Re:Balance -- Jim Peterson

Book Announcement: "Count Down -- The Past, Present and Uncertain Future of the Big Four Accounting Firms"

For those who may have wondered -- my reduced schedule here in recent months had a reason: completion and readying for publication of my book, "Count Down -- The Past, Present and Uncertain Future of the Big Four Accounting Firms".

I am pleased and proud that the book is next in the Emerald Publishing Group's series, "Studies in the Development of Accounting Thought," edited by Gary Previts, E. Mandell de Windt Professor of Accountancy at Case Western Reserve University, member of the Accounting Hall of Fame and past president of the American Accounting Association.

Its scope -- bringing together themes long explored here and going back to my column in the International Herald Tribune -- is summarized in this from Emerald:

The post-Enron disintegration of Arthur Andersen in 2002 reduced to the surviving Big Four the number of international accounting firms that audit nearly all of the world’s largest public companies -- Deloitte, EY, KPMG and PwC.

 Despite their strengths -- market dominance, double-digit annual growth in non-audit services and continued revenue expansion to a global total above $ 120 billion in 2014 – the viability of the Big Four and their business model faces serious threats:

• Widespread dissatisfaction with the standard form and language of their core product -- the traditional “pass-fail” auditor’s report.

• The persistent “expectations gap” between their perceived performance quality and the stated desires of information users.

• Difficult relations with regulators and oversight agencies.

• And especially, the questionable ability of the Big Four and their partners to survive a “black swan” financial shock – a litigation judgment or law enforcement sanction on the scale that destroyed Arthur Andersen.

"Count Down" looks at the complex challenges facing the Big Four, questions the feasibility and achievability of the various proffered “solutions,” and proposes an evolved model for Big Audit that would be both sustainable for the large firms and fit to serve the capital markets of the 21^st century.

“ This book lifts the lid on the story behind the financial statements of the world’s major companies. If you want to understand the system that is allegedly validating the reported data - and why the system is a clone of the Maginot Line - expensive, obsolete and irrelevant - read on. Weak as the present system is, there is a solution. It will take a major change in regulatory attitude and a fresh approach, unfettered by history. The section on the imaginative use of Big Data is worth study by itself. “

     -- Duane R. Kullberg, Arthur Andersen & Co., S.C. Chief Executive Officer, 1980-1989

“Illusions of safety in size doomed allosaurus, empires, and auto makers. In his Count Down, Jim Peterson examines the fragility of the ineffectual audit regime, and the imminent threats to its survival. Peterson combines the insider’s knowledge with an outsider’s critical but sympathetic perspective and suggestions in this fascinating and insightful volume—a must-read for accountants and students of accounting.”

     -- Shyam Sunder, James L. Frank Professor of Accounting, Economics, and Finance, Yale School of Management

Scheduled release date is October 15. For information, and to order:

     From Emerald Books

     From Amazon

Please share with your friends and colleagues. For questions and other inquiries -- and for Emerald's pre-publication discount -- please write me: [email protected]

“Audit Deficiency Syndrome” – IFIAR and the PCAOB Would Call It a Global Epidemic

In the panoply of clumsily identified affinity groups, the acronym for the awkwardly named International Forum of Independent Audit Regulators – IFIAR -- would surely be a top candidate for well-deserved obscurity.

IFIAR came together in 2006, one of the offspring of the Public Company Accounting Oversight Board – the American audit regulator known for short, and no more poetically, as the PCAOB.

That agency was itself born in 2002, in the post-Enron spasm of legislative righteousness that begat the Sarbanes-Oxley law and marked the end of the accounting profession’s exercise of self-inspection and quality oversight. Audit regulators were spawned around the world – the PCAOB and its children in 50 more countries now gather under the IFIAR banner with the mission of “knowledge sharing and collaboration in pursuit of its members’ shared objectives of high quality audit performance.”

That comes from the group’s press release, issued at its assembly in London earlier this month, which was led by current chair Lewis Ferguson, a member of the aforesaid PCAOB.

