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In defense of auditors

Scott Taub | March 29, 2016

I’ve been involved in financial reporting for over 25 years. I’ve been a regulator. I’ve done standard setting. I’ve testified at trials and in depositions and in front of Congress. I’ve consulted with companies on the most complicated transactions. But the most difficult job I had was my first one right out of college, as an auditor. And that was long before Sarbanes-Oxley and the PCAOB.

While I’m not an auditor now, I do hear a lot about auditors from the companies I work with. And they aren’t always happy with their auditor. Sometimes I agree with the complaints I hear, but even when I do, I often feel like the auditor is in a no-win situation. And I always wish that I could somehow get auditor and client on the same page. So, this column covers a few of the most common complaints about auditors, along with a few thoughts on why these things happen. The summary: Your auditors are trying to help, even if it doesn’t always sound that way.

They’re making up GAAP! I frequently hear that the auditor is taking “an extreme position” on an issue and “refuses to accept any other accounting.” Of course, the person with this complaint believes that GAAP allows at least one alternative to the auditor’s view. And it is true that, in many areas, there is more than one way to apply GAAP.

That being said, auditors don’t attempt to create rigidity where it isn’t warranted. There’s no upside for an auditor to object to its client’s accounting when it isn’t necessary to do so. So if the auditor is objecting, it’s likely that the firm understands a nuance about the way the standards work that you aren’t aware of. Or maybe the auditor is aware of a similar situation having been addressed in a particular way by the SEC.

I’m not suggesting you should accept your auditor’s position without question—I know from experience that auditors do sometimes change their view after more discussion. But at least approach the matter under the assumption that your auditor has a good reason for taking such a seemingly harsh position, and try to understand it.

They fill in principles with rules. A corollary to the last complaint comes up whenever a major new accounting standard is issued. Most recently, that would be revenue recognition. I’ve heard from practicing corporate accountants that they are concerned that the big auditing firms are going to take this nice principles-based revenue standard and ruin it by writing a bunch of rules into their manuals.

The theory seems to be that auditors want to make application of the new standard easier (for them) by mandating uniform applications that aren’t required by the standard itself. Even some people who agree with my assertion a few paragraphs back that auditors are not likely to object to a client’s accounting without a real reason still think the firms will try to get uniform interpretations published and accepted before the revenue standard is being broadly applied.

But I don’t buy the conspiracy theory here. In order to prepare financial statements, we need to know how the principles in the standard translate into real live accounting entries. And the big audit firms, by virtue of their size and expertise, are in an excellent position to provide guidance to help everybody think the issues through.

[I]f the national office, Securities and Exchange Commission, or PCAOB is espousing a particular view, there is a reason. The audit team ought to be able to explain the reason, and the company has every right to get that explanation and to have its views heard and considered.

I know first-hand how difficult it is to write about the new revenue recognition standard, as I’m currently updating my revenue recognition book for the new standard (coming later in 2016!). The desire to be clear while acknowledging the judgmental nature of some of the analyses makes it difficult. Nonetheless, the firms have done an admirable job of getting useful guidance out quickly. There’s no need to be scared or suspicious of it.

They won’t give us answers. This is another one that I hear in relation to the new revenue standard. It certainly isn’t universal, but a good number of companies seem frustrated that their auditors are not yet ready to “bless” their analysis of how the accounting for a certain matter will (or why it will not) change under the new standard. I’m sure some of this is because auditors are trying to make sure they don’t give inconsistent advice on what’s OK and what isn’t, and therefore they may hedge on answering questions until there is a “firm position” on a matter.

But that doesn’t explain the fact that the same thing happens with respect to other issues, as many companies do the sensible thing and notify their audit firm of unusual transactions as they are being discussed, hoping to get comfort on the appropriate accounting long before the books are closed. There’s no issue of setting precedent or jumping ahead of the implantation efforts when it’s just a single unusual transaction, but auditors still sometimes hedge on answering the question.

About the only advice I can give here is to make sure your auditor has everything needed to consider the transaction, and remind the audit partner that you want to get this behind you before the pressure of year-end deadlines. And, to avoid the potential of further problems, remember that your auditor still needs to actually audit the transaction, and if they find out something during the audit work that they weren’t aware of earlier, any advice they gave may no longer be valid.

They object to something they accepted last year. Everybody can cite an example where an auditor objected to an accounting treatment that the auditor had considered and accepted in prior years. Obviously, this shouldn’t happen. Of course, the problem isn’t that they’re objecting now—it’s that they didn’t object in the past. The solution is not for the auditor to knowingly accept a position they disagree with, simply because it was missed the first time. The time to consider the implications of the prior failure is after the immediate problem (getting the error corrected) has been addressed.

Similarly, companies often note that a level of documentation, analysis, or work that was enough to satisfy the auditor in the past is no longer sufficient. And it often arises late in an audit, when everybody is scrambling to finish things up so that the earnings release can proceed as scheduled. Sometimes, these changes are due to changes in business, markets, or other circumstances. But sometimes, it’s nothing more than the auditor taking a harder look or a fresh look at something.

Frustrating as it is, this is the nature of an audit. Auditors apply judgment constantly, and if that judgment suggests that more evidence is needed, the auditor should ask for it. Ideally, these requests shouldn’t come as a surprise, but that can’t always be helped. Auditors learn about their client’s transactions and business constantly, and each new piece of information can raise a new concern. It’s the auditor’s job to think about such things and to address them when they arise. The audit opinion isn’t worth much if the auditor can’t alter the planned procedures when something new comes to mind.

They don’t communicate. In any situation where my client is unhappy with their auditor, I’m likely to hear that the auditor hasn’t explained why it disagrees, isn’t done, or can’t form a conclusion. “That’s the national office’s interpretation,” “The SEC won’t like that,” or “The PCAOB is making us do more” sometimes are the only explanation the company is aware of. Unfortunately, when an auditor says this, the company basically hears “Don’t ask questions, just do it.” And to be fair, that’s pretty much what the auditor is saying, but with a little more behind it.

Presuming that the auditors understand the transaction, I think these non-explanations are really just a symptom of the audit team not wanting to spend time dealing with an issue that they believe has already been resolved when it came up elsewhere. They’re trying to put their knowledge of other situations to use in order to more efficiently address the current matter. Even if that is true, though, if the national office, Securities and Exchange Commission, or PCAOB is espousing a particular view, there is a reason. The audit team ought to be able to explain the reason, and the company has every right to get that explanation and to have its views heard and considered. As I mentioned above, I’ve certainly seen an auditor change a conclusion after weighing information about an issue.

And that’s my closing piece of advice. In almost any situation, your auditors should be, and generally are, willing to listen. Even if they sound unyielding and closed-minded, they’re probably not. Though they won’t always agree with you in the end, you should at least be able to get to a point where you believe they’ve fairly considered your point of view, suggestions, or analysis. And that’s their job—to consider whether your financial statements (and don’t forget, they are YOUR financial statements) have been prepared in accordance with GAAP.