The Absurdity of Audits

The following companies have at least 5 things in common:

 Bank of America • JPMorgan Chase • Capital One Bank (Credit Cards) • Goldman Sachs • Citigroup • Keycorp • Wells Fargo • AIG (Insurance) • American Express • US Bancorp • Merrill Lynch • General Motors (including GMAC Financial Services) • Chrysler (including Chrysler Financial)    Answers below*

The general public tends to think of certified public accountants primarily as tax preparers, but anyone can help you file taxes.  Basically, the only thing CPAs can do that you can’t (legally) do is issue an “opinion” on financial statements; specifically, performing the “annual audit.”

For many organizations, foregoing the annual audit is not an option; they are often required by law, grant requirements or loan covenants.  Most directors and stockholders/members (and lenders!) are under the impression the audit is an indication all is well.  By the time an audit report is received (4-6 months after year end) the organization could be in serious trouble.  Even then, it never addresses critical questions:

• Is the organization well-managed?
• Does actual performance match monthly expectations in a current, formal business plan (which should include a detailed budget)?
• Is the operation competitive?
• Is the organization over-staffed?
• How often are ALL policies and procedures reviewed/updated?  By whom, at what levels? (Audits address some financial control issues).
• What hidden costs are never included in the annual audit?

Some other MAJOR misconceptions:

• Auditors works for management.  The auditor actually works for the organization through its board of directors, and should be selected by the board, not management. 
• Audited financial statements imply accuracy in reporting.  The auditor’s cover letter (the “opinion”) typically includes such vague phrases as:  “… present fairly… reasonable assurance… free of material misstatement…”
• CPAs make good candidates for chief financial officers.  Other than a common understanding of accounting fundamentals (GAAP, GAAS, etc.), they require two completely different skill sets.  An auditor is a narrowly-trained, highly-focused technician.  A CFO is (or should be) a first-rate manager, with positive people skills, a solid understanding of how all parts of the organization function together, and the experience to know what the numbers actually mean.  Exceptional CFOs comprehend all aspects of today’s game; auditors simply review last year’s score.
• The audit is a complete financial representation.  It actually indicates only what the “big picture” numbers were at year-end (“…in all material respects…”), but not what those numbers mean to the organization.  Except in extreme cases (e.g., "going concern") there is no attempt by auditors to interpret financial statements; that is clearly not their responsibility (as specified in their engagement letter).

*In addition to being some of the most recognizable names in American business, these companies have at least five other things in common:

1. Each received billions in corporate bailout funds (TARP).
2. Their executives and managers were not required to repay the millions of dollars they received in individual compensation and bonuses, despite the fact it was their personal actions as corporate decision-makers which created the need for government bailouts.
3. They are (or were) all “Publicly Traded” companies, regulated by the Securities & Exchange Commission.  This required them to submit (to the SEC) quarterly (“10Qs”) as well as annual (“10Ks”) operating and financial reports.  Financial institutions were also audited by various federal regulatory agencies.
4. Each one has (or had) substantial internal audit departments.
5. Every one of them received annual audits (over the past several decades) by major international CPA firms.

Enron, Tyco, WorldCom/MCI, Lehman Brothers, Bear Stearns, Washington Mutual, Wachovia, and IndyMac Bank as well as Ponzi scheme felons Bernie Madoff and Lou Pearlman used audited financial statements to dupe lenders, investors and US taxpayers out of hundreds of billions of dollars.

Between 1980 and the mid-1990s, 1,600+ banks closed or received federal financial assistance, as did roughly half the insured savings and loans. The Government Accountability Office estimated the financial institution bailouts during that period cost taxpayers nearly $125 billion.  Over a dozen Alaskan banks also failed or were “absorbed.”  When the “dot-com bubble” burst in 2000, hundreds of millions of dollars evaporated, again taking savings and retirement funds them.  All these entities had been audited or “reviewed.”

In 1986, the GAO identified 34% of CPA audits it reviewed as substandard.  The situation has not improved, even with the addition of Sarbanes-Oxley in 2002, as evidenced by the “TARP bailout” list.  When sued for “audit accountability,” some CPA firms have successfully convinced courts they were simply misled, thereby defeating the sole purpose of the audit (independent, “qualified” affirmation of management’s financial statements).

This year, why not ask your auditor a basic financial question:

"Are we really getting our money's worth?"

It's a fair question, and deserves an honest answer.

 Recommended reading list for this topic:

The Vest Pocket CPA

The Vest Pocket Guide to GAAP

The Vest-Pocket MBA, Third Edition

Auditing For Dummies

The Internal Auditing Pocket Guide: Preparing, Performing, Reporting and Follow-up, Second Edition

Sarbanes-Oxley For Dummies

Reading Financial Reports For Dummies


 "Must See DVD" for this topic: