Failures in Auditing and Auditing Companies


Hunkered Down for the Duration
Staff member
Whilst this really addresses financial auditing, I see a lot of the similarities in auditing to standards especially with resopect to registrars. Just some thoughts.


Who fiddled what?
Dec 20th 2001
From The Economist print edition
“Errors of judgment” are piling up at Andersen

AUDITING is a dull business. But it is also dangerous, as Andersen, the world's fifth-largest firm of accountants, is finding out. Andersen audited Enron for all 16 years since the company's formation. On top of pure audit, it also sold internal-audit and consulting services. But despite this privileged insight, Andersen did not spot the fact that Enron was publishing incorrect financial statements. For failing to do its job, Andersen now faces the wrath and legal claims of thousands of staff, shareholders and creditors who will lose billions from Enron's collapse.

In November, Enron announced that it would restate all its annual financial statements from 1997 to 2000, resulting in a cumulative profit reduction of $591m and an increase in debt of $628m. The reason, it said, was that it should have added in three off-balance-sheet entities, vehicles used by some companies to acquire more capital without adding debt to their balance sheets.

How could Enron's auditor have missed all of this at the time? Joseph Berardino, Andersen's chief executive, admitted to Congress last week that his firm made an “error of judgment” over one of the vehicles. But most of Enron's restatement, he said, came from a bigger “special purpose” vehicle called Chewco: Enron's management did not provide the information about Chewco that would have led Andersen to insist on its consolidation. He said Andersen warned Enron's audit committee about “possible illegal acts”.

Enron is fighting back. It says that it not only discovered and reported the relevant information on Chewco to Andersen, but that Andersen was involved in “real-time” audit procedures on all of its main structured-finance vehicles. If Andersen is found actually to have advised on the design of Enron's off-balance-sheet vehicles, as the company implies, it will find it hard to plead ignorance over their construction.

The Securities and Exchange Commission (SEC) is investigating Andersen's audit work on Enron, and lawsuits have been filed against the firm; doubtless more light will be shed on what happened. But already, some observers are questioning whether Andersen will survive in its present form. This year, the SEC imposed a $7m fine on Andersen for signing the accounts of Waste Management, another Texas firm, knowing that the accounting methods it had used were designed to mislead investors. In the spring, Andersen paid $110m to settle an accounting-fraud lawsuit over auditing work it did for Sunbeam, a Florida consumer-products company that filed for bankruptcy. Given all these cases, it is even possible that the SEC may bar Andersen from taking new audit clients for a time. If plaintiffs are successful, the firm may have to pay out many more millions in compensation.

Mr Berardino's defence, beyond accusing Enron of withholding information, is that the accountancy profession as a whole is at fault, and a few others as well, such as credit-rating agencies and investment bankers. The heads of the other “big-five” accountancy firms joined in: the standard setters are too slow, they said, and failed to produce adequate rules on off-balance-sheet vehicles: the financial reporting model is outdated and there should be firmer regulation and discipline, and improvements to audit effectiveness.

There is truth in this, but it remains to be seen how much change the American accounting profession will accept. At the moment, auditors are supposedly kept honest by a longstanding system of self-regulation, in which big firms conduct “peer reviews” of each others' audit practices. The Public Oversight Board, which monitors the process, lacks independence from the accounting profession, which funds and staffs it, and has little ability to punish miscreant auditors. Lynn Turner, a former chief accountant of the SEC who is now at Colorado State University, says that America would do well to adopt something like Britain's new, independent system for upholding audit standards.

The large part played by special purpose vehicles in Enron's collapse has spurred the Financial Accounting Standards Board (FASB) to revisit its rules on how to account for them. Up to now, the FASB has been chary of using the notion of control, rather than ownership, to decide on consolidation, because of its subjectiveness. That, some say, has led to a too-lenient standard. Andersen did not follow the existing rules anyway, says the FASB, which in the case of Enron's off-balance-sheet entities required consolidation.

Will auditors blow the whistle on future Enrons? The big firms argue that every recession throws up a number of corporate failures and tales of auditing mistakes: they simply pay up and wait for the next. The sheer scale of Enron's demise, though, is likely to demand some meaningful change. Last year, the oversight board's panel on audit effectiveness made some simple suggestions. It said that auditors should use forensic methods. Audit thoroughness, as well as fee generation, should feature in deciding pay and promotion. It should be the audit committee, not management, that decides whether an auditor should be allowed to carry out non-audit work over a certain value.

The worst outcome of the Enron affair, for accounting firms, would be that regulators ban them from selling consulting services to those they audit. Big firms worry that if they were left with audit alone, which for most people is a tedious task, their ability to recruit talented staff would evaporate—and they might as well hand the job to a government agency. Better audits would be the best way to assure regulators that such a ban is unnecessary.
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M Greenaway

I know what you are saying about the auditor should have spotted this, but to blame the auditor is a bit like blaming the inspector when a defective piece reaches the customer. Auditing/Inspection is never the cause of the problem and therefore should not be punished when things go wrong.
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