CPA Journal - August 2003

advertisement
Accounting journal joins tax debate
Adrian Michaels in New York
Financial Times; Sep 01, 2003
The fight by accountants to continue offering tax consultancy to audit clients has taken a fresh
turn with a call in one of the profession's most respected publications for a ban on tax work.
The call comes as parts of the profession believe they have seen off a threat to tax consultancy one of the few services accountancy firms are still allowed to offer audit clients.
In a stinging article in the CPA Journal, a magazine published by the New York State Society of
Certified Public Accountants, three accounting professors write: "This profession has always
claimed to be independent but has seldom practiced it . . . We should voluntarily prohibit tax
work."
Accountancy firms fell foul of regulators and politicians for appearing to jeopardise the
independence of their audit work by offering consultancy and other services to the same clients.
But neither last year's Sarbanes-Oxley Act, nor the Securities and Exchange Commission, the
US's chief financial regulator, took away tax work, leaving the decision to the audit committees of
company boards.
Accounting firms have been furiously lobbying wary audit committees for tax fees, arguing there
is no danger to independence.
But the CPA Journal article, by Ronald Mano, Matthew Mouritsen and James Swearingen at
Weber State University in Utah, reminds accountants that the debate on tax is not dead. The
Public Company Accounting Oversight Board, the accountants' new watchdog, has pledged to
reopen the debate.
Accountancy firms have been heavily criticised for much of their tax work in the past couple of
years. The Internal Revenue Service has a long-running investigation into tax shelters and has
been asking the firms to hand over client lists.
"Tax work requires you to be an advocate for the client," said Mr Mano in an interview. "That is
not compatible with audit work."
Mr Mano and his colleagues call for further reforms in the profession as it battles to restore its
reputation after a run of audit failures, lawsuits, and the destruction of Andersen for its work as
Enron's auditor.
"This is a desperate time for the accounting profession, requiring desperate action," the article
states. "If we are to survive government intervention and control that has been imposed on us, or
perhaps survive at all, it is essential for us to be willing to bite the bullet."
CPA Journal - August 2003
Accounting Profession, Heal Thyself: A Matter of Survival
By Ronald M. Mano, Matthew L. Mouritsen, and James G. Swearingen
After the Enron debacle, which followed and was followed by several other cases of apparent
audit failure, the accounting profession faced unprecedented scrutiny. When then–SEC
Chairman Harvey Pitt recommended a government organization to supervise the accounting
profession, the AICPA’s Public Oversight Board voted itself out of existence. In July 2002, the
Sarbanes-Oxley bill was passed, mandating the SEC to establish the Public Company
Accounting Oversight Board.
There is a great need now for CPAs to step forward and show how serious we are about our own
survival. NYSSCPA Executive Director Lou Grumet wrote last year in Accounting Today, “Now is
the time for CPAs and their professional societies to lead change and to require higher
standards, higher than required by law.” He was right on target.
The CPA profession has the potential to be the single most important player in the financial wellbeing of the United States of America. On the other hand, if financial statements are not truthful,
the auditing profession is worthless. Six actions must be taken if we are to survive as a viable
and respected profession:
•
•
•
•
•
•
•
•
We must totally commit ourselves to the fact that the public is our client regardless of
whose signature is on the check.
We must commit ourselves to the concept of strict independence.
We must decide that the statement, “fairly presented ... in accordance with generally
accepted accounting principles” is two statements rather than one statement; that is,
“fairly presented” and “in accordance with GAAP.”
We must strictly avoid conflicts of interest in audits of publicly held companies.
We must refrain from taking jobs with audit clients.
We must recognize that we are de facto SEC auditors. There are two parts to this:
We must be willing to complete an audit regardless of the findings, even if there is no
prospect of being paid, and
A publicly held client should not be allowed to fire the auditor before completion of the
audit.
The Public Is the Client
This is not a novel concept to anyone who has completed a college-level introductory auditing
course. We have always been taught that the ultimate client is the public; however, we, as a
profession, have not taken this concept to heart. When auditors talk of the client, they almost
always refer to the company and the company personnel.
There is nothing new in this proposal. In 1984, in United States vs. Arthur Young (which resulted
from Arthur Young’s audit of Amerada Hess), Chief Justice Warren Burger told the accounting
profession, “The independent public accountant performing this special function owes ultimate
allegiance to the corporation’s creditors and stockholders, as well as to the investing public.”
