Will Wirecards collapse lead to big changes for the accounting profession?

The Sydney Morning Herald Could the collapse of German payment firm Wirecard be a similar catalyst for changes to the accounting profession as Enrons controversial implosion was in 2001?

Wirecards 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 UKs 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, that 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 Wirecards finances from journalists for more than a decade, along with several investigations by Germanys regulators. 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 committees interim report it recommended: more disclosure of fees for audit and nonaudit 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 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 Wirecards collapse, which has been likened to the collapse of Enron, where there was also large-scale and elaborate accounting fraud. Enrons auditor, Arthur Andersen, was indicted and convicted in 2002 by US authorities for its role in 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 Enrons 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 companys accounts provide a "true and fair" view of the state of the companys affairs and that the financial statements have been presented in accordance with accounting standards. While there is some responsibility on auditors, in providing their assurances, to uncover frauds, that isnt 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 isnt to uncover or 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 wants to see the auditors role expanded to enable them to have access to and consider information beyond financial statements.

The scope of an audit would be very different if, rather than having a reasonable expectation that financial statements dont 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 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 doesnt mean that there shouldnt be discussion about, and reforms to, the breadth of their role and responsibilities, 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 a) How would you expect the Big 4 accounting firms such as EY, KPMG, PwC and Deloitte to react to their involvement with this accounting scandal as in the given case? Your answer will depend on whether you believe the legitimacy of the Big 4 accounting firms 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 possible 1) TWO possible future actions/strategies of the Big 4 accounting firms, 2) expected outcomes of each possible future actions and 3) ethical considerations for each action. You should recommend ONE most appropriate action for Big 4 accounting firms.

b) From the article provided above, the Parliamentary Joint Committee on Corporations and Financial Services recommended that the accounting firms disclose more information regarding their fee structure for audit and non-audit services. From the perspective of Stakeholder Theory, do you think whether Big 4 accounting firms such as EY, KPMG, PwC and Deloitte will disclose more information regarding their water usage and why/why not. Your discussion needs to make reference to the specific perspective from the Stakeholder Theory that links to the discussion from the article with an explanation of the theory.