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October 19, 2010

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Lisa McConkey, CPA

Sorry, I'm in huge disagreement that reforming financial reporting by replacing the cost-based models with "Current Values" would help in any way. As a matter of fact, this move would certainly bring down the house. The current economic state of things is largely due to the overstatement of values on housing by 3rd party appraisers. Having anyone, 3rd party or otherwise, give their opinion on what the current value is, is just asking for trouble. The ONLY true value that the financial statement should attest to is the HISTORIC COST. Yes, investors want to know the current economic value - but that is clearly subjective and the last 3 years of the housing industry is a perfect example of why that should NEVER be adopted as an accounting norm. Just my opinion.

Independent Accountant

Tom:
I've complained about auditor incentives for 34 years. What else is new? As for subjectivity, look at SFAS 133.
I do not believe government auditors would be better than the Big 87654. Why? They will say what they are told. Will the PCAOB conclude the Big 87654's audits of TBTF financial institutions were flawed? Will the PCAOB say the Fed's "stress tests" were just a public relations device? Who is kidding who?
I doubt mandatory CPA firm rotation will help either. Why? Will say PWC "rat out" what it concludes was a poor audit by D&T? Or vice versa? No way. When was the last time a Big 87654 firm testified against another Big 87654 firm in a CPA malpractice case?
I do not think using "third party" valuation will help either. The third parties will want Big 87654 recommendations, so will value things as their Big 87654 firm "referral sources" want. I've seen many valuations by PhD economists, that I saw as worthless. The Big Three rating agencies do some valuations. Would you trust the Big Three raters?
Financial reporting is a political tool. Remember Barney Frank telling Robert Hertz the "fasbee should not be the slowbee", or some such thing when Frank wanted more "flexibility" in SFAS 157?
The "classical agency problem" cannot be resolved with any reform you suggest.

Steve

Hi Tom,
I'd like to offer two proposals to improve current financial reporting process.
1st Proposal - SEC should require companies to issue non-audited financials as soon as quarters close. The reports will still be audited, but the auditor can take more time now if needed.
The benfits: a) Investors will get information much sooner. b)If there is audit adjustment, the public will know it and that information can be valuable. c)It takes the time pressure off the audtiors for them to do a better audit.
2nd Proposal - Auditors should provide more informaiton on how imporatnt assumptions are tested, situations where they disagree with management initially but later, important correspondence with audit committe, etc, etc.
The above information can be easily provided by the auditor and is 1000 times more valuable than the current one page boiler plate audit report.
Come on, they are payed millions of dolloars to audit and that is all they can share with the public!!!
Steve

Independent Accountant

Steve:
I proposed your 1st proposal 30 years ago. Welcome aboard.

Joel C Font

Tom,
Excellent proposals. However, as some of the previous commentators point out, the issues are pregnant with conflicts of interest and a political culture that needs to maintain audit reports vague and auditors weak. For years calls for change have been ignored and we only get token changes when an Enron comes along.

I wrote an article about this in Today's Audit Journal, titled: "Auditing Career: Do “Dumb Auditors” have more Professional Longevity than “Smart” ones?"

Regards.

Superheater

[The following lengthy comment has been significantly shortned.]

I must disagree with you about improving audit effectiveness by requiring mandatory auditor rotation (MAR). MAR might reduce disincentives to bend judgments on “grey areas” to favor the client, but it doesn’t address the root problem.

After leaving auditing, I wondered why, with significant owner involvement and no potential for a shareholder lawsuit or SEC action- why my client, a small company, retained a “Big 4”anyway? There could be only one answer-creditor insistence. Do creditors care about the technicalities of an audit? No, they care about repayment and a clean “Big 4” opinion includes an embedded credit default swap. That’s a generally ignored aspect to the Big 4 hegemony that obviates the need to improve audit effectiveness.
In short, assurance is offered with implicit insurance. I’m not sure if a “Big 4” audit is better, but it’s definitely more expensive. That guarantees “capital adequacy” if there’s a undisclosed financial frailty.
Based on my experience, the greatest impediment to audit effectiveness isn’t unlimited auditor tenure but MANAGEMENT procurement with the right of discharge at will (subject to disclosure). Essentially, we buy information that’s assayed by an entity selected by the seller and serving solely at their pleasure. Auditors should be selected by boards, the SEC, a surety company-ANYBODY but the foxes in charge of the henhouse.
Would MAR “discourage” this sort of behavior? Maybe, but it would be a weak control, if management retains the right of discharge at will. Indeed, the incentive to please the client is magnified when there’s MAR-since there is a limited time to earn a return on the acquisition costs involved with new clients- and to develop efficiencies gained through direct client experience.
Unfortunately, I don’t think there’s enough pressure required to improve audit effectiveness. There’s plenty of acclimation to the present system and those that are harmed can be indemnified with legal action. In short, while we might lament the degradation of the profession described in Mike Brewster’s book “Unaccountable”, it’s a fact of life, not just accounting.
We routinely complain about voice-response systems that allow ANYTHING but a human connection. Yet, we continue to buy from vendors with known “customer no-service”, as long as they have liberal return policies. It seems economic efficiency and quality (audit effectiveness) are at war with each other. Perhaps it’s more efficient to offer lower-quality products with embedded swap or put options-its what we seem to prefer.

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