Why Audits Go Wrong: Are Audit Failures Caused by Resource Constraints?

When audit failures occur, the focus almost always turns to the audit file — missed procedures, weak evidence, or poor judgment. But what if audit failures are actually driven by something more fundamental?

In this episode, we examine whether audit failures are caused by resource constraints within the engagement team. From insufficient technical expertise and lack of industry knowledge to unrealistic time budgets and staffing pressures, we unpack how these resource constraints can undermine audit quality before the audit even begins. 

We also explore how audit failures often reflect deeper issues in firm-level quality management, leadership decisions, and commercial pressures.

If you think audit failures are simply technical breakdowns, this episode will challenge that assumption.

Financial Reporting Conversations is brought to you by Basford Consulting helping professionals go beyond compliance and get financial reporting right.

For technical insights, training, and resources that make the unknowns in financial reporting known, visit basfordconsulting.com

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

Transcript

SPEAKER_01 0:00

Welcome to Financial Reporting Conversations brought to you by Bass for Consulting.

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We're here to make the unknowns anonymous of accounting, auditing and climate standards known so you can avoid the blindfredd 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 the company collapses shortly after receiving a clean audit opinion, the explanation is usually technical. Maybe the auditors missed the procedure. Maybe they didn't gather enough evidence. Or maybe a professional scepticism was lacking. But what if the problem started somewhere else? What if the engagement team never had the resources necessary to perform the audit properly in the first place? That's the topic behind today's discussion. Welcome to Financial Reporting Conversations. In this series, Why Audits Go Wrong, we explore the pressures and decisions that shape audit quality. And today we're examining a question that the profession doesn't always discuss openly. Are some audit failures actually the result of insufficient engagement team resources? And as usual, I'm joined by Wayne Bassford. Wayne, let's start with this topic, today's topic. You argue that at least some of the drivers of audit failure may be insufficient engagement team resources. Why do you think this issue receives so little attention?

SPEAKER_01 1:30

Because it's a nasty secret, and we don't want to mention a couple of problems. And you know, lack of resources means two things. You've got the resources are the audit team really didn't know what it was doing. And that can be from the audit partner down to the managers, senior managers, seniors. They really didn't know the accounting standards, they didn't know the auditing standards, they hadn't got a clue what that industry did, and they were incapable of even identifying the risks to respond to those risks. So you've got the key weaknesses, the team didn't know what they were doing, and because we're on video and because it's one of my favorite quotes, you know, the Parliamentary Commission into the Karellian collapse came up with a classic quote that I love: I wouldn't trust KPMG to audit the contents of my fridge. Now, I wouldn't trust KPMG to audit the contents of my fridge implies they've not got the resource to do an audit. And when you look at some of the responses that the big four have had and publicly had that they've accepted the audit failure, was they needed to train their staff better, they needed to train their partners better. That's one level of resource, and it is a nasty well, nobody in this firm knew what to do, and complete ignorance of accounting, auditing, and and industry. And then the other lack of resources you just haven't put enough t time, you can't put enough staff on the job. The budget is too low, you didn't put enough people on it, or you just gave them insufficient time to do a quality audit, or even though you've put them on that job, on that time planner, they were actually too busy finishing off other jobs, so the resource was was lacking.

SPEAKER_00 3:42

Now, um auditing standards assume that fundamental to an audit is that the engagement teams have the competence and resources necessary to perform the audit. Now, this in real in practice, this assumption may not always hold true. Can you explain a bit more?

SPEAKER_01 3:59

Remember, it the foundations of that presumption are ISQM1 and then ISA 220, ASA 220. So the foundation of a quality audit is a system of quality management that makes sure you've got adequate resource. So you need to have an appropriate training program, an appropriate recruitment program, an appropriate appraisal process in the firm level, that you, as an engagement partner, you look at the staff planner and you say, Yep, that manager's suitable for doing a level of a manager, that's a suitably qualified person suitable for a senior. Now, this is the foundation, the firm must have a system of quality management. And then ACE 220, because everything stops with the the partner, the partner is responsible for making sure appropriate resources are allocated to an engagement. Are there enough people and do those people know what they're doing? Now that's the presumption, because we live in a world that the firm has a quality management system and the engagement partner has ensured appropriate resources are allocated to it. So that's the foundation of that assumption.

