Auditors:

1
Auditors

• ConnivingCo-conspirators
• or Complacent Confirmers?

2
What do auditors do?

• Provide reasonable assurance that the
  representations of management in the financial
  statements are free of material errors in
  accordance with GAAP
• (generally accepted accounting principles)
• Certify this assurance in the forms of a signed
  letter to the board of directors and shareholders
• A copy of this letter is required by SEC
  regulations

3
What auditors do not do

• Guarantee that financial statements are free of
  all errors or else you can sue the auditors
• This is called the Expectations Gap

4
Provide Reasonable Assurance

• Auditors use statistical methods to determine
  quality of statements
• Auditors are allowed discretion in setting the
  error rate
• 10 chance of errors? 5? 1? What is
  acceptable level of risk?

5
Representations of Management

• Auditors are not responsible for the errors in
  the financial statements according to auditing
  standards
• Some judges have held auditors liable anyway
  auditing standards do not always hold up under
  law, but usually do

6
Free of Material Errors

• Materiality sometimes money just doesnt matter
• If you were supposed to have 1,000 in your
  pocket, but you only have 999.95, do you spend
  an hour looking for a nickel?
• If a company has 1 billion in income, do you
  spend an hour looking for 50,000?

7
Who Determines Materiality?

• Auditors Judgment
• Different accounts have different standards
• Inventory, Receivables, and Cash are usually
  examined more closely than other items because of
  the likelihood of theft or fraud

8
GAAP

• Generally Accepted Accounting Practices
• Regulations covering all manner of accounting
  procedures created by accountants for
  accountants
• Volumes and volumes of standards

9
Who sets GAAP?

• FASB Financial Accounting Standards Board
• Other bodies before FASB APB, CAP
• Ultimately SEC has final authority to set
  accounting standards sometimes to disastrous
  results

10
What if the statements are wrong?

• Auditors determine materiality
• Present findings to management or audit committee
  depending on degree of error
• Tell management what they can do to fix the
  problem
• If refusal to fix by management issue a
  negative report

11
Lots of Auditor Judgment

• Percentage of statistical significance
• Level of materiality
• What sort of report to issue
• Standards help provide some of these answers
  but not most

12
Give it a try!

• See if you can find the potential problems in
  these financial statements

13
How long does this take anyways?

• After the close of the fiscal year, auditors are
  called in to examine the records
• Timelines vary based on
• Auditor experience
• Knowledge of the company and its industry
• Complexity of the audit
• Most audits are completed about three months
  after year end

14
Auditors get help

• From well documented procedures
• A company culture of trust and competence
• Internal Auditors
• Company employees who try to prevent some of the
  larger issues
• Computer Software

15
Obvious problems

• Expectations Gap
• Conflicts of Interest
• Sneaky Senior Management
• GAAP rules

16
Expectations Gap

• Public believe that the role of auditors is to
  verify and guarantee
• Financial Loss caused by wrong statements is
  blamed on auditors
• Auditors do not clarify their position except
  when sued

17
Conflicts of Interest Pt. 1

• Auditors are paid
• Wrong statements can cause an auditor to
  withdraw from the audit lowering or eliminating
  compensation
• Payment causes lack of objectivity

18
Conflicts of Interest Pt. 2

• Many auditing firms also consult
• If consulting there should be few problems
• Fear of losing consulting with a bad report

19
Conflicts of Interest Pt. 3

• Billable Hours how long should it take?
• Reliance on Internal Auditors? Why?
• Prestige of having big name Auditors
• Mergers (and bankruptcy) have lowered this number
  of respected auditors to four

20
Sneaky Senior Management

• Clever fraud is hard to discover
• Reluctance to talk to auditors
• Senior Management motivated by profits rather
  than accuracy of financial statements

21
GAAP Rules

• Some rules are complex and hard to interpret
• Confusion about these rules helps lead to
  Expectations Gap
• FASB can be lobbied for new regulations
• Fallen man makes GAAP

22
What can we do?

• Consolidate all accounting?
• Government Regulation?
• Teach Ethics?

23
Some ideas

• Separate other services and auditing
• Provide better guidelines for determining
  auditor judgment items
• Third party payment system