Deficient audits and crisis of credibility

Audit reports are powerful documents in the world of finance. They are meant to be pillars of trust that help investors, banks, donors and regulators make sense of the often-complex world of corporate activity. As independent watchdogs, auditors provide a vital check on a company's financial health. Since no stakeholder can possibly sift through the millions of transactions a company records, they lean on auditors' opinions as a form of assurance. Investors look to these reports before putting money on the line, banks assess creditworthiness through them, donors verify the proper use of funds and even tax authorities rely on them to verify reported profits. However, when this watchdog stays silent instead of raising the alarm, the consequences can be severe and costly. Wrong decisions are made, resources wasted and confidence in companies suffer a serious blow. It is precisely this broad influence that gives auditors their central role in the system of financial accountability.

Yet, for all their power, audit reports have inherent limits. They offer neither absolute guarantees nor perfect insight. By their nature and according to convention, they only express an opinion based on sampling, estimation and judgment. A common defence from audit firms is that their role is to provide 'reasonable assurance,' not absolute certainty. While this is technically correct, it must not become a shield for careless practice. Users of financial statements rightly expect auditors to do more than simply endorse management's narratives. They expect professional scepticism, a proactive investigation of red flags and the application of sound, responsible judgment. 

Unfortunately, the standard of 'reasonable assurance' has repeatedly proven to be a low bar to clear for audit firms. Time and again investors have been misled and lost huge sums after relying on certified financial statements unravelled later. A well-known case is the 2013 scandal involving Tesco in the United Kingdom. The retail giant received a clean audit opinion from PwC, only for it to be revealed soon after that the company had inflated its income by £263 million. The misleading report cost investors heavily, including Warren Buffett who lost about $750 million on his stake.

Closer to home, Bangladesh has seen similar failures with equally devastating results. In 2023, several banks faced a crisis when audit firms failed to detect the massive burden of bad loans dragging them down. The audited financial statements of First Security Islami Bank Limited (FSIBL) that year, for example, reported non-performing loans of just over Tk 20 billion, less than four per cent of its total loans. On the strength of that report the bank received an A plus rating for long-term credit and ST two for short-term implying a healthy banking institution. But soon after the political change in August 2024, the truth emerged. Internal and central bank audits revealed widespread fraud and an actual non-performing loan ratio exceeding twenty per cent, a level that is considered dangerous. The bank's cash counters nearly shut down due to pressure from panicked customers trying to withdraw their deposits. It became clear that if the accounts had been prepared honestly, the bank would not have shown any profit at all which proved the certified audit report was completely divorced from reality. Just like FSIBL, multiple other banks were later found in similar situations where auditors rubber-stamped their financial statements without proper scrutiny.

So why does this keep happening? Part of the answer lies in the way audit reports have long been misused as tools of convenience. It was once common knowledge that many companies in Bangladesh prepared three different audit reports for the same fiscal year, each tailored to a different audience. One would be submitted to tax authorities showing losses or reduced profits to lower tax liabilities. Another would go to VAT authorities with understated sales figures to reduce VAT payments. A third, showing robust profits and high transaction volumes, would be presented to banks to secure generous credit facilities. Tax and VAT officials often searched for these alternate reports, knowing they could demand higher payments if they found them. The introduction of the Document Verification System (DVS) has curbed some of these practices by assigning a unique Document Verification Code (DVC) to each report, making it harder to produce multiple versions. But the problem has not vanished. Many audit firms have still not fully complied with the NBR's requirement that every audit report include a DVC. In practice some continue to sign off on financial statements without conducting rigorous audits that allow manipulation to persist.

When audit reports are not grounded in reality, it especially creates challenges for income tax authorities. Tax officials rely heavily on them to avoid the impractical task of verifying every financial transaction. This reliance, however, turns into vulnerability when reports are inaccurate and they can provide corrupt officials with a pretext to demand bribes as well. Standard practice sees tax officials accepting these reports at face value, only delving deeper if large-scale evasion is suspected. Otherwise, tax assessments are usually confined to clear, rule-based items like allowable expense limits and source tax deductions. But when in-depth investigations do uncover discrepancies, the Income Tax Act of 2023 allows for penalties against the chartered accountancy firm, with fines ranging from Tk 50,000 to Tk 200,000. However, compared to the massive losses such false audits inflict on the state exchequer, penalties amount to little more than a slap on the wrist, doing next to nothing to keep misconduct in check.

Audit firms must remember that their profession commands respect precisely because it serves the public interest. An audit report is only as credible as the integrity and effort behind it. If firms abandon professional standards, they erode the very respect that sustains them. In time their work will cease to be valued and the demand for their services will decline within the financial system as well.

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