No More Mr. Nice Guy

A CFO survey suggests that recently passed rules for auditors may be a wise idea.

PwC’s DiPiazza admits that the audit industry shares much of the blame for the loss of confidence in the capital markets. “Accounting firms must never forget that their work serves the interests of shareholders, not just the company that writes the check,” he wrote in his recently published book, Building Public Trust: The Future of Corporate Reporting. He believes, however, that the reform debate has to shift to broader considerations of corporate reporting rather than just the failings of auditors. “If we’re going to move toward a new auditing framework, we need to consider all the pieces of the puzzle,” says DiPiazza.

U.S. generally accepted accounting principles, long considered the best and most accounting standards in the world, may be the most important piece of that puzzle. Growing numbers of financial accounting experts believe that GAAP itself may be part of the problem. As financial transactions have become more complicated, so too has the accounting for them. “Over the last 10 years, U.S. GAAP has evolved into complex detailed rules that encourage financial engineering rather than transparency,” says DiPiazza. The highly politicized nature of the standards-setting process, wherein businesses lobby politicians to exert pressure on the Financial Accounting Standards Board, is a large part of the problem. New funding sources for FASB independent of the audit industry may improve the situation, but the legacy of the process is thousands of pages of rules riddled with exceptions for specific situations and opportunities to use aggressive assumptions. GAAP has enabled companies to comply with the accounting standards and yet violate basic principles of transparency and risk disclosure.

Given the ground rules, auditors are not wholly to blame for helping finance chiefs negotiate their way through them. But the situation has fostered a culture of gamesmanship in which auditors help their clients engineer transactions to achieve their accounting objectives. Enron is a case in point. Andersen received millions of dollars for helping to structure Enron’s labyrinthine network of off-balance-sheet entities. It clearly bears responsibility for not investigating what transactions the company was conducting in the entities more thoroughly, but at the end of the day, accounting rules may not have been broken.

The solution, says DiPiazza, is principles. Rather than focusing on whether or not the accounting complies with rules, executives and auditors should be evaluating whether or not it portrays the underlying economics of a transaction. “It’s a lot harder for me to bend a principle than to bend a rule,” says DiPiazza. He believes the International Accounting Standards movement, which relies more on a principles-based framework, can provide momentum for a similar approach in the United States. Of course, regulators may not be inclined to rely on the good judgment of auditors at this point, but integrity and adherence to principles are the only things that will restore confidence in the audit community and in financial disclosures. “The auditors have to be willing to take a position on principle,” says Sutton.

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