By Paul B.W. Miller and Paul R. Bahnson
Our preceding column suggested that auditing has devolved to the point that many auditors are no longer gatekeepers for the capital markets, but enablers for their clients’ efforts to mold financial statements to present pretty pictures that aren’t true.
The gatekeeping function existed to improve the efficiency of the markets by allowing financial statement users to essentially take for granted that financial reports were trustworthy. Without unquestionably capable and principled auditors standing guard at that narrow gate, investors now face higher risks and higher processing costs, and managers face higher capital costs.
By sacrificing the gatekeeping role and enabling management’s dysfunctional behavior, auditors now fill a diminished role in the economy and face further erosion of their prestige, security and satisfaction.
The fingerprints of that devolution include extensive fraud, restatements and litigation, as well as the disappearance of one large CPA firm. The causes are many, including the profession’s movement to fixed instead of hourly fees, but at the heart of the decline is lost understanding and vision for what audits should be.
Audits have become commodities, nothing more than shallow exercises in compliance, as evidenced by relatively superficial differences among audit firms. Not surprisingly, managers seek bare-bones audits so that they can pay as little as necessary. It’s sort of like renewing your driver’s license: No one cares how well you do it, as long as you get it done.
This dismal situation cannot be improved without attacking its root cause, which is, we think, managers’ lack of respect for the capital markets. The dominant attitude among them seems to be that the markets are indiscriminate consumers, incapable of knowing what to do with financial information and unable to discern quality differences. Thus, managers might as well do the least work possible to prepare their reports, as long as they can put out glowing press releases.
In fact, the markets are able to determine what is and is not in the statements. Analysts (good ones, anyway) are willing to invest considerable time figuring out what to believe and what not to believe, and where to turn to get really useful information. They never take at face value financial statements that comply with generally accepted accounting principles, especially when they comply minimally.
Thus, the starting point for an audit revolution is the realization by a few good managers that auditing’s gatekeeping role is incredibly important to them. While the Sarbanes-Oxley Act nudges toward recreating that role, it falls short. After all, capital markets are global and highly competitive. To the foresighted victors who voluntarily emphasize quality over glossiness will go the spoils — in this case, lower capital costs and higher stock prices.
In short, we think everyone in the economy needs good audits and auditors. The sign of a good audit is that it adds value to the financial statements. It does so in a couple of ways. First, it makes good information more credible. Second, it causes more good information to be reported.
When this value is added, managers gain access to cheaper capital, statement users save time and money, regulators focus on real problems, and the public enjoys the fruits of a more productive economy driven by more efficient capital markets. Of course, when auditors add real value, they are more respected and entitled to larger fees.
The key for unlocking this real value is restoring the lost integrity and trustworthiness of audits and auditors. We see that some things need to be done while others need to stop.
For one, we would do away with fixed-fee audits so that the cost of curtailing bad reporting practices is clearly shifted back to preparers. We would put an end to all opinion shopping, period. Like others, we would stop all non-audit services by the auditing firm or affiliates. We would like to see audit firms participate meaningfully in standard-setting, with the goal of making GAAP financial statements more useful.
We want the American Institute of CPAs to be either replaced or drastically reformed to be a paragon of professionalism instead of its current status as a model of floundering entrepreneurship. We also call on auditors to adhere to independence concepts that are tougher than today’s compromised and mechanical rules. (Our opinion: If you have to look in the rulebook to determine whether you’re independent, you aren’t.)
We would have financial reports compiled with greater emphasis on quality in terms of their completeness and usefulness. We would have auditors urge managers to take the higher road of transparency, which will happen only when they acknowledge that mere compliance with GAAP is not close to good enough. Accordingly, we cannot support any efforts (active or passive) by auditors to conspire with their clients to hide or destroy the truth.
If these things can be accomplished, auditors will actually find themselves back in demand because they are adding value to financial statements. This situation stands in contrast to the status quo, where auditors (at least good ones) find themselves being browbeaten to go along with their clients’ schemes to produce those false financial images without charging very much.
While we know of no corporate managers who are clamoring for tough audits that will add value to their statements, we are growing more optimistic about seeing this revolution occur. We are greatly encouraged by the words of Robert Bunting, the AICPA’s chairman-elect, because he is saying all the right things about professionalism.
As the chief executive of Moss Adams, the West Coast regional firm, he helped it grow to become the tenth largest CPA firm in the country. Bob attributes his firm’s success and growth to its “Pillar Program,” which cultivated the values of ethics, integrity, passion for excellence, and balanced living as guiding principles. What is more, these ideas were not just framed statements hanging on the wall, but fully integrated into the firm’s hiring, promotion, compensation and client retention decisions.
Bob is now using his high-profile position at the AICPA to proclaim the many virtues of that program. In a recent conversation, he mentioned that
he is increasingly called on by other auditors for assistance in making a similar move.
Whether Bob can lead many others to this ethical epiphany remains to be seen. After all, they must want to have one. Undoubtedly, he will be opposed by those who are chained to the status quo. However, the wave of scandals and the demise of Andersen have surely convinced many that revolution is desperately needed.
Although the accounting profession didn’t get into this mess overnight, it can get out of it a whole lot more quickly. Please join us in encouraging managers and auditors to open up and start to do what is right, because doing so will add real value and make them prosperous, satisfied and prestigious again.
Paul B. W. Miller is a professor at the University of Colorado at Colorado Springs and Paul R. Bahnson is a professor at Boise State University. The authors’ views are not necessarily those of their institutions. Reach them at email@example.com.
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