The Audit Society by Michael Power Book Summary

The Audit Society, Rituals of Verification by Michael Power

Recommendation

Why are individuals willing to live in an “audit society” where almost everything is checked? Perhaps they accept such monitoring because few folks would want to live under the opposite conditions, where nothing is checked. People want to know that their planes can fly, their banks won’t fail and their food is safe. Thus, auditing has become ubiquitous – but does it exist only for its own sake, or does it have intrinsic value? Does it help, hurt or control society? In this reprint of his original 1997 work, accounting lecturer Michael Power explains how auditing has come to permeate the social, political, corporate and economic worlds. His short text is often a hard, dense read, but he’ll broaden your understanding of auditing beyond the numbers in a ledger: Auditing, he teaches, underpins many facets of society and involves crucial questions of trust. getAbstract believes accountants, auditors and those who hire them will find this work particularly relevant, but those seeking deeper knowledge of professional practices and of how society works also will be intrigued.

Take-Aways

• Audits take place throughout society, not just in business.
• The different types of audits are numerous and extend far beyond just financial assessments. The practice overall has experienced an “audit explosion.”
• Auditors essentially render an informed opinion in an audit and ask people to trust it.
• The goal of auditing is “the production of comfort.” It can aid society in determining risk and examine possible risks to provide assurance.
• Financial auditing has four elements: “official knowledge, training and education, practice,” and “quality control.”
• Auditing to improve governance comes in three forms: “New public management, value for money” and “quality management.”
• Auditors must test representative samples and often call on teams of specialists.
• Auditing becomes ineffective if it falls prey to “decoupling” and becomes rote.
• Auditing also falters in the face of “colonization,” when it takes over the client it is screening, such as when testing teachers to make education more accountable.
• Auditing is different from “surveillance” and “inspection,” but can still compel change.

The Audit Society Book Summary

“The Audit Explosion”

You may not realize that you live in an “audit society,” but you do. For example, parents perform an audit every time they check to make sure their child’s safety belt is fastened. However, in the course of your daily life, you also exercise a certain amount of trust. If you lend money to a friend, you probably don’t demand assurance on paper that your pal will reimburse you.

“Could one imagine a society, or even a group of people, where nothing was trusted and where explicit checking and monitoring were more or less constant?”

Thus, though auditing is a fixture of a functioning society, people would not want to live in an environment without trust, an atmosphere that required constant checking. Since the late 1980s and early 1990s, auditing has become ubiquitous. This trend sparked an audit explosion, which continues still in fields such as business, education and medicine.

“Rather than providing a basis for informed dialogue and discussion, audits demand that their efficacy is trusted.”

Beyond vague statements that hint at auditing’s possibilities, experts do not agree on exactly how to describe it. They widely define financial auditing as the “independent examination of, and expression of opinion on, the financial statements of an enterprise.” Authorities do agree that an audit can occur only when auditors have independence from the body they are checking, experience collecting data, the ability to form opinions about their documentation along with “a clearly defined object of the audit process” – for example, a firm’s financial report.

“The production of official definitions of a practice like auditing…is an idealized, normative projection of the hopes invested in the practice, a statement of potential.”

The process of auditing becomes controversial when the organization under examination (the “auditee”) commits fraud, fails or goes out of business. Auditing used to occur without much fanfare, but recent high-profile corporate collapses pointed a new spotlight at the process and imbued it with a certain amount of tension, although the auditing process works on the assumption that people will trust it. In the end, this process produces a report where auditors render an opinion on the state of the organization they’ve audited. Auditors employ specific methods with the goal of becoming and remaining “systematically effective” and developing results that offer assurance.

Fraud Happens

Financial auditing is the oldest type of auditing. Even when members of the public do not understand auditing’s processes, they must have faith in its findings and in its independence from the organization it is checking. Auditing’s goal is to gather enough data to render a sufficient determination of whether a body is financially sound. Sufficiency requires “operational scope” – that is, the auditors’ determination of “how many transactions” to examine – and “operational depth” – that is, their decisions about the nature of the inspections they should conduct.

