How Audits Must Change

Auditors face more pressure to find fraud.

The Reporting Problem

Some critics of the state of auditing don’t blame the auditors as much as the financial reporting that they have to work with. Walter P. Schuetze, former SEC chief accountant and chairman of two audit committees, says that as long as management is allowed to estimate so much of a financial statement, auditors’ hands will be tied. “The way accounting rules are written, management has control of the numbers,” says Schuetze. “Auditors have no traction to change the numbers.”

He advocates fair-value accounting for all assets and liabilities, thus ensuring that a third party is involved in evaluating the market, not historical, value. With third-party involvement, overstating assets à la HealthSouth would be much more difficult, because someone would verify each item. Barring that change, he adds, auditors must be more diligent in seeking underlying evidence to prove the existence of assets and liabilities “instead of just accepting a copy of an invoice. We need to require evidence,” insists Schuetze. “There’s a difference between evidence and hearsay. If auditors presented a court of law with a lot of the backup material that they base their findings on, they’d get thrown out because it’s all hearsay.”

“Peekaboo” Takes Charge

PCAOB personnel will now take over the peer-review process once administered by the AICPA, says Carmichael. “There’s obviously a need for better training,” he says. “For our inspections, we’ll come in and select audit engagements to review, and we’ll see whether there’s conformity to standards. We’ll be able to tell if they should be giving their people better training and if they’re getting the basics right.”

Even auditors seem pleased that the PCAOB has taken over standards setting. They see an opportunity for the board to mandate a clearly defined “bright line” minimum for the basic audit work that is now recognized as crucial in finding fraud, but that often gets pared back by auditors’ cost concerns. Deloitte’s Weaver states the obvious: “I don’t think there’s any objection by us to doing more-expansive audits. But it needs to be an obligation that is established by the PCAOB. Mr. Carmichael can have a significant influence on what those standards are and apply them consistently across all companies. Then we’ll have an obligation that we must meet, and companies will have to pay for it.”

Talk like that makes CFOs nervous, especially in light of the increased compliance costs associated with Sarbanes-Oxley. Auditors will already have to do more extensive work because of Section 404 of the act (which requires auditors to review and sign off on management’s attestation of internal controls, and is expected to bump audit fees by 35 percent, according to a recent study by Financial Executives International). But CFOs are justifiably concerned that if the PCAOB mandates a more expansive “standard minimum” audit for all companies, it would give auditors carte blanche to charge more for a level of audit quality that they should have been providing all along. “If auditors ask for a massive fee increase, you have to ask, what are you going to be doing differently now that you weren’t doing before?” says Bob Agate, former CFO of Colgate-Palmolive and chairman of the audit committee at The Timberland Co.

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