April 2002

Serious Action Requires Serious Thought

In his article “All Is Not Well With the Auditing Profession; How to Fix It?” [Personal Viewpoint, February 2002], Angus McDowell states that auditors should be excluded from any other function. We agree that accounting and consulting should be separated, but restricting firms to auditing would be counterproductive and regressive, returning the profession to the musty days of green eyeshades and smudgy tick-marks. Convincing students of the advantages and promising future to be found in such a field would be difficult as well. They would see it as narrow, dull, and a dead end. Students want a profession that has a broader appeal. McDowell also wants to sanction auditors when problems occur, and indeed they can be sanctioned now under our rules of professional ethics. A true improvement would be to make it a criminal act when a corporate officer lies to the auditor.

Although the media, in a post-Enron fury, are pillorying the accounting profession for its shortcomings, Enron was aided and abetted by lawyers, investment bankers, and financial institutions that made maximum use of creative shenanigans, esoteric derivatives, and special-purpose entities. Enron executives initiated the gimmicks that let the corporation inflate earnings beyond reality. They pushed the complexities of the financial system to their limits, and unfortunately the auditors were carried along. Everybody was happy to collect their fees and help overinflate the balloon, and now everyone points their fingers at somebody else. Meanwhile, the public interest is sidelined, investors lose their savings, and many investors who were also employees lose their jobs as well.

We don’t diminish the serious consequences for the countless people involved in the collapse of Enron, but there is no reason to panic. Unfortunately, large-scale frauds and financial calamities happen, and each time our economy has endured. Hurried congressional action and attempts to regulate economic behavior and solve problems best dealt with in the private sector are not the answer. Serious actions require serious thought. Hastily developed government controls over the accounting profession won’t save us from future Enrons, and in the final analysis the profession must regulate itself. As the dust settles and public confidence is restored, auditors will regain the status it took generations to build and a few years to destroy.

Our profession must reaffirm its commitment to integrity and the highest ethical behavior, and the tone in that reaffirmation must start at the top. The new public oversight agency should exert its influence to support integrity and ethics, and accounting firms should increase their staff training to include the old-fashioned “sniff test” (If it smells bad, it probably is bad). Auditors should be trained to treat no one at any level as being above the law and above being asked questions. They must take responsibility and adopt Harry Truman’s motto: “The buck stops here.” In addition, audit committees and boards of directors must fulfill their responsibilities.

We need to be proactive in addressing the difficulties in rendering an opinion that financial statements are “fairly presented” in a business environment that is increasingly complex. For example, we need to sharpen the concept of materiality. Too many bad judgment calls have been made because something was “immaterial.” We need to pay more attention to each situation’s circumstances and recognize that a few immaterial items can easily add up to materiality.

Internal controls must be strengthened as well, and peer review can become a real force toward that end. But we should change the system so CPA firms don’t perform peer reviews on each other. Accrediting organizations for higher education have the right idea: Each peer review is a “pick-up team” of experts in each field, headed by a leader. The accounting profession could adopt that concept with peer reviewers who are individually qualified by the AICPA or the state societies. The professional organization then selects from among individual experts in the appropriate fields to compose peer review teams. The peer reviewers and the team will then be truly independent, and CPAs will be less able to sweep questionable practices under the rug.

Although greed causes many people to lose perspective, the public interest must become paramount. The profession and the business communities it serves must emphasize integrity and ethics. A code of conduct that is strictly followed by everyone and endorsed by top executives should be the rule, not the exception. When we notice that the winners of the prestigious Malcolm Baldrige Award have exceeded the returns of the S&P 500 two to three times over, qualities like integrity and quality don’t seem so overrated. Everybody in the organizations that win this award gain: the entity whose net is higher than ordinary, the happy employees, and the executives who are running a truly successful operation rather than “cooking the books.”

Investors must regain confidence in the public markets and believe that they have the ability and the facts to evaluate their investments fairly. Perhaps all of us in the accounting profession should pay more attention to our basic concepts that lead to credible financial reporting: relevance, reliability, consistency, materiality, going concern, matching, conservatism, verifiability, objectivity, substance over form, unbiased full disclosures, and, above all, independence. Doing so would certainly help minimize the financial manipulations that are feeding the media frenzy that does more harm than good.

Phil Wolitzer, CPA,
Long Island University, and
Samuel Person, CPA (Retired)

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