Outside Auditors- Toothless Watchdogs? No dentures needed!
A Barrons' cover article a few weeks ago talked about outside auditors and called them "Toothless Watchdogs". It mentioned two of the second tier of CPA firms (just below the Big Four) that missed out on gross misstatements of the financials at one of their clients. The very thing that should have ended with Sarbanes Oxley still took place.
Two examples do not make a universe. What Barrons found does not match what we see.
The opposite is true. Outside accountants are tougher to deal with and less likely to cut you slack. That does not necessarily mean they are heavy handed and unreasonable. It means you have to build a better case and they are more likely to stand on firm ground. What they would have passed on a year ago they now would require you to book. Some areas that can be affected:
- Revenue Recognition
- Inventory Valuation
- Expense Accruals such as warranties and services
- Asset Impairment like goodwill or bad debts on accounts receivable
What changed? What made them tougher?
The banking environment. Many companies are way down in sales and on the borderline with their bank covenants. The auditors are scared about this. They don't want a company to later violate covenants and the banks find that the numbers could have been reported differently- i.e. the company would have crashed the covenants sooner. Word gets out that the accounting firm is soft. A referral source dries up for that accounting firm at best and at worst, the bank gets other clients to switch away from that firm.
Materiality has fallen because net income is way down. Materiality is a fuzzy numbers and it is tough to pin down the auditors on specifics. A company with $10 million in net income might have $500 thousand as the materiality level. But is their income falls to $1 million in 2008, the materiality has now fallen to $50-$100 thousand. Adjustments that were passed a year ago now must get booked.
The watchdogs now have bigger teeth. No dentures are needed. Be prepared for tougher, not softer audits.
I agree with your perspective here. I do not agree that because two firms missed errors, that should reflect on the whole industry. In truth, it is not unfathomable for a CPA firm to miss a marginal error (although good and well staffed audit teams shouldn’t).
I recently left KPMG (just before the market meltdown), and I know how tight our standards were even before the collapse. As I still keep in touch with former colleagues, I know how hard they scrutinized various assets (especially in conjunction with applying FAS 157) before the market collapsed, let alone in the present state of the market.
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Hi,
Nice post! I agree with you.Thanks for sharing.
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