Is the Auditor the CFO’s Fool?

A growing number of finance chiefs seem to believe that they could dupe their auditing firm.
Alan RappeportNovember 14, 2007

In his 1892 manual, Auditing, British accountant Lawrence Dicksee wrote, “The auditor who is able to detect fraud is — other things being equal — a better man than the auditor who cannot.” Amid today’s accounting complexities, despite all the protections installed against fraud, a wide majority of CFOs apparently feels that auditors are in the latter group.

A new survey by accounting firm Grant Thornton polled 221 finance chiefs from a variety of industries and locations in the U.S., and found that 62 percent said they believed it would be possible for them to intentionally misstate their financial statements to their auditors. The percentage marks an increase from the year before, when 57 percent of CFOs believed they could fool their auditor if they so chose.

The numbers are “alarming,” according to Trent Gazzaway, a managing partner of corporate governance at Grant Thornton. He explains that CFOs — if they’ve a mind to — are in a unique position, having the necessary information, intelligence, and access to trick auditors in ways that are hard to decipher. “Anyone who is trying to detect fraud is at somewhat of a disadvantage,” Gazzaway says. “Is it reasonable in the current marketplace for anyone to be the last line of defense?”

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The results do not mean that CFOs think auditors are necessarily to blame for undetected abuse. Of the CFOs queried, 83 percent said they did not feel it was possible for auditors to detect corporate fraud in all cases. That number includes frauds in which management purposefully attempts to mislead an auditor about the firm’s financial health. Further, most CFOs do not think it is the auditor’s responsibility to uncover “any and all” fraud. The survey found that just 17 percent of finance chiefs believed auditors should be able to detect all types of fraud at all times. “We need to have a good public discussion about what the public thinks the auditor should be able to do to combat fraud,” Gazzaway says.

Just such a debate was highlighted last year when the top six accounting firms published a report titled “Global Capital Markets and the Global Economy: A Vision from the CEOs of the International Audit Networks”. The report’s authors noted that there was a significant “expectations gap” between what auditors are capable of doing to combat fraud and what the auditors are expected to do. That report went on to say that today’s audits, while useful, are far from foolproof.

According to Gazzaway, more-foolproof audits would come with additional costs, which do not appear to be in demand among corporate clients and investors. Auditors are, however, making other moves to strengthen their position. Earlier this year the Center for Audit Quality was formed, intending to become the voice of the industry. Some have credited tough auditing for the recent writedowns by several investment banks.

Last month members of a U.S. Treasury panel suggested that smaller audit firms needed help competing with the dominant “big four” of PriceWaterhouseCoopers, Deloitte & Touche, KPMG, and Ernst & Young, which together handle nearly 80 percent of all public-company audits. Robert Steel, the Treasury’s undersecretary for domestic finance, wondered if the marketplace for auditors lacked competition, and if reforms brought by Sarbanes-Oxley were, in fact, producing better audits.

Some, however, think auditors are holding their own. Last summer the Center for Audit Quality released a report showing that 79 percent of the 1,000 investors surveyed think the required independent audit committees have been effective; 76 percent think the Public Company Accounting Oversight Board does a good job; 76 percent approve of companies disclosing their internal controls; and 74 percent think CFOs and CEOs should continue to certify financial reports.

Apparently not everyone believes auditors to be such a hopeless bunch.

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