Professor Ken Trotman University of New South Wales

Two Discussion Topics 1.Differential auditing for SMEs 2.Are auditors being held to a higher level of accountability than other professions

Differential Auditing for SMEs Basis issue: Are present auditing standards, which are primarily designed for larger entities, still applicable to auditing of SMEs.

IFACs Strategic Plan for Notes that there “are increasing issues regarding the applicability and relevance of accounting, auditing and ethical standards to small and medium sized enterprises”.

Raising the Audit Quality Bar Overseas  New IAASB audit standards on risk and auditors’ responsibility to detect fraud  New quality control standards  Sarbanes Oxley Act in USA  Creation of the PCAOB  PCAOB inspections

Raising the Audit Quality Bar Australia  Impact of overseas developments  CLERP 9  Enhanced audit independence  Increased obligation to detect fraud  Auditing standards have the ‘force of law’  ASIC inspection regime

Why Treat SME Audits Differently Many believe ISAs are developed for large public companies As the audit quality bar increases, the cost of an audit of SMEs may be prohibitive Are all independence rules also applicable to audit of SMEs

What Are the Options Status quo Increasing the threshold for a compulsory audit A separate set of auditing standards for SMEs Different interpretations of reasonable assurance Two levels of assurance Greater use of a revised compilation report

Professional Judgment Are auditors being held to a higher level of accountability than other professionals

Recent Newspaper Article (28 December 2005) High Court of Australia – 53 of 73 appeals upheld in Justice Mason – ‘mishaps do occur in any human system’ 40 years of JDM research showing novices/experts, on occasions, make incorrect judgments

A Quote on Expert Judgment (Sunstein 2002) “Of course experts make mistakes… But precisely because they are experts, they are more likely to be right than ordinary people. Brain surgeons make mistakes, but they know more than the rest of us about brain surgery; lawyers make mistakes, but they know more than most people about the law. Where does this leave us? It suggests that many of the disagreements between experts and ordinary people stem from the fact that experts have more information and are also prepared to look at the benefits as well as the risks associated with controversial products and activities. Ordinary people often make judgments on the basis of quick, intuitive assessment, in which affect plays a larger role.”

Auditor Judgments Judgment is a cornerstone of auditing Reference to the need for judgment occurs 244 times in international auditing standards Professional judgments are typically very difficult  Huge technical departments of Big 4  Extensive consultation within firms  Conflicting expert witnesses Raising the audit quality bar

Can We Expect Auditors Never to Make Errors in Judgment? NO, in the past Stronger NO, in the future

Comparison to Other Professions Given the complexity of the human body are we surprised that doctors make errors Medical analogy Appeal courts Police don’t always catch the criminal

Another Expectation Gap In evaluating auditors, particularly in relation to the detection of fraud there is an expectations gap between what stakeholders want and what audit systems are capable of doing, at the prices companies and investors are willing to pay.

Conclusions There will always be some errors in judgment The key is to reduce errors within the costs society can afford The solution is not to make auditing more regulated Stakeholders’ and regulators’ expectations need to match the cost society is willing to pay for an audit.