How Audits Must Change

Auditors face more pressure to find fraud.

For its part, the AICPA has publicly stated that it embraces the work of the new oversight board, and that “it doesn’t matter who comes up with the better mousetrap,” says Landes. Despite statements to the contrary, the AICPA is not making the transition easy. Even after the PCAOB was given authority to set all future audit standards, the AICPA issued an exposure draft for new rules on implementation of Section 404, eliciting a stern rebuke from the SEC, which reminded the association that it was no longer responsible for auditing standards.

The most ironic element of the transition is that the AICPA holds the copyright for all of the auditing standards it has drafted since it began issuing them 60-plus years ago. Until the PCAOB writes its own standards, it must use the ones the AICPA wrote, and some reports indicate that the AICPA is trying to charge the board a fee for their use. Landes wouldn’t comment on the allegation, saying only that “we want to find a satisfactory arrangement that will allow the PCAOB to do the work that is before it. But we’re also cognizant of our members’ interests and the assets of the AICPA.” Critics say that perhaps that was the root of the problem all along.

Dissecting HealthSouth

According to the complaint filed by the Securities and Exchange Commission in U.S. District Court for the Northern District of Alabama against health-care provider HealthSouth Corp. and its former CEO, Richard Scrushy, the company orchestrated a scheme to overstate earnings in order to hit analyst estimates — a scheme concocted in a way to avoid detection by its auditors, Ernst & Young LLP. Between 1999 and the second quarter of 2002, the company overstated income by $1.4 billion by making false journal entries overestimating the amount of third-party insurance reimbursement, and by decreasing expenses.

The firm used the auditor’s own processes against it to perpetrate the fraud, according to the complaint. Executives increased earnings not by boosting revenues directly, which auditors would have been more likely to find, but by reducing a revenue-allowance account that was used to record the difference between gross billings and reimbursement amounts expected from third-party payers. This account, which would then be netted against revenues, has a limited paper trail and is based largely on estimates, and the amounts booked to the account are more difficult to verify. And because HealthSouth executives knew that E&Y did not question fixed-asset additions below a certain dollar threshold, it made random entries to its balance-sheet accounts for fictitious assets worth less than that amount. Senior accounting personnel created false documents to support asset purchases. In this way, the company allegedly overstated property, plant, and equipment by more than $800 million. It also overstated cash accounts by $300 million.

So far, 11 executives, including all five former CFOs, have pleaded guilty to participating in the fraud, which prosecutors believe had gone on since 1986. Scrushy continues to maintain his innocence.

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