The Crisis over How to Audit in a Crisis

The PCAOB's standing advisory committee examines the task of recession-time auditing, including the likelihood that fraud will be a growing problem.
Alan RappeportOctober 22, 2008

The Public Company Accounting Oversight Board, which oversees U.S. auditors, convened its standing advisory group on Wednesday to discuss the impact of the financial crisis on the auditing profession. Its conclusion: There’s a lot to worry about, included increased pressure for fraudulent behavior.

Members of the 36-person group of advisors were concerned not only about increases in fraud, however, but also about the need for more thorough analysis of financial statements, the importance of considering liquidity, and various puzzles connected with the auditing of companies that are recipients of government bailouts.

Martin Baumann, the PCAOB’s director of research and analysis, said that auditors will also need to concentrate on underfunded pension plans, lagging corporate receivables, excess inventory, and other types of asset impairment.

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“When you look at the past and see where auditors didn’t get the job done right, there were indicators that they didn’t pay attention to,” said Lynn Turner, a former CFO and former chief accountant of the Securities and Exchange Commission. “Auditors are going to need to take off the blinders.”

An increase in fraudulent behavior was a top concern among PCAOB advisors. Gregory Jonas, Managing Director, Moody’s Investors Service, noted that senior managers are facing increased pressure to perform right now, and that “cooking the books” could become a problem.

“The pressure is going to be enormous on people,” Jonas said. “The temptation is growing.”

A favorite recipe for cooking the books, according to Joseph Carcello, director of research at the Corporate Governance Center, involves improper revenue recognition.

But whatever the source of the crisis-related challenge, Lawrence Salva, senior vice president, chief accounting officer and controller of Comcast Corp., argued that the PCAOB needs to issue a risk alert to guide companies about how to improve their financial reporting during the crisis.

Advisors stressed that auditors will need to take extra care when reading financial statements, giving special scrutiny to the truthfulness of the Management Discussion and Analysis section and to corporate assets. Turner also stressed that auditors will need to be looking at performance quarter-by-quarter.

“You have to throw out historical trends and look at what is happening on a real-time basis,” Turner said. “What was there in the past will no longer be there in the future.”

Auditors may also be worried about their own futures as a recession takes hold. J. Richard Dietrich, an accounting professor at The Ohio State University, noted that audit fees have been suppressed lately. That could change, he explained, as auditors are asked to work more hours while keeping companies honest.

“Paying more for audit fees this year may be one of the best uses you can have for stockholders funds,” Dietrich said.