 Home Page
|
Auditing reform
Subsequent to the "Enron" problems, much discussion has related to why and how the auditors did not qualify their audit opinions. Angus has had the following article published in accounting trade magazines in the USA / UK. and has attempted to make his views known. ALL
IS NOT WELL WITH THE AUDITING PROFESSION; We
as a profession have dropped the ball. Now we face the unpleasant but
necessary task of true reform. By
Angus McDowell CPA, McDowell
CPA PC New York, NY. The
Institute of Chartered Accountants in England and Wales is considering a
practice review program, provisionally called practice assurance,”
that would help ICAEW member firms identify strengths and weaknesses
as an aid to greater operating efficiency and profitability. The ICAEW plans
for practice assurance to meet public expectations of high-quality
professional accountancy firms with a minimum of bureaucracy and no more
than a marginal extension of the statutory monitoring arrangements. But
I think the whole practice assurance concept is a red herring and it
won’t solve the real problem. The
accounting profession, especially the Big Five, wield considerable
influence over accounting and
auditing standards.
Logically, if accounting and auditing standards and their practical
application have spun out of control - as evidenced by the ongoing Enron
disaster — it must be mainly the fault of the profession itself. The
profession has also allowed giant conflicts of interest to exist. The
function of auditors is to reassure users of financial statements that
the facts are correct and to highlight any problems with the statements
or with the financial position, irrespective of compliance with
standards. If the profession cannot regulate itself, it shouldn’t be a
surprise that government agencies step in. I suggest the following
alternatives to our current, flawed
status quo: •
Restrict auditors to auditing functions and exclude them from
other work or affiliations with other businesses or functions (including
tax, consulting, insurance. real estate, investment advice, corporate
finance, mergers and acquisitions, and myriad other businesses). •
Sanction auditors when problems occur. •
Require auditors to make public any sanctions and settlements
with clients and third parties. •
Require auditors to publicly disclose their ownership and
affiliation structure, and limit the use of names or logos that might
conceal or confuse their ownership structure. • Hold auditors responsible for not only complying with standards, but also for reporting when standards result in presentations that do not show a “true and fair view". •
Reassess how the profession deals with materiality, provisions
and accruals, off balance sheet transactions, and other items that can
distort results. •
Disassociate audit fees from audit results. •
Prohibit contingency or performance-based fees and the use of
auditing services as a marketing tool. •
Grant auditors a minimum and maximum period for their
appointment. •
Restrict auditors from monopolizing clients in certain market
segments or exceeding
a certain size. •
Create a new professional body consisting solely of auditors. • Disclose when audits rely on other parties, including those not wholly owned and controlled by the named auditor. In
short, the profession should ensure that it is independent in both
appearance and fact and that it provides an independent view which can
he relied upon by third parties. Disclosing
ownership of audit practices may seem odd; however, “affiliated
firms” often work under the same or a similar name but under very
different standards, especially outside of the United States. I am
convinced that the branding of audit firms is designed to make users
think that the financial statements are prepared to a high standard,
even when they are prepared to lower local standards. In Eastern Europe,
for example, audited financial statements are prepared by local
affiliates of the Big Five. I doubt that most users understand the
accounting and auditing standards being applied or how they vary from
U.S. standards. They may read all the disclaimers, but they most likely
assume that statements are credible simply because they’re prepared by
brand name CPAs. Users of financial statements will notice warnings only
when they are specifically spelled out, surely the duty of auditors. Now is the time to create a new institute of auditors, limited to performing audits, without connection to other businesses. In other words, no consulting, accounting, tax, or statement preparation — just auditing. We as a profession have dropped the ball. Now we face the unpleasant but necessary task of true reform. FEBRUARY 2002 I THE CPA JOURNAL The author is a past president of the Association of Chartered
Accountants in the US.
