Fresh Ideas on Auditor Independence

Conference yields two new notions of how to liberate audits: Insure the financials and ditch income statements.
Marie LeoneMay 12, 2004

While the Sarbanes-Oxley Act set up a broad-gauge attack on auditor-independence abuse, some off-the-wall tactics might be needed to keep audits honest, academics say.

One way to assure objective accounting is to encourage insurers to underwrite coverage for financial-statement risks, according to one professor. Another proposes melding the income statement and the corporate tax return into a single form to help erase auditor conflicts of interests.

Those ideas emerged at an “Auditor Independence Forum” focused on diagnosing and offering potential cures for what might often be a too-close-for-comfort relationship between auditors and their clients.

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By blocking excessive management influence over auditors, financial-statement insurance could be a boon to auditor independence, says Joshua Ronen, an accounting professor at New York University’s Stern School of Business, which sponsored the event.

Ronen’s notion is to have insurers work with auditors to set coverage and premiums based on the results of the audit. Insurance policies covering the legal liabilities associated with financial-statement fraud would be issued only if auditors can publish clean opinions. If the auditor issues a qualified opinion, the insurer won’t issue coverage unless the company renegotiates new policy terms. Basic policy terms would be released publicly in the auditor’s statement.

If a covered company incurs losses because of financial statement fraud, the insurer would be on the hook for damages related to shareholder suits.

Still, there would be many details to hammer out. Audience members questioned whether actuaries could reliably assess financial-statement risk and whether insurers could profitably underwrite such business. Nevertheless, the idea could work as a deterrent to creating uncomfortably close auditor-client relationships, Ronen thinks.

For his part, Shyam Sunder, a professor of accounting, economics and finance at the Yale School of Business, proposes using the corporate tax return as the publicly reported income statement as a way of reducing earnings management and overly assertive tax reporting.

Sunder contends that management and auditors legally game the tax and accounting systems by decreasing income to lower taxes, while at the same time increasing income to boost earnings. That see-saw effect would be wiped out if the statements were one and the same, he argues.

For corporations, the treatment of income would be less aggressive, audit-firm fees would drop because only a single statement would be involved, and there would be fewer rules to follow, according to the professor. At the same time, such a move would probably cause staff cuts at the Financial Accounting Standards Board and the Securities and Exchange Commission — as well as a reduction in the number of auditors.

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