Accounting Ethics (and fraud)

Postings by Art Berkowitz on ethics and fraud. Most of them are serious, but sometimes we also need to have a little fun.

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Art Berkowitz, C.P.A. is an author, speaker, and consultant from Orange County, California. He writes ethics, fraud, and accounting courses (CPE) for accountants and other financial professionals. Art has also written a weekly online column for The Wall Street Journal and a book on the Enron debacle. To order any of his self-study courses go to

Wednesday, June 29, 2005

Can We Really Have Independent Auditors?

The issue and problems surrounding auditor independence and objectivity will continue as long as auditors are paid by their clients. Whether the audit fee is $25 million as it was with Enron or $25,000 for a private company audit, the independence of the auditing firm could be impacted by the importance of the fee (either real or imagined) to the engagement partner, the firm's managing partner, or the firm itself.

As of yet, no one with any clout has been willing to take up the debate... and yet there are viable alternatives that deserve to be discussed.

The subject of who pays for accounting services was the leadoff section in chapter 4 of my book, Enron: A Professional's Guide to the Events, Ethical Issues, and Proposed Reforms. In it, I summarized three of the most feasible alternatives for paying for auditor services. I called for a national debate on the subject.

That was three years ago. Perhaps with the KPMG and E&Y lawsuits hanging over the accounting profession (Auditors: Too Few to Fail), now could be the time for such a public debate.

Each alternative has its pros and cons. Some of the highlights are summarized below. For a more complete analysis, you can email me at or read my book.

The "user pays" alternative looks to the user of financial statements for payment. For public companies, the theoretical difference between this alternative and what we have now should be small. Stockholders, represented by an independent audit committee and board of directors, hire the auditor and oversee the relationship. Unfortunately in practice management is often the one that actually makes that decision. The good news is that Sarbanes-Oxley is having a positive effect at many companies in the way auditors are chosen. For private companies this alternative would result in a major change in the way auditors are hired. Banks, bonding companies, and other users would directly hire the auditor.

The "pooled funds" alternative would require a group of companies to pool their funds. The auditor would be selected by an independent entity and the fee would be negotiated. Only the independent entity could hire or fire the auditors. This should result in a more independent selection process, but critics contend that a whole new set of bureaucracy and problems would develop.

The "government auditor" alternative would totally change the auditing function to a regulatory one. There are strong advocates and opponents of this alternative who are often influenced by their perspective of the proper role of government. The relationship between company and auditor would change. Critics contend that an adversarial relationship would be the result and the quality of audits would actually decrease.

Clearly there is still much to discuss. But with the recent scandals and their effect on the capital markets, the need for a public debate on the topic of independence and the payment of auditor fees should be clearer now than ever before.


Anonymous Anonymous said...

As a CPA ex auditor (now Tax accountant) I can say two things with a fair amount of authority. 1. The minute you contract for money to do a clients audit you cease to be independent. You will always bend things on the clients insistence. 2. Even the big 4 are ill equipped to handle big companies. There are simply too many complicated transactions. The solution is really simple. Audit firms should be accredited by the Government and assigned audits by the Government. The Government should have oversight. Public companies are public domain and are regulated by Govt at all stages except the most important one. On a final note Gaap has become so convoluted now that I am convinced it has become an exercise in making Financial Reports deliberately unintelligble rather than understandable. We would be better off if companies simply published their trial balance and let interested parties and independent firms do their own analyses.

10:59 PM  

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