained a large focus in recent years and focusing more on emerging risks that resulted from the changing economic conditions.
3. A majority of testees afflict the statement that better risk management could have played a task in preventing this crisis, yet most testees agree internal auditing could have done more to assist their companies in identifying key risks.
4. Changing stakeholder expectations are impacting the most target of internal audit efforts.
5. Internal audit oversight and coverage of emerging risks associated with the acceptance of state stimulus funds are lacking.
Discussions and Critical Evaluation
We have seen that the worldwide financial crisis erupted mostly as a result of risky undertakings by many companies and financial institutions. The very fact that banks are financially leveraging institutions that make money by taking risks further complicates the boundaries as to what should be considered an appropriate risk. After this crisis, many corporate governance reforms have been put in place, especially those linked to internal risk management, and the responsibility of internal auditors is broadened and emphasis are placed on internal risk control and management.
Auditors got to advise their clients on matters concerning excessive risks and notify the independent members of the board of directors of any deviations from the maximum risky benchmarks set by the company.
Previous corporate scandals and the recent financial crisis also point to the fact that there is a need for proper accounting procedures in companies, especially financial institutions. Fair value accounting also needs to be revisited if the need arises. Also to make accounting information reliable companies must conform to the recent corporate governance reforms post-SOX that advocates the constant rotation of external auditors who will subject the accounts of all the businesses under serious scrutiny and present an audit report at the annual AGM as to whether the accounts present a real and fair view of the business in question. Keeping the same audit firm for a long time (say more than five years) in the same company as external auditors can complicate the objectivity of auditors and impair their independence. This is because this audit firm could also be scared of losing a lucrative client.
From the above, I conclude that the global financial crisis came as a result of excessive risk-taking on the one hand and high irresponsibility on the other hand. Auditing may indeed need to be gone an extended thanks to reducing the gravity of this crisis. But to mitigate future occurrences, it is going to take more than just auditing to stop it since much research points to the very fact that auditing alone was not enough to stop the crisis. Therefore, the varied stakeholders involved in business management (CEOs, auditors, employees, government…etc) must stand up and do their homework. Auditors must also try as much as possible not just to do the thing right but also endeavor to do the right thing. This calls for the incorporation of a professional code of ethics and conducts in all businesses and a need for each stakeholder to acknowledge that the other affects us despite ourselves so that they won’t be narcissistic while they perform their functions within the business.
Muhammed Zakir Hossain; Global Journal of Management and Business Research; https://journalofbusiness.org/index.php/GJMBR/article/view/2748/2649