THE Audit Oversight Board (AOB) is established under Part IIIA of the Securities Commission Act Malaysia 1993, and it has been 11 years since it came into force on 1 April 2010 to protect investor interests and promote confidence in the quality and reliability of audited financial statements of public interest entities (PIEs), including licensed intermediaries, public-listed companies, as well as institutions under the Banking and Financial Institutions Act 1989 and insurance companies under the Insurance Act 1996.

However, some have questioned the raison d’être of the AOB, following the news of audit firm partners who were reprimanded by the board and are mulling filing an appeal to the Federal Court after losing in their bid at the Courts of Appeal. This is one in a strings of cases lodged against the board in the past few years.

The Wirecard case in Germany has raised questions about the reliability of statutory audited financial accounts, their scope of auditing and the effectiveness of self-regulatory audit bodies in the European Union.

While it is undeniable that regulations are necessary for auditors, and AOB has made progress in fulfilling its mission of furthering public interest in the preparation of accurate, independent and informative audit reports, murmurs have been circulating of its heavy-handedness and punitive actions against smaller audit firms.

AOB’s oversight lies in its inspection programme. The board inspects audit firms, which are registered with it, that audit public companies, but says little about how the inspection is performed or confidential inspection report content, and that any criticism of or potential defect in firm quality control systems are not to be made public.

AOB in its annual report states that it is objective, impartial and thorough in its evaluation in carrying out any enforcement proceeding, and that any auditor is given numerous opportunities to explain, challenge and provide information to rebut its findings. However, scepticism remains within the industry – specifically in smaller audit firms – of such representation being practised fairly and honestly.

A former AOB chairman has gone on record to claim that the board is always “fair and objective”, with firms given a chance to explain their case before action is taken, adding that it is not a matter of the board taking action, but an auditor not doing his or her job.

Thus, the better course for audit firms is to accept the findings of the board, instead of arguing about inspection deficiencies.

Since AOB’s formation, the number of audit firms that can theoretically audit a public-listed company has fallen to approximately 30 from more than 200, as the environment favours larger firms instead of home-bred ones.

There were 932 listed companies on Bursa Malaysia as at July last year, which work out to some 23 listed entities per audit firm.

Has AOB improved audit quality, which is hard to define and measure? Audit firms are for-profit enterprises, and audit quality comes at a cost.

Confidence in the decision-making process requires that these potentially conflicting goals be acknowledged and structural safeguards put in place to keep them separate, and the board’s existing auditing standards do not entirely reflect these expectations.

Some agree that quality is higher today than it was prior to 2010, with examples of fewer audited financial statements restated, higher investor confidence in audited financial reporting and more reliable audited financial reporting.

On the other side, audit failures still occur, in fact, too frequently.

Can AOB confirm that the number of deficiencies uncovered in inspections has substantially decreased, remained the same or increased? Any trend that shows the same level as prior to the setting up of the board is cause for concern.

AOB, in interpreting the definition of PIEs, has claimed that the 1Malaysia Development Bhd (1MDB), under the Minister of Finance Inc, is not among the 1,140 PIEs under its purview unless it is ordered by the finance minister. Thus, it cannot widen its coverage and extend the scope to government-owned companies.

The failure in the 1MDB audit – of which three of the four Big 4 firms were appointed as auditors since its formation – appears to point to AOB doing little to improve audit quality and not being tough enough on accounting firms, especially the Big 4, when auditing breakdowns are uncovered.

Meanwhile, smaller AOB-member audit firms have argued that the board has been too aggressive with them to the extent that auditors are now largely motivated by fear of AOB inspectors and a keep-the-regulator-happy mentality drives up audit (and internal control) costs out of proportion to any benefit.

The majority of retail investors perceived the oversight role as greater box-checking mentality rather than a focus on substance, where auditors embed checklists and other procedures in the audit process to increase compliance visibility and promoting a standardised orientation that may increase the commoditisation of the audit.

Quality assurance reviews/inspections and investigations impose disproportionally high costs on smaller audit firms, at the risk of pushing them out of the market, leading to greater concentration and lower competence.

The 1MDB debacle had no doubt marred AOB’s reputation, even though it will argue otherwise. The scandal appeared to have “slipped through the cracks”, in that oversights and supervising agencies may have seen the allegations against it, but no clear actions were taken.

Should the board continue to do business as usual in a rapidly changing and challenging environment arising from the unprecedented economic disruption in the global economy from the pandemic, the inability of the audit process to uncover what appear to be readily apparent financial frauds, the increased reliance by investors on information outside of the financial statements and material impact of climate change and other environmental, social and governance matters on the financial statements?

AOB’s role should be reconsidered, or shifts made to its approach and authority moving forward. It is often faulted for the level of its enforcement activity, which remains non-public until the conclusion of the case and, if the board loses, remains non-public forever.

Non-public proceedings deprive the public of a real-time understanding of the kinds of auditing lapses that the board believes require sanctions. AOB should end enforcement secrecy and make its enforcement actions open to the public, beginning with the decision to bring a case.

Its existing standards are also filled with vague and undefined terms, often interfering with adequate inspection and enforcement.

For example, the standard for considering materiality for purposes of determining the “nature, timing and extent of audit procedures” requires only that the level be “appropriate in light of the particular circumstances.”

Levels that are set too high can result in an inadequate audit, yet guidance has not been issued that seeks to ensure that materiality is set at appropriate levels. The current approach is to allow these terms largely to be interpreted by each firm in their methodology. This result in an “expectations gap”, with a chasm separating what investors and other users expect and what firms believe they are required to do.

This “gap” can be narrowed through thoughtful and useful guidance by AOB that ensures these terms are construed in a manner that is consistent with the intent of the standard and meets the expectation of investors and inspection and enforcement needs of AOB, the capacity of audit firms and impact on the financial disclosure process. – November 4, 2021.

* FLK reads The Malaysian Insight.

* This is the opinion of the writer or publication and does not necessarily represent the views of The Malaysian Insight. Article may be edited for brevity and clarity.