A LETTER BY ANGUS MCDOWELL
JUNE 19, 2002 THE SENATE BANKING
COMMITTEE - ATTN. SENATOR P. SARBANES
CONGRATULATIONS ON YOUR CONSENSUS TO RECOMMEND THE FORMATION OF AN AUDITING REGULATORY BOARD. HOWEVER, AS YOU CAN NOW ASCERTAIN FROM THE BEHAVIOR OF THE SELF-SERVING MEMBERS OF MY PROFESSION, YOU CANNOT LEAVE FUNDAMENTAL CHANGES TO SUCH A BOARD. I BELIEVE THAT THE AUDITING PROFESSION WILL EVENTUALLY BE VERY GRATEFUL FOR YOUR LEADERSHIP IN AGAIN MAKING THE PROFESSION RESPECTED AND A VITAL PART OF THE FINANCIAL HEALTH OF THIS COUNTRY AND INDEED THE WORLD. I STRONGLY RECOMMEND THAT YOU INCLUDE THE FOLLOWING IN YOUR LEGISLATION - IT SHOULD APPLY TO ALL AUDITS AND SIMILAR SERVICES AND NOT BE LIMITED TO SEC REGULATED SERVICES:
3. AUDIT FIRMS ARE TO BE PRECLUDED FROM HAVING MARKETING, SHAREHOLDING OR ANY OTHER RELATIONSHIPS TO PROVIDE SERVICES TO THEIR "CLIENTS". IT IS A MYTH THAT AUDITORS CAN BE INDEPENDENT WHEN THEY UNDERTAKE OR RECOMMEND OTHER SERVICES. 4. GRANT AUDITORS A MINIMUM AND MAXIMUM PERIOD FOR THEIR AUDITS (REQUIREMENTS TO SOLELY CHANGE THE AUDIT PARTNER OR STAFF ARE A RED HERRING; IT IS THE FIRMS CULTURE WHICH MUST BE QUESTIONED; AUDITORS WOULD BE REQUIRED TO HAND OVER COPIES OF ALL DOCUMENTATION AND CORRESPONDENCE TO SUCCESSORS). 5. LIMIT AUDIT FIRMS TO 5% OF THE INTERNATIONAL MARKET, 5% OF THE DOMESTIC MARKET AND 10% OF ANY INDUSTRY (EXCEPT WHERE ONE "CLIENT COMPROMISES MORE THAN 10% OF AN INDUSTRY). (WHEN AUDIT FIRMS BECOME TOO LARGE, THEY GENERATE AUTOMATIC CONFLICTS AND COMPROMISES. HOW EASY IS IT FOR AN AUDITOR TO REQUIRE PROVISIONS AGAINST ASSETS SUCH AS RECEIVABLES, WHEN THEY ARE ALSO THE AUDITOR OF THE DEBTOR? IS 10% THE CORRECT OR BEST FIGURE? THAT IS DEBATABLE. AT THE END OF THE DAY, IT IS A ZERO SUM GAME AS FAR AS THE TOTAL INDUSTRY REVENUE AND NUMBERS OF PERSONNEL ARE CONCERNED, SO SOME FIRMS MAY HAVE TO DOWNSIZE, BUT THE TOTAL MARKET WILL REMAIN STATIC.) 6. REQUIRE ALL FIRMS TO HAVE THEIR AUDIT PAPERS REVIEWED BY ANOTHER INDEPENDENT AUDITOR, BEFORE A REPORT CAN BE ISSUED. BOTH AUDITORS WOULD BE IDENTIFIED IN THE AUDIT REPORT. (CURRENTLY MOST AUDITORS HAVE AN INTERNAL REVIEW FUNCTION; THIS WOULD SIMPLY MAKE IT AN EXTERNAL REVIEW AND RELIEVE THE REVIEWER OF THE INTERNAL PRESSURES AND CONFLICTS.) 7. AUDITORS SHOULD BE REQUIRED TO REPORT ON WHETHER THE FINANCIAL STATEMENTS MAKE SENSE - “TRUE AND FAIR VIEW”. (NO BODY OR INDIVIDUAL IS CAPABLY OF SETTING STANDARDS THAT MAKE SENSE IN ALL CIRCUMSTANCES. THIS IS ESPECIALLY TRUE IN OUR PRESENT FAST MOVING ENVIRONMENT.) 8. AUDITORS SHOULD BE REQUIRED TO COMMENT ON ANY ITEMS WHICH THEY FEEL ARE NECESSARY FOR THE USERS OF FINANCIAL STATEMENTS TO FULLY COMPREHEND THE FINANCIAL POSITION OF THE “CLIENT". (TODAY, AUDITS ARE BASICALLY USEFUL TO THIRD PARTIES, SO WITHOUT THE CONSTRAINTS OF AUDIT REPORT FORMATS, AUDITORS SHOULD BE ENCOURAGED TO MAKE THE USERS AWARE OF IMPORTANT CONSIDERATIONS, WHICH MAY NOT OTHERWISE BE OBVIOUS.) 9. THERE HAVE TO BE RESTRICTIONS ON THE MIGRATION OF STAFF FROM AUDITORS TO THEIR CLIENTS. MANY CLIENTS PERCEIVE AUDITS AS BEING A WASTE OF TIME AND MONEY AND THAT THE PROFESSION FEELS IT IS EASIER TO SHOW CLIENTS THAT WE OFFER VALUE FOR MONEY WHEN WE UNDERTAKE TAX AND OTHER WORK. THE PROBLEM HAS PARTLY BEEN THAT, GIVEN MODERN TECHNOLOGY, CLIENTS KNOW THEIR FINANCIAL POSITION BETTER THAN THEIR AUDITORS; SO THE AUDITING FUNCTION DOES NOT PROVIDE DIRECT VALUE ADDED TO MANAGEMENT, DIRECTORS OR SHAREHOLDERS “CLOSE” TO MANAGEMENT AND DIRECTORS – THESE OF COURSE ARE THE VERY PEOPLE WHO ARE RESPONSIBLE FOR AUTHORIZING THE FEES. AUDITORS SURELY ONLY PROVIDE “PERCEIVED VALUE TO MANAGEMENT AND DIRECTORS” WHEN WE THE AUDITORS ARE HELPING TO TELL THE STORY OF THOSE PLAYERS TO THIRD PARTIES, BUT WITH AN ADDED VENEER OF INDEPENDENCE. THAT SERVICE IS PERHAPS ONLY VALUABLE TO MANAGEMENT ET AL WHEN IT MAY NOT BE ABSOLUTELY TRUTHFUL. THE REPRESENTATIVE OF THE ACCOUNTING PROFESSION HAVE MAINTAINED THAT THE ABOVE ARE IMPRACTICAL AND TOO EXPENSIVE. HOWEVER, I SUGGEST THAT IN REALITY THAT IS NOT TRUE.
ANGUS MCDOWELL CPA, FCA
AN OPEN LETTER BY ANGUS MCDOWELL TO THE PRESIDENTS OF THE ICAEW AND AICPA IN RESPONSE TO A MEETING IN NEW YORK AND AN E-MAIL FROM THE AICPA TO ITS MEMBERS JANUARY / FEBRAURY 2002
