Why Audits Go Wrong: An Overview

When a company collapses after a clean audit opinion, the immediate question is always the same: where were the auditors? But audit failure rarely starts in the audit file.

In this episode, we unpack why audit failure is often the result of deeper issues from poor client acceptance decisions to weak systems of quality management and commercial pressures inside audit firms. We explore how audit failure develops as a cascade, driven by human judgment, cognitive bias, and a lack of professional skepticism from the very beginning.

What you’ll learn:

•  Why audit failure rarely starts with audit procedures
•  How poor client acceptance decisions create downstream risk
•  What the “cascade of audit failure” looks like in practice
•  How cognitive bias distorts audit judgment and evidence
•  Why commercial pressure undermines professional skepticism
•  Where audit quality really breaks down — and when it should have been identified

If you think audit failure is just a technical mistake, this episode will challenge that assumption and show where things really start to go wrong.

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🔗 Connect with us:
LinkedIn: Wayne Basford & Judith Leung
YouTube: @BasfordConsulting
Website: basfordconsulting.com

Transcript

SPEAKER_01 0:00

Welcome to Financial Reporting Conversations brought to you by Baster Consulting.

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We're here to make the unknowns and known as accounting, auditing and climate standards known so you can avoid the blindfredding mistakes and do financial reporting better.

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Each episode will unpack what the standards really say, what they mean in practice.

SPEAKER_00 0:18

Whether you're a preparer, auditor, director, or litigator, our aim is to help you get it right. When a company collapses shortly after receiving a clean audit opinion, the public reaction is usually immediate. Where were the auditors? And the assumption behind that question is usually the same. The order failure must have happened in the audit file. A misprocedure, a technical mistake, a lack of scepticism right at the end. But that is rarely where order failure actually begins. In many cases, the real causes have been developing long before the audit opinion is signed. Welcome to Financial Reporting Conversations. In this series, Why Audits Go Wrong, we examine the deeper causes of audit failure and the conditions that make order quality difficult to sustain. In today's episode, we're looking at a fundamental misconception. Do audit failures really start in the order file? And as usual, I'm here today with Wayne Bassford. Wayne, let's start with a fundamental misconception. When a corporate failure follows a clean audit opinion, people tend to assume that the problem must lie somewhere in the audit work itself. From your perspective, is that usually where audit failure begins?

SPEAKER_01 1:31

The simple answer is no. And looking at this from a root cause analysis, the real when anything goes wrong, do you look at was it the audit partner, was it the audit senior manager, or did the firm get it wrong? Why was the firm allowing that audit partner to do the work? Why did the firm put that team together? And it really goes to the firm's system of quality management, its culture. So very likely weak leadership, commercial pressures to accept that client, commercial pressures not to staff the audit properly. It's an it's an ineffective system of quality management. And most likely all those auditors were under pressure. And it's the system of quality management, it's the firm's culture that has put those that audit team under pressure that they've missed a material misstatement.

SPEAKER_00 2:30

Thanks, Vine. So one of the key themes of this series that we're going to explore is that audit fay is rarely just a technical mistake. Why do you think that misunderstand persists?

SPEAKER_01 2:41

It is a question of what is the mistake. Now, I'm still of the opinion if you correctly follow the audit standards, 99% of the time an auditor should identify a material misstatement. And but I'm looking at why it all goes wrong, and I've got a great graphic I will have put up on LinkedIn before this goes out, and I'm describing it as the cascade of audit failure. So the cascade of audit failure is we shouldn't have accepted the client, it was too risky, or we hadn't got the resources to do the audit. And then next bit of this cascade is we just don't understand the business enough. We don't understand the business enough, and because we don't understand the business, we don't understand the risk of misstatement. And then this cascades down. If we don't understand the risk, if we don't identify the risk of material misstatement, we don't respond to those risks, we don't do the required procedures, we don't get sufficient appropriate audit evidence, and we then give an unmodified audit opinion with a material misstatement, and then everybody asks what went wrong, and it is this cascade. Very likely you should never have accepted that client. Or even if you did, why didn't you understand the business? Did you understand its new acquisition? Did you understand its new management? Did you understand its new product? And it's that lack of understanding right at the start that then cascades down to audit failure.

