However, a recent report by the Audit Reform Lab paints a concerning picture: auditors are failing to fulfill their core function at an alarming rate. This calls for the examination of the systemic issues plaguing the audit industry, the consequences of these failures, and the important role of directors in ensuring sound audit practices.

Auditors are tasked with independently assessing a company's financial statements to ensure accuracy and compliance with accounting standards. Their role is vital in providing stakeholders, including investors, regulators, and the public, with confidence in a company's financial health. When auditors fail to perform their duties effectively, it compromises corporate governance, leading to potential financial misstatements, undetected risks, and ultimately, corporate collapses.

The Audit Reform Lab's report highlights that auditors failed to warn about the imminent collapse of three out of the four (75%) largest 250 publicly traded companies that collapsed between 2010 and 2022 in the UK. Failure to flag "material uncertainty related to going concern" in audit reports is a glaring oversight.

For instance, it cited the collapse of Carillion in 2018, despite receiving clean audit reports, exposed the deficiencies in auditor judgment and the regulatory framework. Carillion's downfall led to massive job losses, costly government interventions, and significant disruptions across its supply chain.

Similarly, the bankruptcy of Thomas Cook in 2019, which also had unqualified audit opinions, further exemplifies the failure of auditors to identify and communicate financial risks. These collapses illustrate the direct consequences of audit failures on corporate governance, eroding stakeholder trust and resulting in severe economic and social impacts.

The Audit Reform Lab identifies several systemic issues plaguing the audit industry, including conflicts of interest, weak regulations, and inadequate sanctions for malpractice. The dominance of the Big Four accounting firms (Deloitte, KPMG, PwC, and EY), which earned 96% of FTSE 350 (weighted index of the top 350 companies by free-float market capitalisation on the London Stock Exchange) audit fees in 2022, exacerbates these problems. These firms often derive significant revenues from non-audit services, creating conflicts of interest that compromise audit quality.

The report also reveals that regulatory fines for poor audits are insufficient to deter malpractice. Between 2015 and 2022, fines averaged just 0.16% of revenue and 0.85% of profits for the Big Four firms, failing to impact partner pay significantly. This lack of substantial penalties means there is little incentive for auditors to improve standards or exercise greater professional skepticism.

Like the UK, Nigeria also has a fair share of audit failures. Between 1990 and 1994, the Nigerian economy lost over N6 billion ($42.9 million) to fraud within the banking sector alone. Examining cases in Nigeria provides further insight into the impact of audit failures on corporate governance. The collapse of Afribank Plc 2011 is a notable example. Auditors were indicted for facilitating the falsification of Afribank Plc's accounts. The subsequent investigation highlighted serious shortcomings in the auditing process and the failure of auditors to challenge management assumptions critically.

Another example is the infamous audit failure in the Cadbury saga between 2002 and 2005.  The management used stock buyback, cost deferrals, trade loading, and false suppliers' stock certificates to manipulate its financial reports that were issued to the public and filed with the Security Exchange Commission. It was also accused of falsification of account books in connivance with external auditors. This led to various sanctions including suspension of some directors.

As stewards of corporate governance, directors have a critical responsibility to ensure the integrity and transparency of financial reporting within their organizations. The recent findings by the Audit Reform Lab underscore a dire need for directors to take immediate and decisive action to address systemic audit failures that undermine corporate trust and economic stability.

Directors must champion comprehensive audit reform by advocating for the strengthening of governance to complement the role of the Financial Reporting Council of Nigeria (FRC). This should include the call for FRC to enforce stringent standards and hold auditors accountable.

Furthermore, directors should support the legal separation of audit and non-audit services within their organizations to eliminate conflicts of interest that compromise audit quality. Embracing a culture of rigorous financial scrutiny and professional skepticism is essential.

As custodians of sound corporate governance, directors must also lead the charge for a new audit mission. Encourage a shift from a checklist approach to a culture of critical scrutiny and independent judgment within the audit profession.

Hold auditors accountable. Demand performance reviews for auditors and explore options to hold audit partners personally responsible for misconduct through stricter sanctions and potential removal of limited liability privilege.

Directors must also ensure that their organisations invest in continuous training and development for auditors, fostering a deep understanding of the evolving financial landscape. By demanding higher standards, increased accountability, and greater transparency, directors can play a pivotal role in strengthening the audit process.

Audit failures have profound implications for corporate governance, as evidenced by numerous high-profile corporate collapses highlighted. The stakes are too high to ignore the audit system's failings. Directors must act now to safeguard the future of corporate governance, protect stakeholders, and uphold the integrity of our financial systems.

Inaction could jeopardize public trust in the markets, employees' livelihoods, and the long-term viability of the companies you lead. Championing reforms to ensure a robust audit function that protects investors fosters a healthy economy, builds public confidence in corporate governance, and a more secure and sustainable future.

Research & Advocacy Department,

Chartered Institute of Directors (CIoD), Nigeria

28, Cameron Road, Ikoyi, Lagos.