January 2003

Should the Accounting Profession Take a Step Backward?

By John E. Smigla

My practical accounting experience began 27 years ago with a large, local CPA firm. I was thoroughly impressed with the quality of its audit and tax work, and that experience has proved beneficial over the years. After graduate school, I worked for one of the Big Eight, which, at the time I was hired, were aggressively seeking small business audits, developing small-business audit departments, and hiring business consultants and developing business consulting services. The pressure I encountered there on audits both small and large—to complete the audit on budget and to keep the audit fee low enough to be competitive with the smaller firms—was significant. Several times, when reviewing prior years’ working papers, I had to wonder how anyone could possibly complete those audit steps in the time listed.

A Credibility Problem

Our profession has changed since then, and not for the better. I believe accounting practitioners and educators must attack the accounting credibility issue in four ways.

First, our profession must embrace the concept of rotation of auditors every few years. What one firm loses in audit work another firm gains. Audit costs will increase, but the costs to society when our assurance services fail are greater. Mandatory auditor rotation will force a fresh viewpoint that wil make financial reporting deficiencies more likely to be discovered and disclosed. As with Enron and Andersen, too often a cozy relationship develops between an auditor and client and the auditor can become more concerned with holding onto the business than with its professional responsibility.

Mandatory rotation will enhance auditor independence in two ways. The auditor will no longer experience the pressure of losing a client for disagreeing with questionable accounting practices or GAAP violations. Furthermore, under mandatory rotation an auditor will be concerned that a future auditor will uncover and disclose any accounting irregularities: Auditors auditing auditors.

Second, many experts contend that an auditor that also provides management advisory services cannot remain neutral. The profession needs to sever the dual relationship. Many CPAs excel at management advisory services, but the CPA should not be in a position of providing both assurance and advisory services to the same client.

Third, FASB must separate itself from politics and the SEC must begin backing FASB on reporting issues when constituents fear the reporting impact of proposed sound GAAP. While FASB shares some of the blame, standards-setting is very political, with legislators, industry, and the large CPA firms wielding enormous influence. If the SEC had backed FASB in the mid-1970s on its proposed standard on troubled debt restructuring, the savings-and-loan crisis would have been less severe, possibly even prevented. Creditors should have been required to recognize a loss at the date of restructuring if the present value was less than the carrying value of the receivable. Financial institutions would have been recognizing losses on restructuring loans years earlier than what was required under SFAS 15.

One can see politics at work in SFAS 123 on stock options: Companies need to report the fair market value (FMV) of a stock option as expense only in pro forma data. Any of the FMV pricing models permitted can materially understate compensation expense under stock option plans over several years. The most objective model would be to recognize the difference between the FMV of the stock and the exercise price at the balance sheet date. But many companies lobbied against this approach because it would negatively impact their operating results and force them to restructure their executive compensation.

Furthermore, certain requirements that FASB had proposed on derivative accounting and off-balance sheet financing might have prevented the collapse of Enron or at least lessened the damage. But once again, FASB did not receive support from the SEC and succumbed to constituent pressure.

Finally, accounting educators must be firm in their commitment to provide accounting graduates with strong technical skills. Grade inflation has escalated to new heights over the last two decades with the decline in student enrollments and many professors issue Cs to students who would have received Ds 20 years ago. A and B students are recruited heavily by CPA firms both large and small, and CPA firms need recruits whose technical skills are above average. Recruiters may state that a myriad of other skills are more important, and that they can teach new recruits accounting after they are hired. But given the recent rash of financial reporting problems and financial restatements, I question how well this approach is working. Partners and managers are only as good as their staff auditors because these individuals are the ones expected to bring financial reporting deficiencies and questionable matters to the attention of their higher-ups.

Many small CPA firms say they need employees who have excellent technical and communication skills and can work well with others, and I agree that these skills should be first and foremost. But we cannot expect accounting programs to produce excellent salespeople. Graduates that possess skills at both ends of the spectrum are rare, and accounting firms should not expect every new recruit to possess all the qualities of a potential partner. Over the past 23 years my students with the very best technical skills would not be the best at soliciting new clients or mingling at the country club. However, they would be the best professionals to perform a thorough audit and contend with ethical and highly technical issues. As an educator and practitioner, I ask you: Shouldn’t this be what accounting and auditing are all about?

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