Auditors Wake Up, Global Financial Discipline is in a Shoddy State

Last Updated Apr 24, 2009 7:35 AM EDT

Great economies falter with poor regulation. A great business can fail fast if it has no financial discipline. So who's looking after your numbers?

There's an old saying about company audit that seems pertinent right now: an auditor is a watchdog, not a bloodhound. The idea is that your annual, statutory audit is designed to check your workings and your answers, not seek out malpractice. And in a way, that's true: your own finance function should be doing the hunting.

But that will come as cold comfort to the investors in a slew of businesses that have fallen in spectacular fashion with nary a peep from their audit firms. In some cases, of course, the firm itself pays a hefty price. Arthur Andersen was wiped out after failing to flag up Enron's dodgy structures, for example.

Recent cases suggest the watchdog has not just been asleep â€"- it's been leaving the front door open. According to astute watcher of the Big Four (PwC, KPMG, Ernst & Young, Deloitte) Francine McKenna, there's evidence that PwC auditors mislead managers and investors about Satyam, an Indian outsourcing company facing a £1bn fraud. The case isn't isolated.

Part of the problem is regulation. While business is increasingly global, auditing and accounting are still largely governed by national bodies. True, International Financial Reporting Standards are increasingly in force, but without a truly international auditing practices board to guarantee audit standards are being enforced evently across the world.

Worse still, while the US has flirted with joining the IFRS fold, recent events have seemingly torperdoed "convergence" with other IFRS states.

That's crippled attempts to raise the bar for the reliability of company numbers. For example, US banks with toxic assets on their balance sheets have lobbied to have "mark to market" rules suspended, and fearing they'll appear uncompetitive by contrast, European banks are doing the same thing. There's a real danger than the numbers will be assessed according to the least stringent measures that any substantial government is willing to enforce.

(Mark to market is otherwise known as fair value, which insists you only claim the saleable value of the assets in your company accounts, not what you paid for them. Ditching the rule is the equivalent of claiming your ten-year old car is worth what it was when you bought it. If you used it as collateral for a loan or made an insurance claim on that basis, you'd be done for fraud. Banks, eh?)

Financial discipline is always important. In a downturn, it's essential. That means every company should have a robust, hard-working and intelligent finance director on the board. Yes, you should look for one with great communication skills, a dash of creativity and an open mind. But if they don't feel able to tell you when things are going wrong â€"- or when you're wrong â€"- the result might not just be a breach of the rules. Not doing business by the numbers could spell disaster.