AICPA Unveils Anti-Fraud Standard

Accounting association looking to infuse auditors with healthy dose of skepticism. Plus: large caps get low ratings for governance, automaker pension funds running on empty, and what hath AU 508 wrought?

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The American Institute of Certified Public Accountants (AICPA) has stepped up its effort to combat corporate fraud.

The Auditing Standards Board of the AICPA on Tuesday approved a new standard, Statement on Auditing Standards (SAS) 99: Consideration of Fraud in a Financial Statement Audit. The standard gives U.S. auditors expanded guidance for detecting material fraud.

“The standard is the cornerstone of a multifaceted effort by the AICPA to help restore investor confidence in U.S. capital markets and to re-establish audited financial statements as a clear picture window into Corporate America,” the association asserted in a press release.

“We feel strongly that the standard will substantially change auditor performance, thereby improving the likelihood that auditors will detect material misstatements due to fraud,” claimed Barry Melancon, AICPA president and CEO. “The standard reminds auditors that they must approach every audit with professional skepticism and not assume that management is honest. It puts fraud at the forefront of the auditor’s mind.”

The key provisions of SAS 99 include:

  • Increased emphasis on professional skepticism. The AICPA wants independent auditors to put aside prior beliefs as to a management team’s honesty, and advises audit-team members to exchange ideas on how frauds could occur. Those discussions should be conducted while keeping in mind the characteristics that are present when frauds occur: incentives, opportunities, and ability to rationalize.

Throughout an audit, the AICPA recommends that an engagement team think about and explore the question, “If someone wanted to perpetrate a fraud, how would it be done?” The association thinks those sorts of discussions will put an engagement in a better position to design audit tests responsive to the risks of fraud.

  • Discussions with management. The new standard advises engagement teams to ask senior executives whether they are aware of any frauds. Auditors should also make a point of talking to employees in and outside management. The AICPA’s accounting standards board believes giving employees and others the opportunity to blow the whistle may encourage someone to step forward. The board also believes it might help deter others from committing fraud if they are concerned that a co-worker will turn them in.
  • Unpredictable audit tests. During audits, the AICPA says engagement teams should test areas, locations, and accounts that otherwise might not be tested. Those tests should be unpredictable and unexpected by the client.
  • Responding to management override of controls. Because a management team is often in a position to override controls to commit financial-statement fraud, the new audit standard includes procedures to test for management override of controls on every audit.

The AICPA said SAS 99 supersedes the Auditing Standards Board’s earlier fraud standard, SAS 82, which carried the same title.

SAS 99 is effective for audits of financial statements for periods beginning on or after December 15, 2002.

S&P Measures Corporate Governance

Most companies do a mediocre job of communicating critical information to investors, according to Standard & Poor’s.

On Tuesday, the credit-rating agency unveiled a study that ranks companies in the S&P 500 on their transparency and disclosure.

Using a scale of 1 to 10, with 10 representing the highest level of transparency and disclosure, S&P gave virtually every company in the S&P 500 an overall score of 7 or 8, based on a composite analysis of the companies’ annual reports and other regulatory filings.

Just seven corporations in the index received final scores other than 7 or 8.

Baker-Hughes, Bausch & Lomb, and Progress Energy are at the top of the list. At the bottom: American Power Conversion, Apollo Group, Bed Bath & Beyond, and Sanmina-Sci Corp.

The study was based on 98 questions about financial transparency, board and management structure, ownership structure, and investor rights.

The study examines companies that were members of the S&P 500 Index on both June 30, 2002, and on September 30, 2002. It excludes companies for which there may be some regulatory inquiries relating to their public filings. The study also excludes companies for which Standard & Poor’s had incomplete information as of June 30, 2002.

“American corporations could do a lot to improve their disclosure to individual investors who don’t have access to regulatory filings,” S&P president Leo O’Neill said at a press conference in Manhattan, according to news accounts. “By looking at annual report disclosure alone, the study found that U.S. companies do not uniformly provide an abundance of public information voluntarily.”

