VideoHe advocates fair-value accounting for all assets and liabilities, thus ensuring that a third party is involved in evaluating the market, not historical, value. With third-party involvement, overstating assets à la HealthSouth would be much more difficult, because someone would verify each item. Barring that change, he adds, auditors must be more diligent in seeking underlying evidence to prove the existence of assets and liabilities "instead of just accepting a copy of an invoice. We need to require evidence," insists Schuetze. "There's a difference between evidence and hearsay. If auditors presented a court of law with a lot of the backup material that they base their findings on, they'd get thrown out because it's all hearsay."
"Peekaboo" Takes Charge
PCAOB personnel will now take over the peer-review process once administered by the AICPA, says Carmichael. "There's obviously a need for better training," he says. "For our inspections, we'll come in and select audit engagements to review, and we'll see whether there's conformity to standards. We'll be able to tell if they should be giving their people better training and if they're getting the basics right."
Even auditors seem pleased that the PCAOB has taken over standards setting. They see an opportunity for the board to mandate a clearly defined "bright line" minimum for the basic audit work that is now recognized as crucial in finding fraud, but that often gets pared back by auditors' cost concerns. Deloitte's Weaver states the obvious: "I don't think there's any objection by us to doing more-expansive audits. But it needs to be an obligation that is established by the PCAOB. Mr. Carmichael can have a significant influence on what those standards are and apply them consistently across all companies. Then we'll have an obligation that we must meet, and companies will have to pay for it."
Talk like that makes CFOs nervous, especially in light of the increased compliance costs associated with Sarbanes-Oxley. Auditors will already have to do more extensive work because of Section 404 of the act (which requires auditors to review and sign off on management's attestation of internal controls, and is expected to bump audit fees by 35 percent, according to a recent study by Financial Executives International). But CFOs are justifiably concerned that if the PCAOB mandates a more expansive "standard minimum" audit for all companies, it would give auditors carte blanche to charge more for a level of audit quality that they should have been providing all along. "If auditors ask for a massive fee increase, you have to ask, what are you going to be doing differently now that you weren't doing before?" says Bob Agate, former CFO of Colgate-Palmolive and chairman of the audit committee at The Timberland Co.
For its part, the AICPA has publicly stated that it embraces the work of the new oversight board, and that "it doesn't matter who comes up with the better mousetrap," says Landes. Despite statements to the contrary, the AICPA is not making the transition easy. Even after the PCAOB was given authority to set all future audit standards, the AICPA issued an exposure draft for new rules on implementation of Section 404, eliciting a stern rebuke from the SEC, which reminded the association that it was no longer responsible for auditing standards.
The most ironic element of the transition is that the AICPA holds the copyright for all of the auditing standards it has drafted since it began issuing them 60-plus years ago. Until the PCAOB writes its own standards, it must use the ones the AICPA wrote, and some reports indicate that the AICPA is trying to charge the board a fee for their use. Landes wouldn't comment on the allegation, saying only that "we want to find a satisfactory arrangement that will allow the PCAOB to do the work that is before it. But we're also cognizant of our members' interests and the assets of the AICPA." Critics say that perhaps that was the root of the problem all along.
Dissecting HealthSouth
According to the complaint filed by the Securities and Exchange Commission in U.S. District Court for the Northern District of Alabama against health-care provider HealthSouth Corp. and its former CEO, Richard Scrushy, the company orchestrated a scheme to overstate earnings in order to hit analyst estimates — a scheme concocted in a way to avoid detection by its auditors, Ernst & Young LLP. Between 1999 and the second quarter of 2002, the company overstated income by $1.4 billion by making false journal entries overestimating the amount of third-party insurance reimbursement, and by decreasing expenses.
The firm used the auditor's own processes against it to perpetrate the fraud, according to the complaint. Executives increased earnings not by boosting revenues directly, which auditors would have been more likely to find, but by reducing a revenue-allowance account that was used to record the difference between gross billings and reimbursement amounts expected from third-party payers. This account, which would then be netted against revenues, has a limited paper trail and is based largely on estimates, and the amounts booked to the account are more difficult to verify. And because HealthSouth executives knew that E&Y did not question fixed-asset additions below a certain dollar threshold, it made random entries to its balance-sheet accounts for fictitious assets worth less than that amount. Senior accounting personnel created false documents to support asset purchases. In this way, the company allegedly overstated property, plant, and equipment by more than $800 million. It also overstated cash accounts by $300 million.
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