Michael Groom, FCA - President Gentlemen: I am a member of both your organizations and proud of it. I have recently received an e-mail from the AICPA, Messrs. Castellano and Melancon, a copy is attached. I also recently attended a meeting for members of the ICAE&W in New York, hosted by the Association of Chartered Accountants in the U.S. Given the current turmoil, I believe that it is worth sharing my thoughts. Firstly let me deal with some of Mr. Groom’s comments: As I recall, he urged the attendees not to make “knee jerk reactions”. He also indicated that situations similar to “Enron” could not have happened in the United Kingdom and that auditors should still be allow to undertake consulting and other work. The reasoning for the inability for “Enron type” situations to happen in the UK, is he maintains, because the UK audit opinion requires the auditors to express that the accounts present “a true and fair view”, rather than just complying with accounting standards. In my opinion, there is merit in this system, because it is impossible for the standard setters to preconceive every situation and make appropriate standards. The AICPA should consider a similar system whereby the auditor is required to opine on whether the accounts give a true and valid view of the entity’s financial situation. Of course, this may require legislation in the USA, to enable auditors to be able to freely express their opinion without fear of frivolous lawsuits. Unfortunately, I do take issue with Mr. Groom on the integrity of the UK profession. Given the branding of the large professional firms, the public (and indeed many business people), assume that the standards throughout the world of the large firms are uniform. At least one large firm maintained that it was “one firm worldwide”. In such a situation, if the UK partners in such “branded” or “worldwide” firms maintained higher standards than those in the USA, then surely they should either have controlled their US counterparts or have resigned from the organizations. I would further guess that if one was to look at the audit reports issued by the “branded” firms in Eastern and Central Europe, that there have been similar missteps as have recently occurred in the USA. At least some of the “branded” auditing firms in Eastern and Central Europe are partly owned or controlled by UK (and US) accountants. If the UK accountants want to maintain that they “practice to a higher standard”, then they must surely expect that they will be held responsible at the highest standard for the accounts they audit, not withstanding the fact that local standards may be much lower than UK standards. If accountants want to “brand” themselves, then they must live with the consequences, just like other businesses. Specifically, I believe that in Eastern and Central Europe, the large firms used consulting services to help expand their auditing practices. Some through fees from international organizations and some through host governments. I also believe that in some cases, the auditors received consulting assignments from local governments and also audited government-owned businesses. Even more disturbing, there have been private and some public accusations of corruption in these areas (but not as far as I know of the accounting firms). In such a situation, can the auditors really maintain they are independent? So I say to Mr. Groom, we as professionals may not like it, but to regain public confidence and respect, the time has come to explicitly restrict auditors to attest functions - not even allowing them to prepare the financial statements they audit. If he calls my comments a “knee jerk reaction”, so be it. Mr. Groom will also have to find a new way forward given the fact that the “Chartered Accountant” “CA” in the UK / Europe is perceived as being a cross between an MBA and CPA; so CAs tend to be chosen for functions where MBAs would be used in the USA. Perhaps the broad based rigorous exams and practical training of CAs need to be divorced from the professional body overseeing attest functions. Secondly let me address some of the comments of Messrs. Castellano and Melancon. You say that our profession enjoys a sacred trust. Well lets make sure we get it back. Unfortunately, I