Audit Effectiveness: Views from Corporate Financial Officers

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Audit Effectiveness Views from Corporate
Financial Officers
Philip B. Livingston President and CEO Financial
Executives Institute prepared for the Public
Oversight Boards Panel on Audit
Effectiveness October 7, 1999
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Voice of Finance Executives

• 14,300 members from 8,000 U.S. and Canadian
  companies
• Member Companies by Revenue Size
• 28 under 100 million
• 27 100-499 million
• 11 500-999 million
• 21 over 1 billion
• 85 chapters and 11 technical committees hold
  more than 600 meetings a year

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Our Focus

• VALUE OF A HIGH-QUALITY AUDIT
• DECLINING PRESTIGE OF AUDITING
• MARKET PRESSURES
• BIG 5 LEADERSHIP ROLE

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HIGH QUALITY AUDIT
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High Quality Audit

• Major distinctive element of strong capital
  markets
• FEI Members do NOT perceive a MAJOR slippage in
  actual audit quality. Concerns however -
  emphasis, image and prestige.
• The process isnt broken
• no objective evidence that audit failures or
  fraudulent reporting are on the rise
• historically high market levels and cash flow
  into equities indicate the opposite

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High Quality Audit

• Our members want and need HIGH QUALITY audits
• We share a common objective with the auditor
• Assurance that the financial statements are
  accurate
• Reliant upon each other
• Need great communication between the
  parties

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Improving Audit Quality

• Emphasis on superior audit staff personnel
• Technology toward better risk analysis
• CFOs can stress value of audits
• Audit failures can happen if
• partner is not a strong leader
• staff misses or rationalizes evidence

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Improving Audit Quality

• Encourage more critical thinking. Skepticism can
  be healthy in a high risk environment.
• Study the close sequence - final adjustments
• Understand forecasts and analyst models

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Initiatives that will NOT IMPROVE Audit Quality

• Auditing MDA
• will lead to boilerplate and legalese
• Value of the MDA is that it reflects the state
  of the company in managements own words
• Separating consulting from audit practices
• Restrictions on choice of vendors for consulting
  services

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System Failures Joint Ownership

• Fraudulent or accidentally misstated financial
  statements reflect poorly on BOTH the audit
  profession and the financial executive profession
• Management is responsible for the financial
  statements
• The auditor has a special third-party
  responsibility to provide assurance

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PROFESSIONAL PRESTIGE
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Improve the Image and Attractiveness of the
Profession

• Problem perception that audits are viewed as a
  loss-leader for the consulting practice
• Consulting may be competing for the best employee
  talent and may impact audit quality

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Improve the Image and Attractiveness of the
Profession

• High-profile cases of earnings restatement may
  have tarnished the profession
• respect and integrity of audit services must be
  restored
• independence standards failures hurt too

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Improve the Image and Attractiveness of the
Profession

• Many perceive the audit side of the CPA firm not
  as prestigious, as recognized or as rewarded
  internally as the consulting side of the business
• We wonder how capable young people are attracted
  into auditing, given its image

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MARKET PRESSURES
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Todays Environment

• Economic environment for accounting firms HAS
  changed due to
• consolidation
• continuous cost cutting in corporate America
• rabid MA market driving corporate Darwinism

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Pressures on Management

• Systemic problem resulting from increasingly
  efficient market and the speed and quantity of
  information delivery.
• Number of institutional investors, analysts and
  media way up. Incredibly competitive, pressure
  packed and performance-driven environment.
• Hedge funds, momentum investors and short-
  sellers clearly having impact.
• Most exaggerated in small to medium-sized
  companies
• Quarterly results are projected rapidly into the
  long-term implications
• High PE ratios are based on high-growth
  expectations

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External Pressures Should NOT Impact the Audit

• Quarterly earnings pressure on management should
  not destroy the potential of a successful audit
• Audit diligence, independence, qualified
  personnel and other professional standards lead
  to reliable audits

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BIG 5 LEADERSHIP ROLE
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CPA Firms Must Reestablish Their Leadership

• We sense a shift in the balance of authority in
  accounting and auditing
• auditors relying on regulators to resolve
  difficult accounting issues
• SEC micro-management in some areas
• Authority and confidence undermined

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CPA Firms Must Reestablish Leadership

• CPA firms need to take back the high ground and
  LEAD the development, analysis and interpretation
  of accounting standards
• This will be good for all parties and more
  efficient for our capital markets
• We recognize our part of the problem

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Recommended Actions

• All stakeholders and participants in the process
  should resolve to work together
• greater emphasis on the importance and value of a
  high-quality audit
• seek ways to reduce unproductive pressures from
  capital markets
• work to attract more of the best and brightest to
  the profession
• ensure CPA firms internally restore the luster
  and prestige of their own audit practice

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Leading the Future of Corporate
Financewww.fei.org
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SELECT PANEL QUESTIONS
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Discretionary Areas

• Current process provides for significant
  attention to judgmental areas and probing by the
  auditors

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Detecting Fraud

• We dont see significant problems, except for
  occasional high-profile failures
• Auditors should prioritize risk areas, without
  ignoring low-risk areas

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Quality of Audit Staff

• Seems more difficult to engage in dialogue on
  complex issues at the local level
• partners consult with the firms national office
  much more than in the past
• greater accounting rules complexity, uncertainty
  due to reversals?
• centralizing expertise and decision-making?
• field personnel lack enough experience?

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Breadth of Auditor Involvement

• More training in the clients business and
  operations is not cost effective for audit best
  for a consulting engagement
• Shareholder communications are responsibilities
  of management

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Breadth of Auditor Involvement

• We are skeptical of the value to shareowners of
  standardizing reporting of non-financial data,
  and of the value additional auditing could
  provide
• data is unique to each company
• data elements change as business changes
• competitive information could be disclosed to
  others who dont have such requirements

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Auditor Communications with Investors

• Auditors are communicating effectively, no need
  to expand beyond matters covered by the audit
• Rarely do shareholders question the auditors
  opinion most understand what it means and it
  serves the purpose intended

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Audit Committees

• FEI strongly supports the recommendations of the
  Blue Ribbon Panel
• But Audit Committees should not be expected to
  opine on the financials
• A THREE-WAY DISCUSSION should take place between
  the audit committee, management and auditors on
  the most appropriate accounting policies

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Audit Committees

• The ACs of well-established companies are doing
  a better job than some newer, smaller companies
  in promoting a high-quality audit
• Some ACs are guilty of going through the
  motions
• A great question for the auditor
• If we paid you to perform 25K more
• work, where would you do it?

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Regulation vs. Self-Regulation

• We think the right balance exists

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Leading the Future of Corporate
Financewww.fei.org