Auditor-Client Disagreements

06/03/2010

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Auditor-Client Disagreements
It’s easy to find news accounts of auditor changes. Sometimes the auditor resigns after losing confidence in management’s representations. Other times, the client has a legitimate complaint about the auditor’s services or fees. Many times, the explanation of the auditor change disclosed in the 8K is ambiguous. 

I like to discuss Floyd Norris’s New York Times article in class because it raises the issue of “opinion shopping.” Allegedly, Surebeam sought Deloitte’s approval of its revenue recognition methods before deciding to hire Deloitte, and then felt betrayed when a different partner objected to Surebeam’s accounting.

Articles:
“Auditor-Client Breakups Rise, While Disclosure Often Lags,” P. Plitch & L. Wei, Wall Street Journal (August 3, 2004): C3. Few clients reveal their reasons for changing auditors in their regulatory filings.

“Accounting Regulator Vows to Scrutinize Firings of Auditors,” Wall Street Journal (September 23, 2003). The PCAOB says it will examine auditor changes more closely. Charles Niemeier worries that too many companies switch auditors because they don’t like the answers they are getting.

Examples of Auditor-Client Disagreements:
“Grant Thornton Drops Chinese Chicken Company,” WebCPA (March 12, 2010). GT resigned Yuhe International audit after discovering control weakness and prohibited related party transactions.

“Overstock Hires New Auditor, Disses Previous One,” WebCPA (December 30, 2009). Overstock fired Grant Thornton claiming GT changed its mind when asking Overstock to restate its 2008 financial statements.

“They Fired Two Auditing Firms. Anyone Want to Be No. 3?” Floyd Norris, New York Times (August 22, 2003): C1. Surebeam fired Deloitte because of disagreement over revenue recognition. Surebeam claims Deloitte approved Surebeam’s accounting before accepting the engagement, but then changed its mind.

“Callaway Golf Fires KPMG as Auditor,” R. Frammolino, Los Angeles Times (December 17, 2002): Section 3, Page 2. Callaway Golf fired KPMG after a disagreement over whether a reduction in Callaway’s warranty reserve should be recorded as a change in estimate or a restatement of prior year earnings.

“Deloitte Parts With SEC Over Audit of Company,” Jonathan Glater & Floyd Norris, New York Times, (August 2, 2001): C4. Prepaid Legal Services obeyed SEC instructions to restate its earnings. Deloitte then resigned the audit claiming the original accounting was correct and the restated earnings were wrong.

Research Studies:
“Negotiation Research in Auditing,” Helen Brown & Arnie Wright, Accounting Horizons (March 2008): 91-109. Recognition is growing that the financial statements ultimately result from a resolution or negotiation process between the auditor and management. This article provides a synthesis of the research on auditor-client negotiations.

“Behind the Audit Report: A Descriptive Study of Discussions and Negotiations Between Auditors and Directors,” Vivien Beattie, Stella Fearnley & Richard Brandt, International Journal of Auditing (2000): 177-202. Results from a survey of CFOs and audit partners regarding discussions and negotiations. 
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Audit Reports

06/03/2010

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Audit Reports
The ASB, as part of its Clarity Project, recently updated the wording of the standard auditor's report. The Disclosures article listed below describes the new report. Additional changes may be on the horizon. The PCAOB issued a concept release in 2011 proposing significant expansions to the scope of auditors' reports.

After quickly reviewing the wording of the auditor's report and its various modifications, I like to spend at least 20 minutes discussing one or more proposals to amend or abolish the standardized auditor's report. McAllister & Bell's CPA Journal article proposes having auditors disclose the client's highest risk accounts. My Richmond Magazine article usually generates good class discussion because the students appreciate the analogy to pass/fail grading.

Articles:
"The New (and Improved) Auditor's Report," Paul Clikeman, Disclosures (January/February 2012). This article contrasts the old SAS 58 auditor's report with the new standard auditor's report that will be required for periods ending on or after December 15, 2012.

“SEC Claims Company Forged Audit Report,” WebCPA (February 26, 2010). Tsukuda-America filed a registration statement containing an audit report from Weinburg & Co., but Weinburg denies ever auditing the company.

Proposals to Revise Audit Reports:
“PCAOB Considers Four Approaches to Changing Auditor’s Report,” Journal of Accountancy.com (June 21, 2011). The PCAOB issued a concept release discussing four potential changes to the auditor’s report: (1) a narrative report outlining the auditor’s views on significant matters, (2) expanded use of emphasis paragraphs, (3) auditor assurance on information outside the financial statements, and (4) clarification of language in the standard auditor’s report.

"Expanded Information in the Audit Report," John McAllister & Timothy Bell, CPA Journal (December 2011). The authors advocate having auditors disclose the accounts and transactions (1) that had the highest risk of misstatement, (2) that were the most difficult to audit, (3) for which conclusions about fairness were most challenging.

“Berardino Calls for Change,” M. Wong, Washington Post (June 5, 2002): E4. Former Arthur Andersen chief Joseph Berardino recommends having auditors provide a written commentary on clients’ financial statements rather than only a standardized report.

“Let Auditors Tell Us What They Know,” Floyd Norris, New York Times (February 1, 2002). Recommends permitting auditors to “grade” their clients’ financial statements.