disagree with part of your comments. You say, “the most basic problem lies - the current and outdated financial reporting model and the accounting principles that surround it.” Well, they may be far too complex. But had the AICPA simply required auditors to use their discretion in audit reports, when the information did not make sense, to state that fact and explain why, it may have solved some problems. The proposal to limit changes to “prohibitions on auditors of public companies from providing financial systems design and implementation and internal audit outsourcing”, just will not solve the problem. As in the UK, I believe that the time has come to explicitly restrict auditors to attest functions - not even allowing them to prepare the financial statements they audit. Are you suggesting that an auditor should be allowed to prepare tax provisions and tax returns for clients? Are you really suggesting that an auditor can audit his own firm’s tax calculations relating to the client? Lets face it, the tax code and regulations are so complex, that positions are probably taken on every engagement. Is the auditor really going to question his own tax partner / expert? This should not be limited to public companies. If your aim is to restore public confidence, then you must take bold steps, even if it requires setting-up a new “auditing institute” separate from the AICPA and State CPA Organizations. We as CPA should not be afraid or small minded. A strong and really independent auditing profession will enhance the reputation of all CPAs and will encourage students to become CPAs. Yes, it may require reorganization in the way we do business, both in small and large firms, but once CPAs get used to a new business model, they will find it benefits us all. “We have communicated our zero tolerance of violations of the ethics and standards of our profession, which tarnish us all.” If your statement is realistic, then I suggest you set-up an internal committee to examine the audits undertaken by AICPA members, during the last few years, where non-attest fees from attest clients, exceed the audit fees by a given amount and implement your preceding statement. “We will focus attention on addressing inherent inequities in the auditing process, for example, that it is a felony to lie to a prosecutor, but not to one's auditor”. I suggest that you be very careful what you wish for. It may come true. Surely a basic part of an audit is to independently verify statements made by clients. Do we really want or need the powers as suggested by you? SUGGESTED CHANGES IN THE AUDITING PROFESSION
These are my suggestions for change. • Restrict auditors to attest functions, excluding them from any other type of work, or affiliation of any type with other businesses / functions (including statement preparation, tax, consultancy, insurance, real estate, investment advisors, corporate finance, M&A and the multitude of other "businesses" operated by some accounting firms) • Auditors must make public any and all sanctions and settlements with clients and third parties • Auditors must make public their ownership and affiliation structure and limit the use of names / logos which might hide the real ownership structure - “branding disclosure” • Require the specific audit partners' names on the audit to be disclosed • Auditors should go back to the "old-fashioned reports" and be responsible for not just compliance with standards, but additionally must report when standards result in presentations which do not show a "true and fair view". • The profession should reassess how it deals with "materiality", "provisions and accruals", "off balance sheet transactions", "excluded subsidiaries", "prior period and adjustments to retained earnings" and other items which may distort results. • Dissociate audit fees from audit results • Grant auditors a minimum and maximum period for their appointment • Define monopoly restrictions for auditors as regards total size and market segments • Create a new professional body which consists solely of auditors • Disclose when audits rely on other parties, including those not wholly owned and controlled by the named auditor • Preclude auditors and their professional staff from being