Will Wirecard's collapse lead to big changes for the accounting profession?

Bartholomeusz, S , July 2020, The Sydney Morning Herald

Could the collapse of German payment firm Wirecard be a similar catalyst for changes to theaccounting profession as Enron's controversial implosion was in 2001?

Wirecard's collapse,with its "missing," or non-existent, $3 billion of cash, is coinciding with

reforms to auditors' firms in the UK that were already being contemplated and in train. The impact of the coronavirus, by cutting off access to capital and cash for struggling companies, might reveal more frauds and add to the momentum for change.

On Monday the UK's Financial Reporting Council, which regulates auditors, accountants and actuaries, announced its principles for operational separation of the "Big Four" accounting firms: Deloitte, PwC, Ernst & Young and KPMG.

In effect, audit practices will be ring-fenced from the rest of the firm, with separate staff and separate accounts to avoid cross-subsidisation of audit practices by other parts of the firm. With consulting businesses that are usually more profitable than auditing, there is a perceived risk of conflicts of interest and contamination of audits.

The firms will have until June 2024 to complete their operational separations.

The reforms are part of a suite of recommendations from a review of the quality and effectiveness of audits by former London Stock Exchange chairman, Sir Donald Brydon, which was completed late last year.

The review was prompted by a string of corporate failures, most notably the big construction services group, Carillion, in 2018. Its recommendations have, however, been given a sharper focus by the collapse of Wirecard and the failure of its auditors, EY, to uncover what it has described as

an "elaborate fraud" enacted over a number of years.

In fact, there had been external cynicism about the previously high-flying Wirecard's financesfrom journalists for more than a decade, along with several investigations by Germany'sregulators.

Even without Wirecard to provide a focus for reform the Brydon review was being watched closely by regulators and legislators elsewhere.

In Australia, the Parliamentary Joint Committee on Corporations and Financial Services has been conducting its own review and published an interim report earlier this year, with a final report (delayed by the coronavirus outbreak) scheduled to be delivered in December.

In the committee's interim report it recommended: more disclosure of fees for audit and non- audit services; an explicit prohibition on some services that audit firms can provide the companies they audit; a prohibition on audit partners being remunerated for selling non-audit services to audited entities; the introduction of a quasi-mandatory tendering regime for audits and a review

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of the effectiveness of reporting requirements in preventing and detecting fraud, among other measures.

EY has been caught up in a class action in relation to Wirecard's collapse, which has been likened to the collapse of Enron, where there was also large-scale and elaborate accounting fraud.

Enron's auditor, Arthur Andersen, was indicted and convicted in 2002 by US authorities for its rolein facilitating the fraud and the collapse and the venerable firm-it was founded in 1929-imploded even though the US Supreme Court later over-turned the conviction. Its consultancy and out-sourcing businesses, which had split from the firm just ahead of Enron's collapse, survive and

have prospered as Accenture.

Then, and now, there has been a lot of debate about the role of auditors and its limitations.

Auditors have long (and frequently) referred to an "expectations gap" between what they are legally required to do, and what the wider public thinks and expects them to do.

Audit statements generally say that the company's accounts provide a "true and fair" view of the state of the company's affairs and that the financial statements have been presented inaccordance with accounting standards.

While there is some responsibility on auditors, in providing their assurances, to uncover frauds,that isn't their primary function.

The Wirecard, Carillion, Enron, Parmalat, and many other big collapses involved quite elaborate and difficult-to-detect accounting frauds. Auditors argue that their primary role isn't to uncoveror go actively seeking frauds of that complexity and involving such sophisticated deceptions.

Brydon dealt with that in his review by saying that the "expectation gap" is a distraction.

The purpose of an audit was, he said, to help establish and maintain deserved confidence in a company and its directors and the information in their reports and financial statements. He wantsto see the auditor's role expanded to enable them tohave access to and consider information beyond financial statements.

The scope of an audit would be very different if, rather than having a reasonable expectation thatfinancial statements don't contain material misstatements, auditors were actively obliged to detect fraudulent activities and pass public judgements on the internal controls that companies themselves have in place to prevent and detect them.

Given that the companies choose and pay the auditors-whose firms might also provide other, more lucrative, non-audit services-an enlarged, more expensive and potentially more dangerous role for auditors generates ancillary questions as to who should choose the audit firm and decide the fee structure.

There have been suggestions in the past that the Australian Securities and Investments Commission should appoint auditors from a panel it has approved.

In the wake of the big corporate collapse the role of auditors is always the subject of intense scrutiny and discussion (they are of great interest to creditors and shareholders because they have

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professional indemnity insurance) but the primary responsibility for ensuring solvency and preventing fraud does, of course, sit with directors and managements.

Auditors are a third, or perhaps fourth (after internal auditors) line of defence. That doesn't mean that there shouldn't be discussion about, and reforms to, the breadth of their role andresponsibilities, or structural approaches to dealing with conflicts of interest, but there will always be practical and financial limitations to the ability of external auditors to deliver on the more ambitious expectations that the community has of them unless those the very nature of an audit is transformed.

REQUIRED

1. a)What is the 'expectation gap' mentioned in the article? What are the anticipated consequences when there is the expectation gap? [4 marks]
2. b)How would you expect the Ernst and Young (EY) to react to their involvement with this accounting scandal as in the given case? Your answer will depend onwhether you believe the legitimacy of the EY to be threatened and why/why not. Your discussion needs to explain a specific theory and strategies that can be used within that theory that links to the discussion from the article. You should discuss possible1) TWO possible future actions/strategies of the EY 2) expected outcomes of each possible future actions and 3) ethical considerations for each action. You shouldrecommend ONE most appropriate action for EY.