CFO Blog: Commentary and Opinion

Incognito points me to an article in today's Financial Times, which reports a generous offer by Eugene O'Kelly, chief executive of KPMG's US business, to publish the firm's financials if the government in turn will help limit the firm's liability.

"What a deal!" cries Icognito. "The audit firms will tell us how much they're making if the government indemnifies them against lawsuits."

Certainly must have been an interesting cost-benefit analysis on KPMG's part. Right now, I think a look at audit firm financial results would drive most CFOs off the deep end. Are audit firms thinking they could drop the price of an audit if they eliminated the risk premium, and therefore wouldn't mind opening the financial kimono?

And then today, the SEC
announced that Deloitte was fined another $375,000 for its failed 1999 audit of sneaker retailer Just For Feet. Here's what the SEC had to say about it:

Deloitte [and its auditors] did not respond adequately to indications that the company was recognizing unearned and fraudulent vendor allowances as income. The Order also cited Deloitte [and its auditors] for failing to test adequately the company's reserve for obsolete or excess inventory and failing to respond adequately to indications that Just for Feet was fraudulently increasing its income through fictitious purchases of display booths from its vendors. The Order also finds that Deloitte's National Risk Management Program identified Just for Feet as a high-risk client, but Deloitte did not carry out the responsibilities required by such a designation.

In case anyone's counting, that fine is $14,000 more than Deloitte earned in fees from Just For Feet.

Do not forget the fraud cases that have yet to be settled, like Parmalat - also known as the European Enron because it is the largest financial fraud Europe has ever seen.

In January of 2003, the AICPA issued Practice Alert No. 03-1 Audit Confirmations to remind auditors that confirmations are important and should be performed correctly. Less than one year later, the $5 billion Parmalat bank confirmation fraud occurred. The two CPA firms involved are now being sued for $10 billion each - and ironically enough, they are being sued by Parmalat.

HealthSouth's new management is also suing its ex-auditors for failing to catch the fraud that HealthSouth's old executives committed. Auditors are the financial watchdogs and when a financial failure occurs everyone sues the auditors, and as we have seen, auditors are paying hundreds of millions of dollars in fines and settlements.

Though some members of the PCAOB's Standing Advisory Group suggested at the Novemember 2004 meeting that the PCAOB is taking on more than it can handle with its eleven priorities for 2005, auditors should applaud the PCAOB's desire to quickly put teeth in the auditing standards. The PCAOB recognizes that auditors can no longer hide behind the auditing standards in a court of law as has been tried unsuccessfully in the past. The PCAOB realizes that auditing standards must be updated to provide auditors with the guidance they need so they don't end up in a court of law in the first place.

Comments from Phil Klein:

The issue with the 404 work is that companies also did not, historically, do a good job on the "basics". If you look at the nature of the findings from the first round of 404 reporting, you see that certain areas, such as income taxes for example, have long been ignored by corporate accounting staffs. In addition, it is becoming evident that many companies, even some of the larger ones, have not had adequate financial accounting expertise on staff to handle all of their financial reporting obligations.

Historically, some of this has essentially been "outsourced" to the audit firm, which has too often played a significant role in helping clients meet their basic reporting reporting requirements. While this was acceptable in the pre 404 days under the auspisces of the audit and client service, today it is forbidden. The outcome is that registered companies have had to scramble to fill gaps in the technical staffs and compliance groups.

While I agree that the auditors may be beating to death the small stuff, we need to keep in mind that 1) they have paid a dear price for the corporate frauds of the past, 2) they have significant second guessing to deal with from the SEC and now the PCAOB, and 3) corp America has also done a poor job on the basic blocking and tackling to keep their own house in order.