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Jan 1989

Advisory comments: a remedy for boilerplate.

by Frigo, Mark L.

    Abstract- Communication between auditors and clients is important when it comes to conveying methods which will improve and benefit a client's business. Steps can be followed which will help auditors to develop effective advisory comments, including: describing symptoms; describing specific problems; describing specific solutions; and describing specific benefits.

"A review of receivables shows that the system fosters

slow payments and uncollectible accounts. The policies

governing these matters should be changed. By tightening

up these policies, the financial condition of the

company could be improved."

The essence of this comment is--improve your receivables management. This recommendation probably applies to every business enterprise to some degree. It is so general that it's easy to ignore. And that's what the client will do. Boilerplate comments produce boilerplate results. Repeating the boilerplate comment will only irritate, not persuade, the client.

An advisory comment should help the client own the problem. In the comment, the client must recognize his or her company and its customers, products or services, employees, and business trends. The client can only identify with the problem if it's specific and stated in a familiar factual context.

An effective advisory comment must have some structure and provide a framework for the facts. This is a useful internal organization for an advisory comment:

. Symptons;

. Problem;

. Solution;

. Benefits.

Specific Symptoms

Something caused you to suspect a problem. That's the symptom. We begin with the symptom because it's a logical starting place and a diagnostic clue. It helps the client follow your reasoning. Describing the symptom increases credibility and builds a factual context for the problem.

Often, you note the symptom in connection with audit procedures. Do not consider the audit significance of the symptom in the comment unless the problem relates directly to the audit. Symptoms may consist of:

. Changes in customers' accounts

. Exceptions noted in testing or sampling.

. Observation of some condition or action.

. Remarks of a member of management or an employee.

. Financial data or trends noted in the statements.

. Matters in the minutes of Board of Directors meetings.

Here are two example symptoms from different advisory comments:

"In discussing client relationships, project managers at

Tailored Software mentioned friction due to billing

disagreements. One manager cited a billing disagreement

of $75,000 with your client, Indigo Industries. This

disagreement was finally resolved in the client's favor."

"During our audit of Rotomotor, Inc., we examined credit

memos issued during the year. Nine of these credit

memos were issued because of shipping errors. There

were five instances in which the wrong motors were

shipped and four instances in which motors were

shipped to the wrong customers."

Specific Problem

State the problem in concrete terms. Cut irrelevant detail, but provide enough facts for management to easily recognize its own problem. Defining the problem is a critical step because the definition often dictates the solution. Here are some of the questions that may be answered in a description of the problem:

Nature of problem

. What business functions, operations, or accounts are


. Who is affected by the problem--personnel, clients,

customers, suppliers, stockholders?

. How are the statements affected?

. What sites or locations are affected?

. How can the real problem be distinguished from any

masking problem?

. Is urgent action needed?

Scope of problem

. What is the size of the problem--how can it be measured?

. What are the costs or threats?

. How long has the problem existed--was it cited in

prior management letters?

. When does the problem occur--how often?

Cause of problem

. Why is there a problem--are there multiple causes?

. Does the problem occur because something is not done

at all or because something is not done well?

. Is more research needed to define the problem? If so,

what kind of research?

. What will happen if the problem is not solved?

This example problem continues the advisory comment for Tailored Software.

"Investigation showed that billing disagreements occur

regularly. In 1986, there were 37 billing disagreements

resolved in the client's favor amounting to $325,000. In

1987, there were 53 billing disagreements resolved in

the client's favor amounting to $575,000 or four percent

of 1987 annual billings. Without some action to reverse

this trend, disputed billings are likely to increase in 1989,

reducing profitability and eroding client relationships.

"These disagreements result from ambiguities in

contracts or failure to document client requests for

additional work. Contracts are negotiated by project

managers and are usually informal memoranda of agreement.

Although disputes have been resolved through negotiation,

these conditions are fertile ground for litigation."

This example problem continues the advisory comment for Rotomotor.

"A sample of 100 entries in the Sales Returns and

Allowances Account showed that 73 were due to shipping

errors of rush orders. Clients are especially sensitive to

the quality of service for rush orders. As a customer

incentive in a highly competitive market, Rotomotor has

a goal of outstanding customer service. Shipping errors

conflict with this goal.

"For rush orders, the salesperson phones the order

to the Order Department. The Order Department clerk

checks the credit standing of the customer and phones

the order to Shipping. These are possible sources of


. Incorrect information transmitted by the salesperson.

. Misunderstanding by the Order Department clerk.

. Misunderstanding by the Shipping clerk."

Specific Solution

In developing a solution, look at several solutions. Consider how each solution helps or hurts; a solution may easily create new problems. Bring together the best features of each solution in your recommendation.

