What did I say?

I guess I stepped in it today.

On my other blog for CORE, I wrote today about independence, you know that little section of rules which constrain the CPA from essentially reporting on their own work.

  • Yes, I know that it is done;
  • Yes, I know it is done all the time;
  • Yes, it is a literal interpretation;
  • No, I don’t think you should try and paper it over.

Two reports require the CPA to be independent of the client and management: Audit and Review.  No one is forcing the CPA firm to perform an audit or a review.  If you want to be part of management, I say GO FOR IT!  Help management get their act together.  Help them adjust their books and, more importantly, know when they need to debit this and credit that.  Help them, but don’t come back and then claim your independence isn’t impaired.

Impairment of independence isn’t just a factual matter.  Yes, you can create lots of paper which says that Ms. Whatshername, the a/p clerk, understands what you are doing on her behalf and she is ok with you making that journal entry for her.  But when you are brought in to re-enter the entire accounts payable because Ms. Whatshername didn’t enter anything and the controller was fired so there is no one to check your work… don’t push your luck.

The appearance of impairment is even more important for those reviews and audits.  You are dealing with the integrity of the profession when you ignore what some other person might think about your independence, or lack of it.  If it looks to an innocent person that you are doing the work of management, well, guess what?  You are.

To paraphrase a letter which went from an association to the owners of a condominium:

  • Management way back when got it wrong
  • New management starting in 20XX got it even more wrong
  • New management denied their work was wrong consistently from then until now
  • New management denied it was wrong even after being beat over the head with it
  • Board hired independent CPA to redo management’s work
  • Independent CPA recalculated the numbers, resulting in a major change
  • The CPA says their work is correct
  • And, you can rely upon the CPA for this because they are trustworthy

Sorry, but that wonderful letter praising the CPA now means the CPA probably is no longer independent as to the financial statement audit.

Their work was awesome.  Totally correct.  Nailed it to within $0.02 for every owner.  Told the attorney and the board they were right and said so in a letter to the owners.  they were worth every dime they were paid to fix the mess.

But their independence is now impaired.  There is no one, not management, not the board, definitely not the attorney, who is going to take responsibility for the CPA’s work.  The CPA owns it.  They said so.  Under the rules, both of the AICPA and common sense, they are no longer independent of the client.

No independence no audit.

I get it, it is my interpretation.  Well… Not really.  It is 20 odd years of practicing in this area and reading hundreds of ethics interpretations.  It is having to struggle with deciding when we cross a line and are no longer looked at by Tommy Banker or Amanda Bonding Agent as separate from management.  When the question is, “Are you getting paid to help management or to report on them?”; it does become a little more clear.

Attest firms MUST err on the side of caution.  The big 4 don’t, the next 8 don’t.  Their failures don’t give the rest of us license to slide down that wonderful chute into impairment hell.  Take the road less traveled but best for your client.  Have integrity to admit your lack of independence when it exists.

Make the right call.  Help management or report on them.  If you can’t tell the difference, well, you probably shouldn’t be playing this game.

 

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.