SPEAKER_00 5:28

A lot of large firms have a technical capability or a technical department. How does if lack of technical expertise affect an audit? Why is it necessary to have those resources?

SPEAKER_01 5:44

As we've been doing with the phrases of our survival courses, you don't know what you don't know. And accounting, and I keep on referring to, I've been doing this for 30 years and I'm getting very old. Accounting today is so much more complicated than it was 30 years ago. Revenue recognition, derivatives, derivative liabilities, it is so much more complicated, share based payments, and no auditor should be required to know all of this technical knowledge. The aim is they've can consult the resource, the ASQM1 resource is an auditor when faced with a problem can appropriately consult. They don't need to be reading the books from scratch. And now, as we're seeing more dangerously, they are asking Chat GPT questions rather than asking us questions, which at the moment ChatGPT is not as good as me and you, and ChatGPT can come up with some very convincing propositions that are 180 degrees wrong. So it is all firms, if they're doing audits, if you swim in the sea, you've got to accept the sharks. If you do audits, you've got to accept there's likely to be complex revenue recognition, there's going to be complex financial instruments. You need to have that technical backup.

SPEAKER_00 7:21

So we talked about this, it's important to have that technical backup as part of our resource suite. What about in industry knowledge? That that's also equally as important. Can you explain why that matters so much in auditing?

SPEAKER_01 7:36

We are supposed to understand the business, and we're supposed to understand the business in order to identify a risk of material misstatement. And this idea that all widget all clients sell widgets, every client is the same, all I have to do is send out a debtor's confirmation, get a bank wreck, do after date cash, attend a stock take, doesn't work. And if you look at a number of audit failures, they're the companies that don't fit into that model. So it's understanding trading, understanding derivatives, and you need to understand the business. I I had I followed on an audit years ago, and it was a commodity trader. I audit commodity traders, commodity traders are very similar to auditing a bookmaker. The trader believes that the price of wheat is going to go up, so they actually go long in wheat, or they believe it's going to fall down, they go short. It's a trading business. And I read an audit file that had been that this was like a normal manufacturer. And the margins are ridiculous, the volumes are ridiculous, but the person doing this audit did not understand the risks of trading and completely got it wrong. The number of times as we go through it, a lot of audit failures are construction, long-term contracts, the number of times I see auditors not understanding it's the cost to complete. The risk is the cost to complete. Please check that cost to complete. But I've got ticks all over uh a percentage completion spreadsheet. Because they can see, oh yes, that times that divided by that equals that, but they've not worked it out, they can't see where the risk is.

SPEAKER_00 9:39

Thanks, Wayne. So we can see that resources in auditing are not just about headcount, they're also about technical capability, experience, and industry knowledge. So, Wayne, what happens when an engagement team simply do not have enough time to investigate the issues properly?

SPEAKER_01 9:55

As we discussed on commerciality, the engagement turns into a filing exercise rather than an audit exercise. I have got no time to investigate, I've got no time to think, I really don't want to think about it too much because if I think about it too much, I'll do more work. I haven't got time to do more work and just tick, tick, tick, completed, completed, completed, completed, completed. Give me anything to put on my audit file. I don't care what it is, I won't read it. I just need to file it because I am a super filing clerk, not an auditor. That that's what happened.

SPEAKER_00 10:36

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. Yeah, so you touch on there is an interplay between you know commercialization and fee pressure and resources, and audit firms often heavily rely on junior staff to do the work. Is that a structural risk for audit quality?

SPEAKER_01 11:05

It is conceptually a structured structural risk, but the auditing standards say everybody has to be appropriately supervised. Everybody has to be supervised and their work has to be reviewed. The auditing standards say if you've got an inexperienced staff member, you provide more supervision. So it's not difficult, it's not rocket science, but it's when there's none of us available, we will just send out inexperienced staff to do risky areas. We won't supervise them, we won't uh review their work in detail, uh then things go wrong.