Usually, there will be constraints on the solution. It may be desirable to state less obvious constraints in presenting the solution. Generally, the solution must be:

. Financially feasible and practical.

. Cost beneficial.

. Politically reasonable.

. Consistent with the client's goals.

The level of detail you use in proposing the solution depends on the client's technical sophistication. Some client's will want to know only what should be done. Others may want to know how it should be done, when it should be done, and who should do it.

Describe the advantages and disadvantages of the solution; the advantages must outweigh the disadvantages. A discussion of the disadvantages or tradeoffs reassures the client as to your thoroughness and objectivity. How much does the solution cost in time and money? Will there be dislocations in service or production? What are the risks and unknowns?

Here is the solution in the Tailored Software advisory comment:

"Billing disagreements could be largely avoided by

requiring project managers to use a standard contract form.

Project managers will sacrifice some flexibility in using

standard contracts, but there are compensating benefits

for Tailored Software. Formal work order changes,

including fees and client approval, should be used to record

client requests for additional work. Contracts and work

order changes should be reviewed and approved by the

Controller and maintained in the Accounting Department.

The modest administrative costs for these measures

would be more than offset by savings from reduced

billing disputes."

Here is the solution in the Rotomotor advisory comment:

"Errors could be reduced by formalizing telephone

procedures for rush orders. The person receiving the

order should repeat the entire order to the person sending

the order and receive confirmation of accuracy before

concluding. This procedure should be required."

"The persons sending and receiving phoned orders

should give the highest priority to those orders in

processing records. This step will assure the earliest possible

discovery of errors."

Specific Benefit

Suppose you used the same advisory comment year after year in your management letter to Client X. Why does Client X ignore it? Because you have not persuaded Client X there's a benefit to following through with your suggestion. It's arguable that the most important part of an advisory comment is a statement of the benefit. It gives the CEO a motive to act and provides the CEO with ammunition to persuade his or her subordinates to act.

What is a benefit? It's something that the client views as valuable and desirable. Note that we're talking about the client's perspective and not the auditor's. A computerized ABC inventory classification system may help the auditor in his or her inventory valuation. But the benefit is not inventory valuation, it's a savings of $100,000 in inventory operating control costs.

A benefit is not only a future advantage, it may consist of avoiding future costs or risks. Sometimes it's most persuasive to describe the financial loss or other penalty if a recommendation is not followed.

Here are the characteristics of an effective statement of benefits in an advisory comment:

. The benefit is simply stated and easy for the client to


. The benefit is specific and concrete to the client.

. The benefit has been quantified where possible.

. The benefit is shown to support the client's goals when

this is possible.

An after-the-fact projection can highlight the benefit of some recommendations. It answers the question, "How would the situation be different if the recommendation had been carried out last year?" For example, "It would have cost about $5,000 to conduct credit checks for customers last year. Current bad debt losses to high-risk customers would be lowered by about $50,000. Five hundred thousand dollars in additional sales would be needed to increase profits by $50,000."

Don't quantify an expected benefit unless there is a reasonable basis for projection. This is a matter of professional judgment. If such a basis exists, then the benefit should be quantified with appropriate qualification.

Be specific in describing expected results of recommendations, but include qualification. Without qualification, such statements can be interpreted as forecasts. If predicted results are not achieved and the client is disappointed, he or she may hold the auditor responsible.

Here is the statement of benefits from the Tailored Software advisory comment:

"These are the advantages of adequately documenting

contracts and work changes:

. Billing disputes will decrease.

. Client relationships will improve.

. Billing disputes that do occur are more likely to be

resolved in favor of the company.

. Exposure to litigation will be reduced.

. Profitability will improve; suppose Tailored Software

had not lost $575,000 in billing disputes in 1987."

Here is the statement of benefits from the Rotomotor advisory comment:

"For the 73 shipping errors, average shipping costs were

$37. If 73 percent of the 1500 entries in the Sales Returns

and Allowance Account cost $37 each, then shipping

costs for errors amount to about $40,000.

"There could be significant benefits in requiring

salespersons, order clerks, and shipping clerks to follow

the simple procedures recommended:

. Reduced shipping costs of about $40,000.

. Reduced administrative costs.

. Greater customer satisfaction".


This structure of symptom, problem, solution, and benefit, along with other guidelines suggested in this article, will not apply to all advisory comments. They may not be appropriate for comments dealing with material weaknesses in internal control structure. But they should be useful for most other comments. They will help you avoid a boilerplate presentation of your recommendations.

The best way of assuring that a client will accept a recommendation is tailoring it to the client's specific needs and presenting it persuasively. Is the effort justified? If you doubt it, consider the waste of the auditor's effort and the client's resources when a truly cost-beneficial recommendation is rejected.

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