Tuesday, 9 December 2008

DATs and the future of Audit and Assurance

Sayes law of economics shows us that gains in productivity offset any economic equilibrium leaving the general state of the economy one being of flux or change. In this, the undertakings that survive are those that embrace change. This requires entrepreneurial thought and constant innovation.

In contradiction to the common belief that entrepreneurs necessarily start new businesses, Sayes’ definition of an entrepreneur was one that shifts the means of production from less productive to more productive enterprises. In this, the entrepreneur is anyone who increases an undertaking's productivity.

Change does not happen as quickly as people believe. Through the nature of compound interest, small incremental changes result in large subsequent results. Currently, and for a number of years, the big four international accounting firms have been engaging in technology research and productivity innovations that have delivered between 4 and 6% each year for the last decade. This may seem small, but when you consider that a 5% yearly compounding rate over the last 10 years together has made an incremental 50%+ increase on productivity from just a decade ago.

From my observations, the accounting and audit would seem to be increasing its productivity at a rate of between 1 and 3% per annum. At this rate, not only can organizations who are not growing fail to maintain equilibrium (this is currently attained through exceeding with the big four) in the long run, but within a decade, small to medium firms will likely lose up to 50% of their business to them.

Lemar Swinney of KPMG and several groups within PWC are actively researching “the future of the financial audit”. John Fogarty directs Deloitte's "third generation audit" which is focused on a similar line. He has been quoted with saying, “Web-based audits. In the future, a company's financial accounts and data will be completely digitized. The Web will act as host. That will allow auditors to sit in one location and access all necessary corporate information and transactions. While the technology for this exists and while there are small-scale experiments under way, Swinney believes widespread Web-based audits are "realistically six, seven years down the road."

Existing research has resulted in advanced CAAT technologies now known as DATs (digital audit techniques). DATs (research available on request) are consistently detecting over 90% of all financial statement frauds. The big four firms are starting to implement these technologies. Some of the Mid-Tiers are following suit (and I am trying to lead this change). But what of the others?

These technologies will be commercial on a wide scale usage within the next decade.

DATs have also shown and accuracy of over 96% on analysis of non-fraud financial statements. When teams are developed implementing both traditional audit techniques and the use of advanced technologies and mathematical formulations, the accuracy has exceeded 99.8%.

Current figures put traditional audit techniques at a level of 8% accuracy in the determination of financial statement fraud.

There has been a lot of discussion concerning productivity of late. MOst audit firms operate as isolated pockets of technical skills. We embrace our skills close to ourselves and do not share them. We do not seek ways to work together.

Not only are DAT based audits more accurate, but they are faster and more productive. This is not incrementally more productive, rather studies have shown that they are capable of being up to 90% more productive than existing audit techniques.

To make these types of productivity gains, we don’t need to work harder we need to follow the oft stated idiom that we need to work smarter. We need to look at working with each other and thinking about how we can better implement technology.

These techniques are not going to go away. Change is pervasive, either we embrace it in an entrepreneurial manner or it will steam roller us.

This is a call for change and progress in the industry as a whole!

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