To Whom does the Auditor Answer?

One of my google alerts brought an interesting article about the auditor and the relationship the audit firm has with management and the board.  It seems that many boards are concerned that the auditor appears aligned with management and not the shareholders.  This is, sadly, not a new problem, but it is one that C.O.R.E. is trying to address is our own little world of auditing.

At C.O.R.E., we understand our loyalty lies to the reader of the financial statements – that is, the shareholders.  We are engaged by the board on behalf of the owners to audit management.  Ensuring that current and prospective owners get the best information about their association is key to our success, but sometimes getting owners the best information means upsetting management.

Upsetting management, however, potentially hurts the pocketbook of the auditing CPA firm.  In many situations, management offers very profitable consulting opportunities to the auditor.  Systems design, software evaluation, and other arrangements are absolutely essential to the financial health of an organization and a CPA is highly qualified to offer those services.  The problem is the potential for the auditor to be compromised – that is, does the auditor get the consulting gig because they went soft on management?

If you don’t think it is a very real possibility think again.  Can you imagine anyone hiring a consultant who just got through bashing them?  If a CPA firm had the chance to earn $100,000 consulting with management or $30,000 auditing the client (or both hopefully), is it possible that the auditor might turn a blind eye to a problem found on audit for the chance to earn more money?

And in the small and medium sized entity market, it is potentially even more painful.  The small CPA firm gets most of its new business by referral.  But referrals are hard to come by when your work upsets management.  This has impacted us directly – we have had to issue specific communication about management violating internal control systems to an entity’s board.  The Chair of the board was also the president who hired his son, the person who broke the rules.  That organization and six other companies found a new CPA firm because they wanted someone less “negative”.   Seven entities is a lot of billing.  Financially, would we have been better off remaining silent?

This is not an attempt to justify the auditor’s failure to live up to their responsibility to protect owners and stakeholders.  An auditor who accepts a consulting job with a client needs to consider it a bribe, or worse, an attempt to make them complicit in management’s failure.  That is the auditor’s failure.

But the greater failure is on behalf of the boards of directors who have the primary responsibility to protect the shareholders.  When you ask management to interview auditors, when you accept management’s recommendation to terminate the CPA, when you accept management’s excuses for their misdemeanors, you are abrogating your responsibility.

But you can start to address the problem.  It will require boards to start holding management accountable.  And, when it comes to engaging the auditor to attest to your organization’s financial statements:

You, not management, should

  • request proposals from auditors
  • interview the auditor
  • determine if the auditor takes any fees from management for consulting
  • ask how auditors get clients – board or management referral
  • never allow management to dictate non-GAAP policies without auditor approval
  • interview new auditors every 3-5 years
  • demand that the auditor refuse to accept any consulting arrangement with management

As long as the board, or its audit committee, continues to allow management any involvement in the process of selecting, engaging and compensating auditors, this problem will not go away.  The board must make it clear to management that the auditor is the board’s tool to review management and its adherence to appropriate accounting policy and not someone who is there to help management look good.  And the board must make it clear to the auditor they look to them to protect the owners and their investment.  This is your chance to hold both auditor and management accountable, will you step up to the challenge?

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