An Open Letter to Certain Community Management Companies

Dear Community Management Company,

In response to the emails we have been receiving, please allow me to once again point out to you certain truths regarding the relationship between the auditor, the board, you as management and the owners.  This is a very important point to understand and can save you from performing an inordinate amount of rework, recriminations, general ill-feelings and time wasted writing pointless emails to me about how your feelings are hurt.

First, please understand that we are performing an audit of the financial statements prepared by management on behalf of the readers of that financial statement – i.e. current and prospective owners.  We are engaged to perform the audit by the board of directors who are elected by the owners’ within the association.  Our audit is on the financial statements prepared by you, as management.

It has likely not slipped by you that you, as management, are not included in the chain of authority.  We are engaged to audit your work.  The people who hire us, as part of their fiduciary responsibility, verify that we are independent of management.  That means we do not work for you, are not paid by you, and are not responsible to you.  We are, in fact, completely independent of you.

Auditor independence is an ethics requirement.  Auditor independence means that we are not involved in any manner with the people or companies we are auditing.  One step that we at C.O.R.E. take is to verify, prior to the start of any engagement: be it audit, review, consulting or other, that the work we are being asked to do does not put us in a position where a reasonable person might conclude that our work could be compromised because of some other relationship.

This doesn’t mean, by the way, that we cannot perform consulting or even management services.  We can even elect to perform certain services on behalf of management.  As a matter of fact, given the, shall we say, ethically challenged behaviors we have witnessed of late, we are seriously contemplating offering association management services.  The owners have the right to have someone looking out for their best interest and we think we are a superior choice for the right board and association.

What we could not do, is perform an independent audit of that association for which we are also performing management services.  THAT, is a conflict of interest.  The board and owners deserve to have someone independently examine our work to ensure we comply, not only with GAAP, but with basic common-sense internal control.  The obvious things like getting board approval for writing yourself a check in excess of your contract.  And the not so obvious things like performing and paying yourself for work that the board authorized another contractor to do.

Being able to offer a superior service to what you are offering is not a conflict of interest.  It is competition.  Modern capitalism encourages those who can offer a superior service at a reasonable price to put inferior businesses in that marketplace – OUT OF BUSINESS.  Walmart put tens of thousands of small time corner drug stores out of business and there was never a conflict of interest – there was just good old fashioned competition.

But you are correct, we could, in theory, leverage our position as the independent auditor to point out your significant internal control weaknesses over your clients’ money to suggest they hire us instead.  But if you were to think about it you would realize that would create a conflict of interest.  I cannot audit someone with the intention of going to work for them in another capacity because, you guessed it, there are ethics rules against it.  And we take our ethical responsibility seriously.  You do not want to even hint otherwise.

No, I do not owe you an explanation for a report to the board on your material weaknesses over internal control.  No, I am not obligated to help you fix your accounting errors.  No, I don’t have to ignore your failure to follow ethical business practices.  And, finally, no, I don’t have to communicate with you directly.  Unless you are ready to pay my rather hefty consulting fees.  Which, by the way, I couldn’t take, because it would cause a conflict.  Elegant, isn’t it?

Competing with you for management services is not a conflict of interest my dear management company friends.  Making journal entries to paper over your accounting errors 12 months after the fact possibly is.  Perhaps other auditor’s don’t see the irony, but make no mistake, we do.

Because if a board ever questioned your logic, they would wonder why they have to pay three times:

  • Once for you to get it wrong in the first place
  • Once for the auditor to make adjustments to fix your error
  • and you the second time to post the journal entries to the accounting system you control and shouldn’t have gotten wrong to begin with

Please, management, remember that the auditor does not work for you.  We are ok if you don’t want to refer us to your boards – they will find us anyhow.  We are even OK if you want to form a CPA firm to perform audits in competition with us.  We actually encourage it – after all –

you might learn something.

And for those management companies who take their responsibilities seriously, we would like to work with your boards in auditing you.  We appreciate that are open to the fact that sometimes things go wrong and you want to get it right.  We are thankful that you are open to constructive criticism and are willing to evaluate how our thoughts on effective internal controls might work better for you.  And we are happy to refer our audit clients to you.  Not because we are friends or you give us a kick-back but because you have your clients’ interest in mind and that makes our job just a little bit easier.  So thank you and we look forward to auditing you.