SPEAKER_00 12:01

And you've talked about uh you talked about insufficient time and having unrealistic budgets can arrow audit quality. Can you explain a bit more on why time pressure is particularly risky in auditing?

SPEAKER_01 12:15

Again, it's auditing it's supposed to be an investigative process. We're supposed to question things, we're supposed to reflect on does this tie in with that? That's an audit. That is the process of an audit obtaining and evaluating audit evidence. And as I say, horribly, we haven't got time, just give it to me, I haven't got time, give me that information, I'll file it, I'll file it, I'll file it. So that's a massive pressure. And remember as we came into the other issue on pressure, is I've asked for it too late. I'm doing the audit too late, I've not got the evidence I need. Even if I can work 24 hours for the next three days, I'm never going to be able to finish it. So that rush in that last week, you know, we used to look at the by hours, days, the number of files that are lodged in that last week in September. You step back from that and say, I don't believe there's enough hours in the day for the audit partners to be reviewing those audit files. I certainly question how the managers and seniors can be finishing those files off appropriately in that last week of September.

SPEAKER_00 13:40

And how does this like lack of time impact professional scepticism?

SPEAKER_01 13:45

I know I should be doing this. I really don't want to ask this question. If I ask this question, I'm gonna have to work another Saturday morning, I'm gonna have to work another Sunday afternoon, I haven't got time to ask this question on the 28th of September. The idea I need to ask that question, that doesn't quite work, that doesn't quite make sense, that's contradicted there. You there is so much incentive for the audit partner or down to the audit senior. Uh, don't be skeptical. That's the time pressure.

SPEAKER_00 14:21

So we've talked about uh resources from you know time not enough time, as um, you know, technical capability, industry experience. So when a firm audit firm lacks some of these resources, is this ultimately a leadership issue?

SPEAKER_01 14:37

The answer is yes. You know, going back to this base principle, whenever we see audit failure and they look at the audit failure and they name the audit partner, it was that audit partner, that audit partner may have got it wrong. Let's go and see if they name the senior manager, let's go and name the EQCR. That's not what people should be questioning. When you see audit failure, it should be the name of the head of audit. When you see audit failure, you should be looking at who is the head of audit, who is the managing partner, how did they let that happen? And well, what was their system of quality management? Why didn't they have appropriate resources? Now that can be going back to I wouldn't let KPMG audit the contents of my fridge. How did that partner become an audit partner? How did that partner be allowed to use the firm's name, to use the firm's clients when that audit partner clearly didn't understand accounting standards, didn't follow the firm's procedures or the senior manager? Why was that senior manager allowed on the job when we've not trained that person, we've not got the appraisals for that person, we've not checked whether his CV made sense, we've not checked his CPD? Why are we putting such poor individuals onto an engagement? That all goes to the top. Why did we accept the engagement if we couldn't resource it? You know, as part of the system of quality management is client acceptance retention. I accepted an engagement which in hindsight I couldn't staff. I didn't put the appropriate resource onto it. Well, that again is a failure in the system of quality management. Did we have enough technical support? Could they have phoned up and asked you about derivative liabilities, asked you about revenue recognition? Or did they just bumble by doing their best, completely worn out, just desperate to keep the client happy? Culture. What is the culture? Fees versus quality. So whenever you see the question, whenever you're questioning why did the audit go wrong, did they put the appropriate resources on it? It should be looking at that head of audit and saying, why did you let this happen?

SPEAKER_00 17:18

Thanks, Wayne. So we'll wrap it up in this episode. So when audit failures occur, attention often focuses on the audit file. But perhaps we should also be asking a different question. Did the engagement team ever have the resources necessary to perform the audit properly? And that is exactly the kind of questions this series, Why Audits Go Wrong, is designed to explore. Thank you for joining us on this episode of Financial Reporting Conversations, and we'll hope you'll join us next time as we continue to examine the pressures, the risks, the decisions that shape order quality and financial reporting.

SPEAKER_01 17:53

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SPEAKER_00 18:04

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.