SPEAKER_00 4:19

Another theme we're explored in this series is the role of human judgment in auditing. Auditing standard appear very structural, like when you said, you know, you start from the beginning about accepting a audit and very procedural, understand their business. But in reality, how much of auditing depends on judgment?

SPEAKER_01 4:38

It's judgment and its human nature and its bias and personal interests. So, speaking as an auditor for a long, long time, almost there is no reward from finding something. If you find an error, it is really painful. You have to work. You've got the problem of more work because the client is most likely going to challenge you, so you've got to go and do more work on it. The client is very, very upset. And we are client-driven. Every firm says we are client-focused, and we are commercial organizations. We like having clients, we like retaining clients. So finding something that's going to upset your client is just against human nature. And you do get you see people that are auditors, it's different styles, different bedside manners. Are people confrontational? Do you want to agree with the client? Do you challenge the client? Do you shake your head and say, Well, I'm not quite sure that made any sense, but I'll write it down. It is judgment. Is that sufficient evidence? Have I got enough evidence? Does that client know what they're doing? Is the control right? It's all judgment. And once you get into judgment, the world gets difficult.

SPEAKER_00 6:15

And so you've talked about evidence and interpreting that evidence. Can you explain a bit more about this confirmation bias anchoring on evidence and how the interaction of the two?

SPEAKER_01 6:29

The phrase is cognitive bias. So we're all driven by our set opinions. We do not go into any conversation with an open mind. You walk into a room, you almost look around that room, you've made your decision of who you want to talk to, who's going to be interesting, who's going to be boring, who's going to be trustworthy. That's just welcome to a dinner party. When you're auditing, it's the same thing. You will have formed a view that that financial controller is honest. That financial controller knows what they're doing. That CEO knows what they're doing. So you've now got bias. And no matter what that person says to you, you are driven to trust that person perhaps more than you should do. You've also got anchoring. Somehow I have decided a number is right. And rather than saying there are three, four options of what the number could be, and rather than being saying, well, maybe we shouldn't have recognised any revenue at all, maybe we're acting as agent versus rather than principal, you come in with a view, we are recognizing revenue. That's it, we are recognising revenue, we are selling, and you've everything that you're trying then to question is biased because you've walked in with an anchored opinion.

SPEAKER_00 8:09

In the perfect world, we should be going in with an open mind. I guess it's sounds from what you're talking about. It's a human nature, it's what you built with these biases as we walk into a room or walk into a dinner party.

SPEAKER_01 8:24

From an auditor's world, we are supposed to apply the appropriate level of professional skepticism. So these biases that we trust people wrongly, we have a set view of their number is right. And this is all you know the audit problems. In hindsight, the audit is littered with contradictory audit evidence. But because we were anchored that the client's position was correct, we've not really looked at that contradictory audit evidence, or we've gone in there that the client's position is right and it's always going to be right until absolutely proven wrong. And that's not the way an auditor should think.

SPEAKER_00 9:12

If you're finding this discussion useful, please take a moment to click like, subscribe, and share. It helps others in the financial reporting community discover financial reporting conversations and keeps you up to date with every new episode. So thanks. So we've touched on that order quality isn't just about technical standards, it's also about judgment, behavior, bias, the environment in which the auditors work. So, and that brings us to another theme we'll uh examine deeper in this series is pressure inside the firms themselves. Professional skepticism is one of the core principles of auditing, but why is it harder to maintain in practice than it appears in the standards?

