Auditors’ Independence Risk  …the primary contributing factor in the financial sector’s woes

The responsibility for current financial sector ructions- with the collapse of five banks, namely The BEIGE bank, Sovereign Bank, The Royal Bank, The Construction Bank (Gh) Ltd. and UniBank – must be placed squarely on both the internal and external auditors of these banks. It is the foremost duty of the external auditor to express an opinion on the financial statement and also identify any financial misstatement. Internal auditors’ duties include giving assurance and consulting service through risk-based auditing to impact on the governance of these banks. These roles are handled by professionals who are supposed to be independent and give objective opinions, assessment, advice, advocacy and catalytic insights to both the board and management as well as the public.

External auditors’ opinions are to be fairly expressed and presented, and reported according to the generally accepted accounting principles. Audit approach and outcome is affected by four main elements: which are enterprise risk, engagement risk, audit risk and financial risk.

Enterprise risk affects the operations and potential outcomes of organisation activities. Engagement risk comes with an association to a specific client. Audit risk relates to when an auditor provides an unqualified opinion on financial statements that are materially misstated; and Financial risk relates directly to recording transactions and the presentation of financial statements. Auditors assess each firms risk based on inherent risk, control risk, and detection risk. The auditors’ independence risk influences these three risk elements.

Independence risk is when auditors are compromised in their assessment, investigation, and assurance and consulting service to objectives and untruthfully report on inherent business risk, control risk, and detection risk.

Inherent risk relates to vulnerability of transactions to be recorded in error; Control risk is failure of the auditor to prevent or detect misstatement; and Detection risk is failure of the audit procedure to find out material misstatement.  It must be noted that the independence risk is the most fundamental and vital asset of the auditing profession. Auditors provide value to capital, protecting the interests of both shareholders and the public.

The auditing professionals in Ghana must bow their heads in shame about this issue because of their independence risk. Auditing firms are focusing on their direct and indirect incentives instead of providing a true and fair opinion. The direct incentives which cause the independent risk are: auditing fees; auditors investing in client services and mutual funds; contingent fees; potential employment with both clients; and financial dependence.

The indirect incentive is that the one controlling the auditing process is involved in a personal or family relationship with the bank. The opinions expressed in their financial statements to the Bank of Ghana are all untrue due to independence risk. Even though independence risk can be mitigated by regulatory oversight, corporate governance mechanisms, auditing firms’ policies, auditing culture and individual auditor’s characteristics, the overriding financial and revenue factors blinded these auditors and prevented them from raising the alarm to prevent this current situation.

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Auditors address the question of how and why. In the current case of the five banks, the problems have been summed-up into inherent risk and control risk, or equity-related risk and operating risk. In financial management, we term them as risks of a financial decision and operating decision.

Whereas The Beige Bank, Sovereign Bank, The construction Bank (Gh) Ltd. and UniBank had an issue with equity or capital or financial decision risk, The Royal Bank had an issue with operating risk. The  auditing profession has in place a substantive test to be performed – classified into assertions, specific audit objectives and substantive audit procedures which should have been performed in order to have averted these situations.

Presented below this article is the substantive test for owners’ equity and liability as per the auditing standard which the auditors of these banks compromised on to give an unqualified opinion on the financial statements as forwarded to the Bank of Ghana, Ghana Revenue Authorities and the entire public. These auditors should have obtained sufficient, appropriate audit evidence to support their unqualified opinion. This evidence should have been relevant, indicated sources and evident hierarchy, and objective prose-subjective evidence.

The critical question is: can any of the stakeholders sue the auditors of these banks for their role in them collapsing? The answer is yes. This is because auditors have responsibilities and professional liability. It was the duty of those banks’ auditors to have detected material errors which included such things as mistakes in calculations, omissions, misunderstanding, misapplication of accounting standards, and incorrect summarisations and descriptions.