Have a great day.

Take one for the team?

As a follow up to my post the other day I wanted to add a few things which I have pondered since I wrote.

One of the main reasons we are not “part of the team” is that we understand that “team” is typically a one way street.  It is an effort on behalf of a certain party to gain our cooperation in not holding them accountable.  Our independence is seen as a problem and the easiest way to overcome it is to hoist the flag of our mutual interest so that we feel uncomfortable addressing our “team mates” weaknesses.  After all, team mates cover for each other, one person’s strength is used to offset another’s weakness, right?

We learned this lesson long ago in auditor school.  Also known as the University of Adversity.  “The Team”, in these instances, only exists to protect one party.  How can I say this?

Is it really a team effort when someone in management knows a fact and fails to bring it to our attention?  When management hides facts from the auditor in the hopes we won’t find out?  “We are a team but I am under no obligation to give you what you need to do your job.”  This isn’t what team mates do.

Is it really a team effort when you say, “I know I have an obligation to take a step but frankly it isn’t important and you can just trust me.”  Team mates hold each other accountable.  I will trust you when you show you can be trusted, why should it be an obligation of “Team work”?  You create a one way street of loyalty wherein you expect me to help you be successful but you have no obligation to help me.  Hardly team spirit.

Is it a duty of a team member to turn a blind eye to sloth and laziness?  Can you imagine a ball club saying, “Yeah, that Brady.  Never shows up to practice, can’t block worth a damn but meh, he is part of the team so I guess it is ok that he is starting Tackle.”  You believe you can forgo your “A” game and it is everyone else’s responsibility to pick up the slack?

Ignore for the moment an auditor’s ethical responsibility.  Let’s say that we could be part of the team.  Don’t you think, team mate of ours, that part of your belonging to the “TEAM” demands that you give your best to the shared result?  That if our part is to help you fix your errors, your part is to identify them?  That when you know a material fact, you should tell us so we can be successful?

But that isn’t the sort of team you want.  You want the team that feels obligated to commit extra to cover for your inadequacies.  You are the lunch buddy who orders the filet mignon while everyone else orders a salad and then says that the team should split the bill evenly.  No one deserves to be part of THAT team.

So no, auditors are not part of the team.  We are not here to be popular and we are not here to sweep poor behavior under the rug.  We took our “oath of office” to protect owners from management.  We actually kinda like the job, even if it upsets certain people.

If you want me to be part of the team, pay my consulting rates.  I will walk away from auditing on behalf of your owners.  I will help you fix your obvious deficiencies in ethics and business practice.  I will even endeavor to fix those that are not so obvious.  Trust me, “team mate”, you won’t like accountability this way either, but you can at least say we are on the same “Team.”

 

Auditor Relationship

I have written about this before but it is probably worth repeating.

In a meeting today we were told “management’s expectation”… that we are part of the team.  Somewhere there is a misunderstanding as we are not part of any team.

To be clear:

Auditors are engaged by the board of directors to independently audit management on behalf of the owners or others who contractually require an independent check on the financial reports being issued..

The key term there is independently.  To be effective, auditors must be independent of management.  So, how can an auditor remain independent while also being part of “the team?”  We really can’t and we definitely shouldn’t.

Part of the confusion is no doubt that some auditor’s have billed this as a team effort to provide information to the owners.  I have seen proposals by firms which essentially tout this approach; but it is not quite accurate to say this.  I would argue it is against auditing standards to say that you, as an independent auditor, are going to help management through their tough spots.  The independent auditor is not the clean-up position.  We are not fixers.  Finding the error, correcting the error and then expecting the entity to pay for it, when they have already paid management (and the accounting department) to get it wrong defeats the purpose of auditing the books.

Remember: Boards set policy.  Management implements policy.  Auditor’s verify that the implementation was correct.  If it isn’t, well, that is a problem.  It will obviously need to be cleaned up.  The problem is that when the auditor cleans it up, they are actually stepping into management’s role.  Acting as management impairs independence.  There are numerous ethics rulings on this matter.   The auditor is only as good as their independence by the way.  So why would we do it?

