I receive letters, lots of letters, some nice, some not so nice.
In response to my recent commentary, "Financial Literacy - a Gulf of Misunderstanding," (Accounting Today, Aug. 23-Sept. 5, 2004) I received a fascinating letter from a retired Arthur Andersen senior partner who has also held some high posts in the accounting profession and who requested anonymity.
In a paper I wrote in 1968 titled "A Gulf of Misunderstanding," I stated, "Whether we like it or not, millions of readers of financial reports directly associate the CPA with the financial statements. Their eye travels from the name of the accounting firm to the figures in the statements. They pay little attention to the accountant's opinion, which all agree is dull reading.
"Many of them believe that (1) the accountants prepared the statements, (2) that the statements are highly accurate, and (3) if for any reason, including management malfeasance, the statements are inaccurate, the accountants should be held responsible.
"Many of us believe that (1) we did not prepare the statements, (2) the statements are a fair presentation involving areas of judgment and reliance on company representations, and (3) that we should not be responsible per se for 'inaccuracies,' some of which may have been caused by corporate malfeasance and were not due to negligence on the part of the accountant."
In response to the foregoing, my correspondent, an acknowledged expert in auditing, wrote to me as follows: "Asking the auditors to find all major misstatements is a system doomed to failure. In large companies, it is simply too easy to hide fraud from auditors. Part of this is for the reasons discussed below. While Sarbanes-Oxley puts in significant penalties, it is only a matter of time before we see the next round of fraud and/or failures. The rewards of fraud are simply too great in the short run for it not to happen.
"The other major point is that there are a significant number of large companies that can't be and are not audited by any definition that you, I or the public thinks is an audit.
"This includes GE, mentioned in your article. On companies the size and complexity of General Electric, there is no number in the financial statements that is audited. [Correspondent's emphasis.] Large transactions may or may not be audited, but that leaves a large gap for dishonest management to hide things in. You simply can't audit billions of dollars of transactions and get the report out on a timely basis with the limited number of people you can throw at the project. So, the auditors are auditing a 'system,' but not the numbers, and the public thinks they are auditing the numbers. 'We have attempted to audit the company's system of reporting and accumulating its results but have not verified any balance in the accompanying financial statements.' True, but don't look for it anytime soon."
To me, the foregoing was a shocking revelation by an experienced and knowledgeable CPA, which, in effect, stated that, especially in the case of very large companies, the "independent accountants" literally do not audit the figures - they audit the system. If the public knew of the limitations described by my correspondent, they would shout, "Who needs the auditors?"
So, where does the Public Company Accounting Oversight Board fit in?
Sooner or later, it must decide whether to accept the current system or to insist on a new mechanism for the benefit of the public and shareholders. Most importantly, the PCAOB should receive a complete set of computerized workpapers on the audit of every public company, so that the public knows and the auditors know that their work product can be scrutinized by the PCAOB inspectors before, during and after the completion of an audit.
The PCAOB was created because the system of auditing large public companies failed, because shareholders lost billions in investments and, in all candor, because the accounting establishment performed on a less-than-admirable scale. If, as my correspondent advised, the "independent accountant" who is required to submit an audit report pursuant to Securities and Exchange Commission Regulation S-X is charged with an impossible task, there must be a revision of the rules. If, as he stated, in the case of companies the size and complexity of GE there is no number in the financial statements that is audited, then the old adage, "We conducted our audit in accordance with generally accepted auditing standards," may not have been true.
Members of the PCAOB, please take note.
Eli Mason is a past president of the New York State Society of CPAs, a past chairman of the New York State Board for Public Accountancy, and a past vice president of the American Institute of CPAs. He is also the recipient of the American Accounting Association's Exemplar Award. He recently took time off to write his book, Conscience of the Profession.