Strict Independence Is Essential
This profession has always claimed to be independent but has seldom practiced it. Strict
independence means that auditors of publicly held companies should not do any sort of
consulting for that client. They certainly should not be their outsourced internal auditors. They
should not even do tax work for publicly held audit clients. Again referring to United States vs.
Arthur Young, Chief Justice Burger said, “This ‘public watchdog’ function demands that the
accountant maintain total independence from the client at all times and requires complete fidelity
to the public trust” (emphasis added).
In this area the profession should, as Grumet said, go beyond what is now required by law. The
Sarbanes-Oxley Act prohibits certain types of consulting, not including taxes, but only
contemporaneously with the audit. We should also voluntarily prohibit tax work, and these
prohibitions should apply to any audit client, regardless of whether it is contemporaneous with the
audit. This does not mean that CPAs should not be allowed to do consulting, internal auditing, or
taxes; the only restriction should be that they cannot perform them for their own publicly held
audit clients.
What about that long-time problem we call “low-balling”? Were the profession to require strict
independence, low-balling would end. What rational professional would use an audit as a “loss
leader” when no other service revenue is permitted with that client and the client is required by
law to be audited?
Two Statements, Not One
Past court cases involving audit failures can teach important lessons. But often, the accounting
profession as a whole does not take such case law to heart. One such case is Continental
Vending, which was settled in criminal court in 1968. In that case, two partners and a manager of
Lybrand, Ross Brothers & Montgomery (now PricewaterhouseCoopers) were found guilty of
criminal negligence.
All seven of the other then–Big Eight testified on behalf of Lybrand, supporting the position that
the defendants had followed generally accepted auditing standards and that the financial
statements were in accordance with GAAP. The judge was not persuaded, and instructed the jury
that regardless of what the accounting standards say, the profession must be held to a higher
standard than GAAP. The message was that auditors should evaluate the probable effect of
disclosures on stockholders’ investment decisions, and if the disclosures are likely to affect such
decisions, disclosure is appropriate regardless of GAAP’s requirements. Clearly, the judge was
saying that “fairly presented ... in accordance with GAAP” are two statements, not one.
Internal auditing includes the concepts of “condition” and “criteria.” The public accounting
profession could learn much from these concepts. Condition is how things exist: the current
situation. Criteria is how things ought to be. To determine criteria an internal auditor must analyze
the business or situation and must form his own conviction about how it ought to be. The internal
auditor does not have a rulebook for this, but must decide what the ideal situation is. In public
accounting, auditors have often been willing to put their stamp of approval on the financial
statements as long as they could be convinced that the presentation could somehow be
shoehorned into GAAP. There was no conviction on the auditor’s part that meeting GAAP was
meeting the ideal.
The 1978 annual report of Con Agra, an agribusiness corporation headquartered in Omaha,
included an audited report from Coopers & Lybrand (now PricewaterhouseCoopers). The
auditors’ opinion was a standard unqualified opinion, thus implying full disclosure. The footnote
related to taxes was completely baffling.
A CPA, attorney, and tax professor read the footnote several times and confessed that he did not
understand it. He contacted an uncle who worked for Con Agra in the accounting function about
the note, and was told “It’s none of your damn business!” Con Agra was presumably attempting
to comply with required disclosures but did not want the general public, a non–tax accounting
professor, a tax expert, or even a relative to know what it really meant. Coopers & Lybrand had
given the financial statements its stamp of approval even though the firm was probably fully
aware that they were incomprehensible to anyone who would read them.
That was 1978; this is now. An article in the November 5, 2001, Wall Street Journal, “Andersen
Faces Scrutiny on Clarity of Enron Disclosures,” discusses how parts of the Enron annual report
are “indecipherable” and quotes Enron spokesperson Karen Denne, who states that if anyone
does not understand the financial statements all they need to do is ask. Judging from other
statements in the article attributed to Denne, would her response be very similar to Con Agra’s?
Elsewhere in the article, apparently unaware of Continental Vending, she tries to defend the
quality of Enron’s financial statements by saying, “They comply with reporting requirements.” She
continues with this appalling statement: “[I]nvestors who didn’t understand the transactions didn’t
have to buy Enron stock.” What a way to justify a lack of full disclosure!
