What does your company’s auditor do and here’s why you should care

Each and every ASX-listed company will have auditor. But what do they do? Why is it almost always one of the so-called ‘Big Four’? And should you really care? What could possibly go wrong if you don’t give thought to these questions?

What does an auditor do?

The purpose of a company’s auditor is to perform an independent evaluation of the company’s financial statements, ensuring that they are accurate and free from any fraudulent activities or misstatements. Specifically, they must verify that the company’s accounts provide a ‘true and fair’ view of the business’ position. This process involves examining the accounting records as well as testing internal controls and verifying documents.

The auditor will look at all areas of the business, including general ledger accounts, payroll, receivables and inventory. In addition they may also review debt covenants and legal contracts. The audit is generally conducted in accordance with the Australian Accounting Standards in order to provide assurance that the financial statements present a true and fair view of the company’s financial position.

If an auditor finds any material misstatement or potential fraud, they must disclose it to management so that correction or remediation can be taken if necessary.

Ultimately, the auditor’s opinion serves as a signal of trustworthiness for investors, creditors or other stakeholders who rely on the company’s financial reports for making decisions.

What are some of the auditing firms?

The vast majority of ASX companies employ one of the so-called ‘Big Four’ accounting firms as an auditor. The ‘Big Four’ are: Deloitte, PricewaterhouseCoopers (PwC), Ernst & Young (EY) and KPMG. These companies provide a range of services including auditing, consulting, taxation and legal advice to individuals and businesses.

The Big Four have been influential for many decades and are employed by many companies due to their global presence and strong market position. They audit about 80 percent of all publicly listed companies globally as well as many private companies. As such they are a source of trust for investors when assessing financial statements. In addition to auditing services they offer advisory services to listed companies (and private companies) on topics such as tax optimisation strategies and investments plans. Nonetheless, a minority of firms hire non-Big 4 firms such as BDO.

The going concern

One of the key things auditors must verify is whether or not the entity should be regarded as a ‘going concern’. They also must disclose any events or conditions that ‘may cast significant doubt upon the entity’s ability to continue as a going concern’. An audit may be submitted with auditor doubts that an entity can continue as a going concern – something that’d raise eyebrows at the ASX.

Why should you care?

Well because as we’ve noted above, auditors verify whether or not an entity is a going concern, and also help companies finalise their books. Also keep in mind that investors in a company vote on a company’s auditor at an AGM meeting, so this decision is (theoretically) in investors hands. This can be a fait accompli, as is the case with many AGM resolutions, and this has led to long tenures for auditors.

Also remember that auditors do not come cheap. Telstra paid its auditor EY over $17m in FY23. The reason we single out Telstra is because it is replacing EY with Deloitte this financial year, subject to shareholder approval, as well as ASIC’s. This brings a 25-year tenure to an end. There hasn’t been anything EY has done that has been wrong, but Telstra obviously thought it was time for a change. While not commenting on why it chose Deloitte, Deloitte has won a significant amount of business from its rival firms on the basis of its cost-effective technology. Other companies to switch of late include CSL, Aurizon and Boral.

While much of what we’ve been discussing so far is just theory, auditors can cause headaches for their client companies. Downer (ASX:DOW) has blamed KPMG for failing to detect accounting irregularities and is suing it for the trouble. And with the AICD recently recommending companies’ audit committees look to change auditors every five years, perhaps we’ll see more consideration given by the audit committees at least.

Auditors are a safeguard, but not a guarantee

An auditor provides an important safeguard as an external entity that verifies a company’s statements are good. However, even though they provide a theoretical guarantee, the scandal with Downer highlights that auditors can’t be perfect in practice. Enron is another example, it had hired Arthur Anderson as its auditor, then one of the ‘Big Five’ auditors. Most investors should know what happened to Enron, but what specifically Arthur Anderson did (leading it to collapse) is a point of confusion.

By signing off on its audits, Arthur Anderson misrepresented the true value of the corporation and did not follow generally accepted accounting principals. It was also accused of destroying thousands of Enron documents that could’ve helped with the investigation. It wound down its operations barely months after Enron collapsed. Ultimately, after being convicted as a corporation, it was cleared in 2005 – too late to revive itself unfortunately.

This story illustrates that just because a company is audited, it doesn’t mean it is a safe investment and doesn’t excuse investors from doing their own “sanity check” on companies they want to invest in.

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