By the way, management has access to lots of consultants and CPA’s who could help them get the information right to begin with.  It isn’t like no one would help them.  But when it is done wrong and you expect the auditor to fix it, you are waiting far too long.  Months, possibly even longer than a year has gone by with the incorrect information being reported over and over.  Every report was inaccurate and somehow my pointing it out during the audit means I am not a team player?  Where is management’s responsibility in this?

Management could even have requested the board to make the auditor available to explain the expectations.  We love to talk (most of us anyway) and help you make sure it is right.  Believe it or not, we often sit around and dream about how awesome it would be to have the perfect audit – where everything balanced, management adjusted for all the issues before we brought it up, every receivable was collected and nothing ever happened after the balance sheet date.  We would be happy with just 10% of that truth be told.

Truthfully, we can’t be on your team.  We might like you, hell, you could be the greatest thing since sliced bread and we are going to be envious of your stock options and bonuses; but we can’t support you.  Our job, remember, is to make sure your stock option and bonus isn’t clouding your judgement when you decided to record a transaction.  Our responsibility is to ensure that you didn’t record only one part of the transaction to ensure you hit your target to keep your cushy job.  It isn’t that we don’t trust you but… oh who am I kidding, it is precisely that we don’t trust you.  You are management after all.

So, record the transactions.  Document compliance with policy.  Keep your financial statements in accordance with GAAP.  Or don’t.  But don’t blame the auditor when we find the work lacking.  We are doing our job of keeping “the team” honest and we make no apologies for it.

Auditor Independence

One of the more challenging aspects of being an auditor is having to turn down potential work.  It is not so much the money we could be paid for that other work, although that is nice in most cases; it is the recognition that our experience and problem-solving ability is valued and desired.  But, if auditors take their ethical responsibilities seriously they should not take additional projects on for their audit clients.

Doug and I discuss this frequently.  For instance, we have intentionally chosen to not prepare tax returns for individuals and businesses and we will only do the most basic 1120-H or 1120 for property associations.  Why?  It is the concern that a reader could question if the tax preparation work would cause us to subordinate our judgement as the auditor.

I know, you are saying, “It’s only a tax return.” And you are right.  But think about it: Let’s say an auditor prepares the tax return for a board member and his small business.  Then the auditor is asked to audit the small business.  The auditor discovers that $100,000 of scrap metal sales was not reported as income by the business.  Or the owner.  And the auditor is also auditing the condo association where the small business owner is also the chair of the board.  And it just so happens the auditor discovers that the association has a contract with the chair’s company to install new piping.  Are you still certain it is only a tax return?

But it can become even more challenging for an auditor if it looks like the fees they charge for that “other service” to the client appears more lucrative than the audit.  First, lets say that you charge $20,000 to a client for an audit.  At the same time the board approves the audit, management dangles a $50,000 consulting fee.  Is this a potential independence problem?

Unfortunately for the profession, many practitioners say “No” or worse, “Not necessarily”.  But think about it.  You are reading the financial statement the auditor attested to and which said there were no problems.  You then find out one of the issues above exists.  Would you, as the reader and who is relying upon that financial statement, be concerned that either of these situations could cause the auditor to issue an inappropriate report?

You see, I can unequivocally state that our opinion is not for sale.  But that is an assertion which is challenging to believe when I receive payments for services that are not audit related.  And I don’t think it matters if it is the board which offers the consulting work or management.  Our engagement is to audit the financial statements prepared by management and to which the board signs off on.  The board engages the auditor on behalf of the owners – but the board still might have its own agenda.  Thus, It is the risk that a reader could believe that our independence – from management AND board – could be impaired that matters.  Accepting money for additional services to an audit client should inevitably lead to the concern that the auditor’s independence is impaired.

Now, I understand that some professionals would say that this is an extreme position.  That is their right.  But I believe that the profession accepting the concept that non-audit fees do not impair independence is one of the primary reasons the auditor and the audit opinion are not held in high regard.

If you want to offer audit or review services to a client, then I think you have to accept that this is all the work you can do for that client.  At C.O.R.E., we believe that an auditor must maintain independence in both action and appearance.  It sucks sometimes.  We have turned down consulting arrangements because we audited the prior year financial statement.  We have turned down audit engagements because we proposed a consulting arrangement in the prior year.

It is our responsibility to do so.