The CPA Journal

February 2002

All Is Not Well with the Auditing Profession; How To Fix It?

By Angus McDowell, CPA, McDowell CPA PC, New York, N.Y.

The Institute of Charted 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. n 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 be 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.

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