Accounting is at a crossroads: The way audits work is about to change

Chinese banker caught with $42m in cash in cupboards that he was 'too scared to spend'

Chinese people are left staggered by the scale of a case in which a former top banker took millions of dollars in cash bribes, which he stored in an apartment he nicknamed the "supermarket".

Accounting is at a crossroads. The Big Four accounting firms are under more scrutiny than at any time since the Enron scandal. This week’s state of play explains what’s wrong with how public companies are audited, and how the industry is trying to improve.

Future of Finance: How to fix Big Four accounting

Hello Quartz readers!

The accounting industry is at a crossroads. Ernst & Young, to pick one recent example, gave WeWork a clean bill of health, shortly before investors ripped into the office-space-sharing company’s finances and business model. The accounting firm is far from alone—nearly a third of Big Four audits inspected by the industry’s US regulator have deficiencies, as Michael Rapoport reports this week in our field guide for Quartz members.

Consulting and advisory makes a bunch of money for the major accounting companies. The industry says this makes them “multidisciplinary,” especially when it comes to upgrading their technology know-how, and the Big Four are pouring billions of dollars into artificial intelligence and whizzy machine learning technologies. Automation could strip out the most dreary, tedious work of auditors, freeing them to work on more challenging and creative problems.

Tech could also make their audits more efficient and precise. A pilot project using AI and natural language processing to analyze documents cut processing time as much as 90%, and it boosted accuracy by some 25%. Machines could make their reviews vastly more comprehensive, rendering the spot audit a thing of the past. As Rapoport writes:

Audits are typically performed by checking just a sampling of a company’s transactions; a big company might have billions of transactions, so auditors couldn’t possibly review them all. But a computer can, and so it has the capability to unearth errors or other problems in transactions that otherwise no reviewer might have looked at.

The problem is that tech won’t resolve a fundamental conflict of interest between their accounting and consulting practices. “At the big accounting firms, consulting is the tail that wags the dog,” Rapoportreports in the field guide.

Consulting spins off more money, is less regulated, and is a less mature field. About 44% of the Big Four’s 2019 revenue came from consulting and other non-tax advisory services, compared with some 33% from auditing.

But the obvious concern is that auditors will go easy on their clients to win consulting fees. We’ve been here before—Arthur Andersen, Enron’s auditor, made more in fees from non-audit services for the collapsed energy company than it did from auditing. Most big firms spun off their consulting businesses around the turn of the century, but they’ve since been rebuilt.

Changes are coming from regulators, politicians, executives, and technologists. The UK, after several bungled audits, is considering splitting up the auditing and consulting businesses to reduce conflicts. The EU put in place restrictions for non-audit services starting in 2016.

There’s much more in the field guide. As Rapoport writes, “In the end, both technology and institutional reforms may have to play a part to fix the audit.”

Let’s talk

Also for members: Today I’m having a call with Viktor Nebehaj, co-founder of London-based digital brokerage Freetrade. The ex-Googler and I will discuss entrepreneurship, the digital brokerage scene, and making the leap from Big Tech to fintech. That call is at 11am ET (4 pm GMT). Want to tee up a question in advance? Shoot me an email at jd@qz.com.

How digital sleuths unravelled the mystery of Iran’s plane crash  Wired – Open-source intelligence proved vital in the investigation into Ukraine Airlines flight PS752. Then Iranian officials had to admit the truth: “..I.t’s not unusual nowadays for OSINT to lead the way in decoding key news events. When Sergei Skripal was poisoned, Bellingcat, an open-source intelligence website, tracked and identified his killers as they traipsed across London and Salisbury. They delved into military records to blow the cover of agents sent to kill. And in the days after the Ukraine Airlines plane crashed into the ground outside Tehran, Bellingcat and The New York Times have blown a hole in the supposition that the downing of the aircraft was an engine failure. The pressure – and the weight of public evidence – compelled Iranian officials to admit overnight on January 10 that the country had shot down the plane “in error”. So how do they do it? “You can think of OSINT as a puzzle. To get the complete picture, you need to find the missing pieces and put everything together,” says Loránd Bodó, an OSINT  analyst at Tech versus Terrorism, a campaign group. The team at Bellingcat and other open-source investigators pore over publicly available material. Thanks to our propensity to reach for our cameraphones at the sight of any newsworthy incident, video and photos are often available, posted to social media in the immediate aftermath of events. (The person who shot and uploaded the second video in this incident, of the missile appearing to hit the Boeing plane was a perfect example: they grabbed their phone after they heard “some sort of shot fired”.) “Open source investigations essentially involve the collection, preservation, verification, and analysis of evidence that is available in the public domain to build a picture of what happened,” says Yvonne McDermott Rees, a lecturer at Swansea University…”