Auditors’ responsibility to detect material fraud

Auditors can be held legally liable for actions that represent a failure to perform professional services adequately. A case is cited in the court opinion: Larry Waslow, Trustee for Jack Greenberg, Inc. v. Grant Thorntons LLP; United State Bankruptcy Court for the Eastern District of Pennsylvania, where both the firm and auditing firm were found liable but later settled out of court with the parties.

The Judge ruled that the auditors had a responsibility to prevent fraud, but they failed. In the same vein, auditors of these banks could have helped the Bank of Ghana in their audit risk (inherent risk, control risk and detecting risk) assessment of these banks and expressed their opinions as qualified or adverse or disclaimer but for their independence risk.

I think that it is time for any stakeholder of these affected banks to sue their auditors for this professional failure. It will serve as a warning and a sit-up call for all the auditing firms in Ghana to uphold these professional standards and not to be compromised by the direct and indirect incentives they obtain from their clients.

Both internal and external auditors work to assist the regulatory supervision role of the Bank of Ghana. Primarily, it would save the nation the GH¢5.7billion bond to be raised by government to invest in the Consolidated Bank in order to harmonise the financial sector. I conclude by saying that the auditing profession in Ghana is liable for the GH¢5.7billion recapitalisation cost.

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Owners’ Equity Account

Assertion Specific Audit Objective Substantive Audit Procedure
Existence/Occurrence Share capital recorded as issued was issued, and recorded dividends were declared Examine the corporate charter for the number of authorised shares and determine that the entity is in compliance.

Examine minutes of the board of directors’ meetings for authorisation to issue shares, pay dividends, split shares, or purchase Treasury shares.

Perform analytical procedures

Completeness All issued share capital and declared dividends are recorded Based on a reading of the minutes of the directors’ meeting, determine that all declared cash or share dividends and approved shares splits have been recorded.

Confirm with the outside share registrar and share transfer agent (a) the number of shares issued and outstanding; and (b) the dividend paid. Alternatively, foot shareholders’ ledger and reconcile it to the general ledger and the share certificate book. Account for all certificates

Rights and Obligations Share capital transactions represent an ownership interest in the entity Examine remittance advice for cash receipts for shares issued during the period under audit. Examine paid cheques and the shares certificates for shares repurchased. Trace authorisation for dividends to minutes of the board of directors’ meeting.
Valuation/Measurement Shareholders’ equity transactions are recorded for the proper amount Recalculate earnings per share and dividend. Trace posting of dividends to the retained earnings account

Reconcile the shareholders’ ledger with the general ledger.

Verify the amount transferred from retained earnings for share dividends by reference to the published market price of the shares.

Presentation and Disclosure Shareholders’ equity transactions are recorded to result in presentation and disclosure Review the financial statements to determine the share capital, retained earnings, and earnings per share are properly classified, described, and disclosed

 

Liability

Assertion Specific Audit Objective Substantive Audit Procedure
Existence Debt and similar obligations in the statement of financial position exist at the balance date Confirmation of identified liabilities

General procedures

Completeness The statement of financial position includes all debt and similar obligations incurred at the balance date General procedures

Analytical procedures

Rights and Obligations Debt and similar and obligations are legal or specific and definite obligations of the entity General procedures

Inquiry

Measurement Non-current liabilities are recorded in the correct amount. The cut-off is not usually a major issue because there is not a continuous flow of transactions relating to this account. Tests as to whether the recording takes place in the correct period are usually included under existence and completeness. Test clerical accuracy of listing for non- current liabilities
Valuation Debt and similar obligations are presented in the proper amounts. Recomputation, vouching and tracing
Presentation and Disclosure Debt and similar obligations are properly described and classified and related disclosures are adequate.

 

General procedures

Inquiry

     

 

The writer is a  Ph.D. in Commerce (majoring in Accounting and Finance) candidate, Adventist University of the Philippines, Putting Kahoy, Silang, Cavite, Philippines

Email: wpeprah@yahoo.com

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