Hercules managed to clean the Augean stables in just one day. His superhuman strength would certainly be beneficial to us today, primarily in cleaning the world of insatiable greed – although it would take him a bit more time because there are, for example: irregularities in FIFA, athletics and doping, Volkswagen’s cheating on emission tests, bribery allegations against pharmaceutical manufacturers, leading banks accused of tax evasion and avoidance. So let us ask ourselves how many clients today would express trust in the integrity of banks? And what about accounting and auditing?
Games with bookkeeping
It seems that the continuous efforts to restructure the business management process (government/administration) have not succeeded in reducing the temptation to falsify numerical amounts in financial statements. All business regulations that stifle companies, hefty fines, and longer prison sentences have failed to achieve anything in improving financial reporting practices. The first prize for questionable reporting should be awarded to Toshiba – not only because of the volume (almost two billion dollars, or 1.3 billion pounds of overstated profits) but also due to the fraud that continued for almost seven years. This is referred to as the well-known problem of ‘corporate culture’: superiors set impossible goals and subordinates take accounting shortcuts to meet them – prematurely recognizing revenues and deferring the recognition of expenses.
When in 2009 the CEO learned that the company was heading for a loss of 1.5 billion dollars, he stated that the result was so embarrassing that it should not be published. Therefore, his compliant subordinate associates made an operational intervention and a profit of four million dollars was published. Any cynical person could assume that the style and volume of deviations are consistent enough year after year that they cannot be detected by the basic analytical tests of the Japanese auditing firm Ernst&Young ShinNihon LLC (EYS). However, auditing tools should have evolved in a way that keeps pace with the possibilities of fraud, and it is astonishing that EYS’s procedures failed to alert auditors to fraud of such magnitude, which in itself nullifies all the value of their work over six consecutive reporting periods. The fraud was, in fact, immediately exposed by external experts using advanced digital forensic technology.
Blind auditors
The euphemistic technical jargon of auditors reveals itself just as much as it alarms: although Toshiba’s Westinghouse project showed losses of 332 million dollars, the company insisted that the loss be reported as 225 million dollars. The company’s interpretation prevailed and 107 million dollars (equivalent to 25% of pre-tax profit for that quarter) was simply classified in the audit records as ‘unadjusted misrepresentation’. As if that figure does not pertain to material value.
Tesco’s practice of misreporting has much in common with Toshiba’s. When senior employees realized that the sales targets set by management would not be met, they went so far as to book rebates on payments to suppliers that were a condition for achieving those targets – meanwhile secretly agreeing with suppliers to accept delayed payments. The result? In some cases, Tesco had to pay its suppliers without rebates.
When the largest public companies promote a culture of achieving profits in such a short period, it is the auditors’ (PwC in Tesco’s case) duty to always expect or anticipate their tricks. In his brilliant analysis of fraud in the American Equity Funding Corporation in 1970, author Raymond Dirks succinctly explained the standard comment that routine audit procedures are not designed to detect fraud: ‘If routine audit procedures cannot detect 64,000 false insurance policies, 25 million dollars of forged bonds, and 100 million dollars of missing assets, what then is the purpose of an audit?’
