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ANALYSIS
March 2, 2009
Sagging Index no longer reflects what’s going on in the market, some say, Replacements? Google it, to start.
March 2, 2009
Downward price spiral will actually boost the cost of capital for most companies. CFOS, take note.
March 2, 2009
The latest bailout at AIG could be a preview of how the president will deal with Wall Street.
March 2, 2009
No corporate defaults. Big debt offerings. Percolating CP issuance. Things may be looking up in the capital markets.
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December 17, 2007 12:01 AM ET
The top regulator of the audit industry is turning up the heat on audit firms to do a better job assuring that their clients stay on the straight and narrow, pushing for potentially more expensive, forensic-like approaches to annual reviews of financial statements. Thomas Ray, chief auditor of the Public Company Accounting Standards Board (PCAOB), put a room full of accountants on notice at a conference held last week by the American Institute of Certified Public Accountants that he expects them to do more to ferret out potential fraud on corporate financial statements. “It’s essential that auditors maintain professional skepticism and that they follow up on red flags they find,” said Mr. Ray, a former partner with KPMG and Grant Thornton. “Auditors have to evaluate the risk of fraud.” Mr. Ray has yet to propose any new requirements that auditors add more costly forensic-like procedures to their audits, but his tough talk alone could drive up audit costs for companies. The audit firms have long maintained that there’s little they can do to stop senior executives intent on doctoring the financials. “If high-level executives want to lie, cheat and steal, they can lie, cheat and steal,” said Cynthia Fornelli, executive director of the Center for Audit Quality, a trade group. “We can never eradicate fraud totally, no matter what tools you give auditors.” Mr. Ray, however, contends that the watchdogs could and should do more to guard against the possibility. According to Statement on Auditing Standard 99, which went into effect in 2005, auditors are already expected to assess the risks of fraud in financial statements. And they’re expected to take steps to check that it hasn’t occurred. PCAOB inspectors who have been eyeballing the firms’ work for the last four years complain that auditors aren’t putting in much of an effort. “Our inspection reports indicate that some firms are taking a checklist approach to the process,” Mr. Ray, who directs standard-setting at the PCAOB, said in an interview. “SAS 99 is a good standard, but there are opportunities for auditors to do a better job following it.” That might sound a little unnerving to chief financial officers. The first step that auditors should take per SAS 99 is to gather experienced audit managers in a room and brainstorm on where they think clients would most likely commit fraud. SAS 99—adopted as an interim standard by the PCAOB—suggests that they “set aside any prior beliefs the audit team members may have that management is honest and has integrity.” The standard goes on to recommend they consider surprise inventory counts, additional asset confirmation procedures and a variety of other tactics to investigate transactions they think carry high risks of fraud. “They’re supposed to play the devil’s advocate,” said Martin Wilczynski, senior managing director at forensic accounting firm FTI Consulting, who worked at PricewaterhouseCoopers for 10 years and at the Securities and Exchange Commission for six. “They have to determine where the greatest risks of fraud are and they have to tailor their audit procedures to address the risks.” Those procedures are where the billable hours can mount. Forensic activities, including extensive interviewing, more substantial testing and more rigorous investigation of transactions, don’t come cheap. Key areas where auditors need to beef up their efforts, according to Mr. Ray, include examination of late or post-period journal entries, related-party transactions and accounting estimates. They also have to assess what incentives senior executives have and whether and where that might lead them to fiddle with the financials. With that in mind, he wants auditors to identify types of journal entries that might require additional testing, as well as entries made late in a reporting period that might potentially enable a company to hit performance targets. A large number of financial frauds are done by simply booking late journal entries. “It’s the easiest way to commit fraud,” Mr. Ray said, “and it’s the easiest to find.” Not always. Dell, for example, did it for more than four years without auditors from PricewaterhouseCoopers finding it. The company recently restated its financials for those years and remains under investigation by the SEC. Transactions that involve accounting estimates and/or complicated valuation processes—subprime mortgage securitization comes to mind—are also common areas for manipulation. They include allowances for bad debt, accruals for merger-related expenses, and restructuring reserves. The appraisal of hard-to-value securities and financial obligations relating to subprime loans is a key priority of the subprime working group established by the SEC’s enforcement division, said SEC deputy director Wayne Ricciardi at the same AICPA conference last week. FW
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