S&P’s corporate-governance scores are part of a larger announcement by the credit-rating agency that it is launching a corporate-governance practice.

Earlier this month, rival ratings agency Moody’s Investors Service hired Kenneth Bertsch, formerly director of corporate governance at pension fund giant TIAA-CREF, as its new director of corporate governance.

Fitch Warns of Pension Gap

The pension funding gap for U.S. workers in the auto industry will more than double, from $13.9 billion in 2001 to more than $30 billion by the end of fiscal year 2002, according to Fitch Ratings.

“The impact on corporate income statements, the true economic impact on a company’s credit position, cash-funding requirements, and flexibility in the timing of these requirements are all areas which may be both very volatile and difficult to ascertain,” said Chris Struve, director of Fitch Ratings.

But Struve added: “As quickly as the problem has developed for a number of these companies, particularly those that have swung from an overfunded to an underfunded position, the problems may be alleviated over the longer term in the event of higher asset returns, company contributions, and/or increases in the discount rate.”

Ford Motor Co. and General Motors Corp. have the largest pension-funding gaps. In fact, GM and Ford might be responsible for a combined $22 billion of underfunded pensions by year-end, according to Fitch.

On the other hand, DaimlerChrysler is in the best position of the Big Three, mostly due to the strong operating performance of its Mercedes brand.

The new report examines the defined benefit plans of 22 auto-industry participants and utilizes public information to assess the current pension status of these companies.

According to the survey, suppliers such as tire maker Goodyear Tire and Rubber Co. and diesel-engine maker Cummins Inc. might also face pension fund challenges.

“What will mitigate this problem,” Struve told Reuters, “is stronger operating performance, substantial cash contributions, rising stocks and an economy that turns up.”

Slippery Slope: Will AU 508 Force Reaudits?

Management at American Skiing Co. said it must reaudit the company’s financial statements for fiscal 2000 and 2001 because its former auditor, Arthur Andersen, stopped auditing the ski resort operator’s books.

American Skiing’s management said the Auditing Standards Board’s recent Interpretation of AU 508, “Reports on Audited Financial Statements,” requires that when a company’s previous independent auditor has ceased operations and is unable to issue a report on previous years’ results that reflect discontinued operations, a reaudit of those previous years must be performed.

Management at American Skiing believes it won’t be the only company reauditing its financial statements because of AU 508. “This interpretation of auditing standards is a national issue which we expect will affect many companies,” said Mark Miller, CFO at American Skiing.

The company’s management indicated that, in its case, the reaudit became necessary because of the sale of the Heavenly ski resort in fiscal 2002.

In accordance with Statement of Financial Accounting Standards No. 144, the company said it is required to reflect Heavenly’s current year results from operations as discontinued operations, and all comparative prior periods must have a comparable presentation.

The company’s management did assert, however, that the reaudit is not the result of any known issues with previously reported results or the financial condition of the company. Instead, it was necessitated by the recent interpretation of AU 508.

Signs of Life in the IPO Market

Call it strange timing. Winter is approaching, but it looks like the initial public offering market may actually be coming out of hibernation.

On Tuesday night, Dick’s Sporting Goods Inc. finally priced its long-awaited IPO at $12 a share, below its expected range of $15 to $18.

Of the 7.29 million shares being offered, the company is selling 2.77 million. Insiders are selling 4.52 million shares.

The offering from Dick’s Sporting Goods is one of four IPOs that are expected to come to market this week.

The other three are Dominion Resources, Gold Banc Corp., and Gray Television.

And given the stock market’s recent four-day run-up, there seems little chance that these deals will be cancelled.

Short Takes

  • Former ImClone Systems CEO Samuel Waksal pleaded guilty to insider trading charges on Tuesday. A prosecutor warned that more recipients of Waksal’s tips could be charged as well.
  • The California Public Employees’ Retirement System (Calpers) said it would co-sponsor a shareholder proposal urging General Electric Co. to use performance-based stock options.

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