“Auditors' Reports Should Be More Like Movie Reviews,” Paul Clikeman, Richmond Magazine (Summer 2002). Recommends that audit reports should be more like movie reviews – containing both a written commentary and an overall evaluation on a 5-point scale.

Research:
“Investors’, Auditors’, and Lenders’ Understanding of the Message Conveyed by the Standard Auditor Report on the Financial Statements,” Stephen Asare & Arnold Wright, Accounting Horizons (June 2012): 193-217. A survey of auditors, investors, and lenders found a fundamental communication gap between users and auditors.

“What do Investors Want from the Standard Auditor’s Report?” Joseph Carcello, CPA Journal (January 2012). A survey of investment bankers and money managers found that they wanted auditors to report more information about (1) estimates and judgments made by management, (2) areas of high audit risk, (3) unusual transactions, and (4) the quality of the client’s accounting policies.

“Perceptions and Misperceptions Regarding the Unqualified Auditor’s Report by Financial Statement Preparers, Users, and Auditors,” Glen Gray, Jerry Turner, Paul Coram & Theodore Mock, Accounting Horizons (December 2011): 659-684. Focus groups of CFOs, bankers, analysts, non-professional investors, and auditors share ideas for improving the standard auditor’s report.

"The Auditor’s Reporting Model: A Literature Overview and Research Synthesis,” Bryan Church, Shawn Davis & Susan McCracken, Accounting Horizons (March 2008): 69-90. This article traces the development of the auditor’s report, and summarizes academic research regarding the auditor’s reporting decision and the content of the auditor’s report.


 
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Evaluating Misstatements

06/03/2010

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Evaluating Misstatements
My students are mystified as to why auditors don’t simply insist that clients record all proposed adjustments to their financial statements. I try to explain that, in many cases, the engagement partner needs the client more than the client needs that particular auditing firm. An S&P 500 corporation can hire a new auditor far more easily than an individual engagement partner can attract a new S&P 500 client. 

Both clients and auditors rationalize the decision not to correct known misstatements by claiming the misstatements are “immaterial.” I always share Art Levitt’s question from his famous “Numbers Game” speech. If the proposed adjustments are immaterial, why do companies object to recording them? 

The Brody et al. Accounting Horizons article is an interesting analysis of Arthur Andersen’s decision to waive $51 million of proposed adjustments to Enron’s financial statements; I’ve used it successfully in my master’s level auditing class. The two Wright & Wright research studies provide interesting insights into the factors auditors consider when deciding whether to waive proposed adjustments.

Articles:
“Understanding Audit Adjustments,” Thomas Ratcliffe, CPA Journal (April 2000): 34-39. This article describes SAS No. 89’s requirements that auditors include a summary of uncorrected misstatements in the management representation letter and inform the audit committee about uncorrected misstatements. 

Examples of Uncorrected Misstatements:
“Early Warnings of Trouble at Enron; Accounting Firm Found $51 Million in Problems, But Still Signed Off on the Books,” David Hilzenrath, Washington Post (December 30, 2001): A10. Enron managers declined to record $51 million of proposed audit adjustments that would have reduced 1997 income from $105 million to $54 million.

“SEC Fines Arthur Andersen in Fraud Case,” Michael Schroeder, Wall Street Journal (June 20, 2001). Arthur Andersen partners permitted Waste Management to publish financial statements containing $128 million of current and prior period misstatements based on management’s promise to correct the errors in the future.

“Auditors Noticed Sunbeam’s Fraud but Ignored It,” Floyd Norris, New York Times (May 18, 2001). Andersen partner Phillip Harlow decided that $18 million of uncorrected misstatements in Sunbeam’s 1996 financial statements were immaterial.

Cases:
“Xerox, Inc.” Edward Seipp, Sean Kinsella & Deborah Lindberg, Issues in Accounting Education (February 2011): 219-240. This case describes Xerox’s faulty accounting and the SEC’s charges against five KPMG partners for performing deficient audits of Xerox’s financial statements. The case highlights the importance of the “concurring partner” in a firm’s audit quality control program.

“Resolving Difficult Accounting Issues: A Case Study in Client-Auditor Interaction,” Karla Johnstone & Steven Muzatko, Issues in Accounting Education (February 2002): 27-39. Students posing as auditors negotiate inventory and accounts receivable adjustments with students posing as client management.

Research Studies:
“The Impact of Client and Misstatement Characteristics on the Disposition of Proposed Audit Adjustments,” Jennifer Joe, Arnold Wright & Sally Wright, Auditing: A Journal of Practice & Theory (May 2011): 103-124. Auditors are more likely to waive proposed audit adjustments for repeat misstatements and for clients with whom the audit firm has had a longer relationship.

“Could $51 Million Be Immaterial When Enron Reports Income of $105 Million?” Richard Brody, D. Jordan Lowe & Kurt Pany, Accounting Horizons (June 2003): 153-160. This article analyzes Arthur Andersen’s decision to waive $51 million of proposed adjustments in light of professional standards in effect at that time.

“An Examination of Factors Affecting the Decision to Waive Audit Adjustments,” Arnold Wright and Sally Wright, Journal of Accounting, Auditing, and Finance (Winter 1997): 15-36. Auditors’ decisions to waive proposed audit adjustments appear to depend on materiality, directional impact on income, the nature of the adjustment (objective versus subjective), and the size of the client.
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