What Exactly Do Auditors Do? The Chase Bank Case.

This morning, Chase Bank, a bank a lot of people liked and banked with (yours truly included), went into receivership. Prior to that, their published accounts had a note of a “qualified opinion” being given by their auditors, and many questions have come up: Did their auditors lie to us? How come the auditors didn’t detect weak/illegal lending practices? What do auditors do exactly?And so on and so forth.

In this post, I will attempt to simplify the role of an auditor, and what a “qualified” audit opinion really means.

So, what do auditors do? In basic terms, an auditor’s role is to ascertain that a company’s financial statements (income statement, balance sheet, cashflow statement and accompanying notes and schedules):

1. Have been prepared in accordance to laid out reporting standards. In Kenya, we use the International Financial Reporting Standards (IFRS) to prepare our financial statements. So the auditor checks if the accounts are adhering to IFRS:
2. Are a FAIR representation of the company’s financial position.

The auditor relies on information provided by management (representations by management), third party confirmations and samples of company documents to do the two above.

Fraud detection is not the function of an auditor. If they encounter fraud in the process of the audit, they are obliged to report it, but it is not their mandate. 

What is an audit opinion? Once an auditor’s work is done, they’re supposed to write their opinion on the the accounts as per the two areas above. This opinion informs tells us how we should interpret the financial statements presented to us. There are at least 4 types of  audit opinion, ,but I want to focus on three of them on this post.

1. Unqualified opinion

Contrary to the sound of it, getting an unqualified opinion is actually a good thing. It means that in the opinion of the auditors, the company’s accounts are sound: they have adhered to IFRS, and are a fair representation of the financial state of the company.

Does this mean the business is profitable? NOPE. It means that whatever you’re reading in the accounts is pretty close to the actual state of the business.

Does it mean there’s no fraud in the business? NOPE. Remember, an auditor’s mandate doesn’t include fraud detection.

Does it mean the management is honest and super? NOPE. Remember, an auditor doesn’t have super powers, to detect if management are concealing information, UNLESS it is so blatant from the financial statements presented to the auditor for audit.

Does it mean the accounting department of the company is perfect? NOPE. Often in an audit, issues come up, that are  discussed with management and tagged as “areas of improvement”, despite which the auditor goes ahead and issues an unqualified opinion.

You see there’s potential for a lot of murk here.

2. Qualified opinion

This is what Chase Bank’s 2015 accounts got, which was interesting, because for as long as I’ve been in finance, I haven’t heard of a big bank getting a qualified audit opinion. What does this mean? It means one of two things, or both:

1. During the audit, the auditor was unable to get satisfactory audit evidence on a particular balance in the accounts. Therefore, the auditor is not sure if this balance gives a true and fair view of accounts
2. That the accounts presented have a material misstatement

HOWEVER, none of the above have a pervasive effect on the financial statements. This is a warning to the readers that the accounts have a problem.

Are auditors under obligation to reveal what the issues are? Not to the public, no, but to the board and shareholders of the company (this sucks).

Does it mean there’s fraud? NOPE.

Does this mean there’s a problem with management? Almost always, yes.

Why is this a big deal for Chase Bank? Because like I said, it rarely happens. In Kenya, auditors tend to bend over backwards to please the board of directors (story for another day), and will therefore put in extra effort to ensure they do not give you a qualified opinion. For Deloitte to have done this, the issues at hand required them to cover their behinds.

3. An Adverse opinion
An adverse opinion means, RUN. Seriously, it means that the accounts are trash.