employed by former clients after they leave the auditing profession In short, the profession should make sure it is not only independent, but is seen to be independent, and provides an independent view which can be relied upon by third parties. END NOTE The last decade or so has seen changes in the way business and probably government has been conducted. It is quite clear that the vast and complex laws and regulations have made auditing and business very difficult, additionally lawsuits have turned the nation into “practitioners of law”. This surely needs to be addressed by the legislature, partly to restrain themselves from passing laws or allowing regulation which they (the legislators) do not completely understand, not to mention the general public who are deemed to know the law (read, the legislators should be able to pass a test on all laws and regulations coming into force or being changed); and partly by reducing merit less lawsuits and awards in excess of the true damage suffered. There has been discussion on the possibility of the SEC or other governmental body overseeing the CPAs. Of course all CPAs are already licensed and the SEC had shown that it has not been effective. There surely should not be a new governmental oversight function. If for no other reason, auditors actually audit government units, so it would be a nonsense for the government to oversee the auditors auditing itself. As much as we may all dislike it, it is time for a change, let the CPA profession show that we are really one of integrity and ahead of the business, financial, political and other communities. We need you, the leaders of our community to stand up and be counted, for our common good, not just the self-interest of some members. Angus McDowell, CPA, FCA LETTER FROM THE AICPA Dear
AICPA Member, For the last two weeks, we have been working around the clock to improve the perception of the accounting profession. During this period we have been called upon to speak for the profession in literally scores of broadcast and print interviews. We have communicated our zero tolerance of violations of the ethics and standards of our profession, which tarnish us all. And we are attempting to focus scrutiny on where we believe the most basic problem lies - the current and outdated financial reporting model and the accounting principles that surround it. What our observations of the current debate have driven home to us is that because scope of services has become such an issue, it must be addressed before the real issues will ever be considered. For that reason, your Board approved a resolution to support prohibitions on auditors of public companies from providing financial systems design and implementation and internal audit outsourcing in order to restore the public's confidence in the financial reporting system. While necessary to restore the public confidence, the Board does not believe that prohibiting non-audit services will improve the quality of audits nor prevent business failures. We will therefore continue to work on substantive improvements to the financial reporting and regulatory process. To this end, we have already begun to focus others on the benefits that will accrue from a reporting model that is suitable to Information Age companies, whose earning assets are often not accurately valued by traditional, manufacturing-based measures. We will work with the SEC to strengthen regulation of the profession as it implements a system that incorporates active public participation to enhance discipline and quality monitoring. We will continue to marshal support for moving from rules-based to principles-based accounting. Finally, we will focus attention on addressing We have communicated our zero tolerance of violations of the ethics and standards of our profession, which tarnish us all. Let us reaffirm and be perfectly clear that the Board recognizes that the reporting needs of private companies and their auditors are very different and should not be subjected to the same restrictions on non-audit services. It is the tradition of CPAs throughout the U.S. to provide a range of services including audit, tax, business advisory and information technology, to their privately held clients. In