Avoid Conflicts of Interest
In the early 1980s, the courts tried to teach the accounting profession a lesson regarding conflicts
of interest. Unfortunately, we seem to have refused to learn. In The Fund of Funds, Ltd. v. Arthur
Andersen & Co., Arthur Andersen auditors completed the audit with no problems encountered
and issued an unqualified opinion. Shortly thereafter, essentially the same audit team began the
audit of King Resources. While conducting that audit, the auditors realized that there was a
significant contract between King Resources and Fund of Funds. Undaunted, the auditors
continued with the audit and were surprised to find that King Resources had not dealt fairly with
Fund of Funds. Now the auditors were caught in a dilemma: They could tell Fund of Funds and
likely be sued by King Resources; alternatively, they could refrain from telling Fund of Funds and
hope that Fund of Funds would never find out because if it did, it would probably sue Andersen.
Andersen decided on the latter option but was unfortunate in that Fund of Funds did find out,
sued Andersen, and was awarded the first judgment against a CPA firm that exceeded $50
million.
This case clearly tells us that we must avoid all conflicts of interest in our audits. Obviously, if
King Resources had dealt fairly with Fund of Funds, Andersen would not have been in trouble.
When the Andersen auditors realized that King Resources had not been fair in its dealings with
Fund of Funds, it was already too late. Andersen was caught in a dilemma of its own creation.
As soon as Andersen realized it was auditing both sides of the same transaction, it should have
declared itself unqualified to complete the audit. In the legal profession, a lawyer cannot
represent both sides of a contract.
The run of CPA firm mergers during the 1980s and 1990s, which decreased the number of
national CPA firms, increased the likelihood that another Fund of Funds case would occur.
Refrain from Taking Jobs with Audit Clients
Auditors at the Defense Contract Audit Agency (DCAA), the agency that audits private
companies that have defense contracts with the federal government, mainly military contracts,
are not allowed to take a job with an auditee for a two-year period after leaving the DCAA.
To enhance the independence in fact of external auditors, it is essential that CPA auditors not be
allowed to take employment with auditees for some period of time, and two years seems
reasonable. Certainly, CPA auditors should be willing to exercise as much independence as
DCAA auditors. Apparently, many accounting personnel at Enron were former Andersen
employees. In Lincoln Savings, the Arthur Young partner in charge of that audit took a job with
Lincoln Savings less than a month after completing the audit, at a salary four times his previous
salary.
The Sarbanes-Oxley Act prohibits “a chief executive officer, controller, chief financial officer, chief
accounting officer, or any person serving in an equivalent position” (section 206) to have worked
for the auditing firm within the past year. Let’s follow Grumet’s advice and go beyond the law by
extending the timeframe to two years.
Cannot Be Fired, Cannot Quit
After the 1929 stock market crash, many people lost their life savings as they saw the value of
their investments sink out of sight. Most of those investors had little or no information about the
companies in which they were invested. The SEC was established and charged with the
responsibility to see that investors were given essential, reliable financial information about their
investments. The SEC was also charged with the responsibility to see that the financial
information is subject to independent review and audit.
At that time, the SEC lacked sufficient personnel to conduct all of the audits of publicly held
entities. Therefore, that franchise was given to the public accounting profession. We became de
facto SEC auditors.
Now, consider what would happen if the SEC, rather than CPA auditors, were actually doing
those audits.
If the SEC were auditing a company and found disturbing information, could the client fire the
SEC auditor? Obviously not. Additionally, could that SEC auditor decide to quit and not complete
the audit? Again, obviously not. Therefore, because CPAs are de facto SEC auditors, they should
be required to complete the audit once it has begun. They should not be allowed to resign even if
there is no prospect of being paid for their work unless they encounter a conflict of interest as
discussed above. Remember that the real client is the public. Likewise, regardless of how much
the auditee disagrees with the auditor, if the company is publicly held, it should not be allowed to
terminate that auditor.
This final proposal could not be enacted by the accounting profession, but would have to be
mandated by the SEC. All other recommendations proposed here could be enacted by the
profession itself, totally without action by any outside agency or influence.
Desperate Times, Desperate Measures
This is a desperate time for the accounting profession, requiring desperate action. We realize that
the proposals presented here would be difficult for the profession. However, if we are to survive
government intervention and control that has been imposed on us, or perhaps survive at all, it is
essential for us to be willing to bite the bullet and adopt these recommendations, on our own
accord if necessary. It is time for the accounting profession to solve its own problems.
Ronald M. Mano, PhD, CFE, CPA, is a professor of accounting, Eccles Accounting Fellow, and
department chair; Matthew L. Mouritsen, PhD, is an assistant professor of accounting; and
James G. Swearingen, PhD, CPA, is a professor of accounting, all at Weber State University,
Ogden, Utah.
Download