Bidding for media attention to its inspection and oversight programs, Ferguson’s press briefing announced the results of IFIAR’s latest survey of its members’ sampling of the work of large-company auditors:

“We continue to see high levels of inspection deficiencies in vital areas of public company audits. This is a problem for investors and stakeholders around the world.”

Numbers came with the words -- appropriate for this sector of the capital markets: the survey reported deficiencies in fully 47 % of the 948 public company audits inspected, and 41 % of the inspected audits of 148 financial institutions.

Splashed across the business and trade press, the attribution of persistent, recurring high levels of inspection deficiencies in vital audit areas was characterized as “staggering” and “chronic” in outlets such as Forbes, Economia, CFO Magazine, Financial Director, the Journal of Accountancy, Accounting Today and Accountancy Live.

Hold on a second. What of this alarmist message – a forty-plus percent deficiency rate in “vital areas of public company audits”?

On the one hand, while the IFIAR cautions against extrapolating, its findings of deficiencies:

“indicate that the audit firm did not obtain sufficient appropriate audit evidence to support its opinion … and that the audit failed to provide the level of assurance about the financial statements that it purported to do and that is required by professional standards.” (Emphasis added.)

Pass for a second the litigation implications of such charges of sub-standard performance, under the threatening regimes of legal liability in the world’s large economies. Such a failure rate in any other sector would – if credible – also be intolerable to the interested parties.

Some examples: New car warranties are now in place above and beyond 100,000 miles. Airline casualties are measured per hundred million passenger miles. Food safety and environmental pollution standards are expressed in parts per billion. Such dangerous activities as construction sites and chemical plants advertise their accident-free periods over months and years.

Even at the hands of the most casual food-safety agency, such a pervasive rate of “deficiencies in vital areas” would cost the operator’s license of a neighborhood coffee shop or a curbside taco truck in a heartbeat.

And yet – every securities trade on every stock exchange in every IFIAR country is based on financial statements audited by a firm subject to inspection by an IFIAR member. And the very raison d’être of those members is, as they put it (press release, page 3), their “mandate to improve audit quality.”

Which leads to this choice: Is the quality of the Big Audit model so fundamentally degraded that large-firm performance deserves the headline-grabbing assertion of persistent, recurring serious deficiencies?

Or – perhaps – is this global aggregation of audit regulators choosing to devise and apply the proper standards of measurement and evaluation in the first place? In other words, what counts? Who is doing the counting? And what’s the point?

After all – take the case of Andre Drummond, the 6’11” center for the Pistons, Detroit’s professional basketball team. He has the NBA’s worst current career free-throw shooting record, at less than 40 % – well below half the rate of the league’s leaders. Yet he is in his third successful year, based on his skills in rebounding and defense.

The same in professional baseball, where a batter failing to hit safely three times out of four can still achieve Hall of Fame status (see the career batting averages of Bill Mazeroski -- .260 -- Ozzie Smith -- .262 -- and Harmon Killebrew -- .256).

Properly defined measures of performance quality and rates of failure and error are not designed or intended, if legitimate, to be evaded or eroded. So IFIAR’s assertion, as Ferguson put it, that its finding of deficiencies “does not necessarily mean that the audited financial statements themselves were materially misstated,” bangs hard up against its own inability to give affirmative comfort that its findings are consistent with good reliable audit practice.  

IFIAR’s promotional efforts confront the dangerous inanity of “managing what you can measure.” So it is left not only unable to find a satisfactory answer to the wrong question – it is blinkered from even asking the right one.   

Lest we forget, there are two lessons in the legend of the shepherd boy who cried “wolf”:

The publicity-seeking little boy was met with public rejection and the lack of respect that his over-reaching deserved.

And also, when the wolf actually did show up, the villagers really did lose their sheep.

 

Thanks for joining this dialog. Please share with friends and colleagues. Comments are welcome, and subscription sign-up is easy and free, both at the Main page.