SPEAKER_01 9:55

Because going back to the base principle, finding an error is really not good for your life, your your paycheck, your draw, your work-life balance. So it's skepticism. And you upset people. You know, there it we are auditors, we're supposed to be sceptical, but again, human nature. People get upset if you if they're not believed. So if you're too skeptical, if you're too oh, you sure show me, then you will have genuine people get confronted that they're being challenged. But by the way, that is the the way a fraudster continually gets oversensitive. I think that does protest too much, is the classic reaction to when an auditor is asked the right question, but the client overreacts as to the trust. I saw a situation, it was a horrible situation. I was reviewing an audit file that may have been a failure, and the audit manager had picked the issue up, and the audit manager asked the question of the client, the correct question, and then the response was rubbish. The response didn't make any sense, and the audit manager was doing the correct thing, but the the politeness or fawning in the response was just horrible to watch. I know that this I'm very, very sorry for asking this again, but and in a ridiculously polite manner said this doesn't make any sense. And then in that manner, the audit manager spotted it, the client fobbed it off, and then the audit partner managed to make it go away. And the audit manager has spotted it, but you did not want for client service, you don't want to keep on questioning the client. And all of us, it is now the 25th of September, you've got five reports that still need to go out by the 30th of September. How sceptical do I do I need to do it? There's all sorts of things going against why I should be skeptical, and it's commercial. It is commercial. I challenge somebody, they're correct, they are justified, I challenge them, they get upset about me challenging them. I spend a lot of time, a lot of hours going down this route that turns out no, the client was right. Well, can I recover that time? Will I lose the client? So there's so much against being as skeptical as we should. The key aspect, and this is training on it, you know, it is a question of training auditors in the culture. What is the polite way to question? What is the subtle way of asking it? And a lot of this going back to audit process, skepticism needs to start at the planning phase. It's not a problem being skeptical and saying, Well, I'm gonna need this information, having that conversation in May, having that conversation in June when you're doing the planning and doing the risk assessment, suddenly deciding that you're gonna be skeptical at the 27th of September isn't really the time to be skeptical.

SPEAKER_00 13:34

Maintain professional skepticism throughout the audit.

SPEAKER_01 13:37

Now, this is audit failure. You know, looking at audit failure, typically, and hindsight is 2020, you go through the audit files, you look at the situation, you read the board minutes, you see most times the audit evidence was there to say the accounts were materially misstated. The audit evidence was there to say there's material uncertainty about going concern. Material, there's evidence there the asset isn't really working as well as it should. We have not been skeptical when we've looked to that contradictory audit evidence, and there's the audit failure.

SPEAKER_00 14:14

When you mentioned about pressure, commercial pressure, which is another theme that we'll be exploring in this series, how does that affect order quality?

SPEAKER_01 14:23

It's massive. We are a business, and you've got two aspects of it. We are a business, and certain firms, certain partners, are just driven to win clients at any cost in order to get promoted to the next level, the next banding, in order to stay employed, you need to win work. Audit partners are supposed to be rainmakers, audit partners have got just commercially, there's a base level of fees they're supposed to have. Now, what does that drive? It drives two things. It drives winning clients you really shouldn't win, retaining clients you shouldn't retain, and low balling. I'm gonna win this, and this is the market, this is the horrible world of corporate governance in Australia. Let's buy audit as the cheapest level. It causes audit failure. And I've won the audit, I get measured on recoveries, I get everybody gets measured on recoveries, my managers get measured on recoveries. Well, how am I going to get a decent recovery on this? I'm going to do less work. I do less work on a risky client, audit quality goes wrong, audits go wrong. I collect all these small clients. I'm a very good audit partner, but there's only so many hours in the day. There's only so many files I can review in that last week in September. Why what's the risk of me missing something in that last week in September? Well, it's again the root cause. It's a business, most likely the firm's leadership, the firm's remuneration model is pressurizing, causing audit failure. You know, and rhetorically, anybody listening to this, how many people's REM model rewards new clients? One rewards the size of the audit portfolio, rewards profitability versus doing a good job doing quality. Most auditors are driven by fees and recovery, and it just leads to audit failure. It's one of the components of audit failure.

SPEAKER_00 16:49

Another thing we're gonna explore in this series is systems or quality management within audit firms. Why are these systems so important?