“Audit was a practice long before it was able to give an ‘account’ of itself in anything approaching a conceptual fashion.”

People generally assume that financial auditing sets out to find mistakes or lies. That said, the public now also tends to conclude that auditors who don’t find fraud have failed. Auditors must balance such expectations with reality, because when the public perceives that an audit has failed, the reaction can lead to more governmental regulation and control.

“The audit explosion reflects a distinctive response to the need to process risk.”

The financial auditing system has four elements:

1. “Official knowledge” – The rules and regulations governing auditing procedures.
2. “Training and education” – The skills auditors learn.
3. “Practice” – The actual methods auditors use.
4. “Quality control” – The “feedback mechanisms” of the peer review process.

“Auditing the Reinvention of Governance”

In addition to finance, auditing is important to the administration of an organization or firm. Companies must be careful over time that their methods and practices continue to serve their needs and their customers. That need helped generate the audit explosion. Companies use one of these three auditing practices:

1. “New public management” – This type of auditing checks the governance of public entities. It received a boost from the push for restraint in government spending. Auditors use this approach to encourage competence within slow bureaucracies.
2. “Value for money” – This kind of auditing checks economic resources to ensure that “regulated entities” observe the relevant rules. Auditors employ this method to examine firms’ “fiscal regularity” (how they manage income), “economy” (how responsibly they use supplies), “efficiency” (whether they achieve “maximum output”) and “effectiveness” (whether they produce what they say they will).
3. “Quality management” – This auditing method makes sure that organizations function at the highest possible level. These efforts usually lead organizations to institute internal performance measurements.

“A certain balance between the personal and the anonymous, the subjective and objective, the judgmental and technical, the concrete and the abstract is at the heart of professional expertise.”

When corporate scandals or fraudulent business practices come to public attention, the government usually reacts by regulating related firms more heavily. Aversion to increased regulation has, in turn, led companies to adopt more “internal control” structures.

“Samples, Specialists and Systems”

Auditors must determine “how much testing is necessary” and what subgroup constitutes a fair “representative sample.” Such sampling is not the same thing as a “block test,” where an auditor examines an organization’s activities during a certain time frame. Although auditors rely on scientific sampling methods, they must exercise their judgment to complete the audit process. When they find evidence, they must balance their conclusions with their other knowledge.

“Public sector auditing implicates questions about the distribution of authority and control in a way that financial auditing does not.”

The auditor and the auditee take a risk that legal liabilities may result if the auditor’s judgment is incorrect. Because no auditor can be an expert in every subject, auditors frequently join with teams of specialists to complete the audit process.

Auditors also must deal with the internal control systems of the organizations they audit. “Compliance structures” that exist at the ground floor and work their way up through the company should function well. However, some organizations may stumble at the difficulty of establishing internal controls, so their processes and results can vary greatly and become auditing issues. In that case, auditors face the task of “making things auditable,” a challenge they usually accomplish by conducting thorough representative sampling, calling in specialists as partners and using an organization’s existing systems for corroborating their findings.

“Auditees and the Auditable Performance”

The audit explosion has led to increasing “formalization” of audit procedures. The reason for this is because organizations expect audits to serve as mechanisms that encourage change (increased moneymaking abilities, better quality, and the like). Here, auditing can fall short in two ways:

1. “Decoupling” – Auditing loses its meaning if it becomes decoupled from its purpose. In such situations, the audit process becomes “ceremonial” and rote. This can happen when the entity undergoing auditing has internal control structures (like “audit committees, internal auditors, audit officers,” and the like) that ritualize and channel outside audits.
2. “Colonization” – Auditing can lose effectiveness if it “provides a dominant reference point” for the actions of an organization under audit, taking over or colonizing the body it is assessing. This can lead to auditing practices that fit the organizations’ ends, such as testing teachers to make educators more accountable or grading doctors to control the quality of health care. When colonization occurs, auditors and audited entities veer from their real goals. They end up measuring effectiveness, not fiscal solidity. Colonization can turn auditing from a useful exercise into a “fatal remedy” that “creates forms of dysfunction for the audit itself” instead of assessing a client’s financial controls.