the coming weeks, you will see advertisements in The Wall Street Journal, New York Times, Washington Post and USA Today that we believe will begin the process of restoring confidence. We will not delay launching our student website and recruiting efforts, as our integrated marketing consultants advise us that the profession's heightened visibility makes this an opportune time to convey our messages regarding its viability, dynamism and high standards. We will use every communications vehicle at our disposal, including mail, e-mail, our website, CPA Letter and Journal of Accountancy, to keep you apprised of developments and to provide you with the information that you need. This has been a difficult time for all of us, but we look forward to restored public confidence in our profession. As always, please feel free to contact us with your comments and suggestions. Yours sincerely, James G. Castellano, CPA Chair of the Board Barry C. Melancon, CPA President and CEO To: James G. Castellano, CPA Barry
C. Melancon, CPA
Gentlemen:
I personally believe that the ethic of allowing Auditors to perform
any tax work for audit clients is inherently flawed.
Gentlemen, I believe that the AICPA is wrong in supporting auditors
in providing tax advice and tax compliance to clients, especially to
the same clients.
Today's tax work entails inherent risk, positions and strategies for
both the client and the auditor which can be so material to a
financial statement that, I believe in many cases, an auditor
providing both services is by definition not independent.
As much as I personally dislike having to force Certified Public
Accountants to curtail such cross service provision, for the sake of
the credibility of CPAs, I urge the AIPCA to change its policy and
prohibit audit firms from providing tax services.
Angus McDowell CPA
LETTER FROM THE AICPA
On February 8, 2002, we wrote to you to discuss the AICPA’s recent efforts with regard to the new auditor independence standard issued by The U.S. General Accounting Office (GAO) on January 25, 2002. Specifically, that letter described how our efforts to communicate the serious issues and concerns of CPAs to the GAO remained relentless, even up until the day before the rule's release. The letter also encouraged you to
submit implementation issues or questions to us so that we could
address them with the GAO as implementation guidance is developed.
As a result, we received hundreds of questions on the effect of the
new standard from small, medium
and large CPA firm auditors,
members in government,
members in tax practice,
members who specialize in audits of government and nonprofit
organizations, and
members who specialize in audits of the federal government's
component units.
We continue to encourage you to submit any additional implementation
issues or questions on the GAO standard to us via email to
GAOIndependence@aicpa.org. Over the past month, we have been
actively engaged in reviewing your questions and concerns and
compiling a list of implementation issues and questions that need to
be addressed in implementation guidance. Based on these questions, we
have begun to remit our views to the GAO to assist them in
developing appropriate independence interpretive guidance. The GAO
has stated it intends to issue a “questions and answers document” in
May 2002. The GAO has also committed to include us in the
development of the guidance and we are in the process of setting up
meetings with the GAO to begin that process. The GAO has assured
us that the guidance will make it clear that preparation of tax
returns, the provision of routine advice and answering technical
questions in the normal course of a client relationship by the same
people who work on the audit will be permitted.
We
stand ready to assist the GAO in any way we can and
believe that by
working collaboratively in the guidance development process the GAO
will achieve seamless and transparent implementation of the rules.
Independence is a cornerstone of the profession, and we support independence standards that are meaningful, comprehensive and protect the public interest. We will continue to keep you abreast of important developments. James G. Castellano, CPA Barry
C. Melancon, CPA |
|