SPEAKER_01 16:59

As I said, going back to the opening question, the system of quality management, if there is an audit that goes wrong, it really shouldn't be a question of was it the engagement partner? Was it the was it the senior, what was it the senior manager? All audit failures should be let's look at the head of audit. Let's look at the firm CEO. How did the head of audit let this failure happen? What was the tone at the top? How did they let that audit partner retain that client or win that client? Did they give that audit partner appropriate staff? Were the staff the audit partner was working on appropriately trained? Had they got the appropriate experience? Or even if they were trained and had got the appropriate experience, were they given enough time? Were those staff overworked and stretched too thin during the audit process? And it all goes to this system of quality management, ASQM1, and a lot of audit failure wonderfully goes tone at the top. If you've not developed a culture of audit quality, audit failure's gonna happen.

SPEAKER_00 18:23

Why does tone at the top how does that the tone at the top shape the culture?

SPEAKER_01 18:28

The head of audit, the managing partner, what do how do they create this quality culture? Do they just keep on driving fees? Well done, this is fees. We would like to congratulate Judith for winning this other audit. Do you promote quality? Or do you just want to win fees, celebrate fees? Who do you promote? Do you promote those people that are diligent or do you promote the salespeople? If somebody's done a shortcut on an audit, if you know somebody as an audit partner isn't doing their CPD, or their senior managers aren't doing their CPD, do you take any action? Or is it just because they're managing a portfolio of two million, they're they can get promoted to the next level. So everything is toned at the top. Did they give enough budget for training? Are they going for the cheapest training they can? Because as soon as you say you can't go on that training, or I want to cram 200 people in one room looking over at one little screen. Well, what's that telling the people that are doing the work? And you know, there should be surveys of staff. Well, does the firm's leadership put quality first or does it put fees first? And if I'm being skeptical, I'm I would be wary of the answer to that.

SPEAKER_00 20:08

So I know this series is based on a course that you'll be writing and running one of our webinars on why audits go wrong. What is the key message you want people to take away from this series and from if they want to attend a training?

SPEAKER_01 20:23

It's been it's actually been fun writing the course, and as some of you may have seen, it'd be fun creating some of the graphics for the the course. And it's trying to work out what is audit failure, and it's it's made up of just so many components, and we're trying to run through those components. So you've got the components of system of quality management, turn at the top, then you've got all this human nature, human nature, not being skeptical, cognitive bias, need needing to have an easy life, uh, wanting to earn a living wage, and then you've got factors we'll go into is change. When you actually look at where the audit failures come from, a lot of it is something changed in that organization, and nobody spotted it for all of this negativity about audit failure. Remember that in my opinion, the real failure is the audit committee chair. When these companies have issued materially misstated financial reports, they're approved by the directors, they're approved by the audit committee. The directors and the audit committee are supposed to have appropriate controls in place to identify that material misstatement. So ultimately, if the accounts are wrong, it rests with the directors. Where the auditors have gone wrong is they've trusted the directors. This idea, the number of times you see We believe it's got a good control system, it's got good governance, it's got a good board, and the real audit failure is they got that wrong. That judgment by the audit partner from the acceptance, continuance, and then all through the audit, that's what the auditor got wrong. So it's a fun series.

SPEAKER_00 22:18

In this series, to recap why audits go wrong, we'll be exploring these issues in much greater depth. We'll look at how audit failures develop over time, how commercial pressures influence behaviour, how leadership and quality management systems shape audit outcomes. And so thank you for joining us this overview of why audits go wrong, and we'll hope you join us next time. We'll continue examining the deeper issues on why audits go wrong. Thanks for joining us in Financial Reporting Conversations.

SPEAKER_01 22:48

Thanks for listening to Financial Reporting Conversations. For guidance on applying accounting and auditing standards, or to access our online training programs, please visit busfordconsulting.com.

SPEAKER_00 22:59

Don't forget to like, subscribe, and share this episode with your colleagues and contacts. We'll see you next time where we make the unknowns in financial reporting known.