“What makes auditing auditing is the legitimate requirement for one party to give an account of those actions relevant to its relation to another party.”

To avoid these pitfalls, auditors should “construct concepts of performance” that are true to auditing’s professional monitoring mission, and not deviate from that purpose.

Auditing has encountered new challenges in research, education and medicine. In the UK, auditors tried to use auditing to determine researchers’ eligibility for future funding, but they could not nail down the “auditability” of academic research. They considered compelling researchers to keep timesheets but abandoned the idea as intrusive.

“In the audit society the power to define and institutionalize auditable performance reduces evaluation to auditing.”

Still, the threat of audits that affect future funding has taught these scientists that they’re accountable to their “peers, patrons and publics.” Auditing in education has led universities to establish internal control systems to assess and cultivate high-quality teachers. The result: Auditing has become a tool for directing teachers rather than a mechanism to encourage better learning.

“The guarantee of quality in ‘inscrutable markets’ is somehow to have trust in people.”

The health care profession, by contrast, traditionally used a form of auditing to ensure quality and safety. Physicians have turned to case reviews, consultations and improved information to provide better diagnoses and health services. But medical auditing is undergoing a transformation: Funding agencies now predicate physicians’ financial reimbursements upon meeting certain quality standards, thus rendering medical audits more “programmatic.” Unsurprisingly, many doctors resent these audits as infringements on their independence, so “medical auditing remains a contested field.”

Trust, But Verify

Auditing exists because people need assurance that their systems and societies work. The “production of comfort” – the confidence that society has done all it can to avoid risk – is auditing’s central goal. However, societies should be wary of putting too much conviction in the auditing process and in allowing it to blind them to risk.

“Audit is a paradoxical and complex combination of surveillance and trust.”

To be fully aware, carefully examine the methods that auditors use. For example, auditors conduct financial audits according to the standards of Generally Accepted Accounting Practice (GAAP) – but an audit can’t keep a firm that doesn’t meet GAAP standards from conducting business. And a shortfall in that quality level generally does not become a subject of public discussion. When auditors present their findings, the audited organization essentially receives a “quality label.” If that label is negative, society must determine if the auditor’s report carries any real consequences.

“The risk of audit is not simply that it does not work and leads to fatal remedies…it is also impossible to know when it is justified and effective.”

Where creating consequences is important, using “surveillance” or “inspection” may be more appropriate than relying on an audit. Surveillance focuses on the actions of people in an observed organization. Because it can raise privacy and control issues, surveillance can be more “coercive” than an audit. Inspection is “an examination of what is happening” and usually results in some kind of certification or testimonial (such as in the case of food safety). More than auditing, inspection pays extra attention to how the examined organization acts. Surveillance and inspection are even more likely than audits to lead to increased regulation.

“The way societies call individuals and organizations to account says much about fundamental social and economic values.”

The rise in the use of audit, surveillance and inspection does not negate the continuing importance of trust. The social contract requires that auditors must be able to believe auditees, who must be able to trust auditors’ reports – as must society itself. The audit society, in short, “is not simply a distrusting society; rather, it reflects a tendency not to trust trust.”

One result of this reality is the constant presence of risk. Trust can mean that society is taking risks in, for example, medicine and manufacturing. Mistakes can occur in the operating room; substandard products can reach consumers. Auditing has become a primary vehicle for assessing those risks – “a style of risk processing,” even when circumstances call on auditors to verify “the unknowable.” Is auditing, then, the “tail…wagging the dog”? Is it the driver of results rather than the evaluator? After all, despite its limitations and inefficiencies, auditing remains the preeminent method for producing comfort and for gaining the “ability to demand accounts.”

About the Author

Former Coopers and Lybrand auditor Michael Power teaches accounting at the London School of Economics.