Auditing a company's financial statements has become more of an art than a science in our increasingly complex global economy, a blue-ribbon panel concludes in a report released by The American Assembly, a non-partisan public policy think tank affiliated with Columbia , entitled "The Future of the Accounting Profession."
"For too long we have existed in a world where financial reports have conveyed no more than a 'brittle illusion of exactitude', as The Economist so aptly phrased it in an article last year," said Roderick M. Hills, partner at Hills & Stern and former Chairman of the Securities & Exchange Commission. Hills and Russell E. Palmer, chief executive of the Palmer Group and former chief executive of Touche Ross & Co., directed a three-year project of The American Assembly to study the future of the accounting profession. The goal of the project, which was conceived long before Enron's demise, was to address the causes of those scandals and to consider suggestions for change that will help the accounting industry regain its professionalism.
The report, which is the culmination of this Assembly project, is the product of a three-day meeting held last November. More than 50 distinguished leaders from the worlds of accounting, academia, media, the law and investment banking together with a number of current and former regulators reached a consensus on changes that, if implemented, can have a dramatic and long lasting impact on the accounting profession.
Participants agreed that the accounting profession has come to rely too heavily on a maze of complex and prescriptive rules when conducting an audit when they should have relied more on their expertise and professional judgment. "Rather than alerting the public to aggressive financial statements by rejecting them outright or qualifying their opinions, independent auditors transformed themselves into rule-checkers," the report states. "If the rules were satisfied, they concluded, (too often) that the (financial) statements were fair."
To guard against a repetition of these failures and the subsequent accounting scandals, the Assembly report urges auditors -- and the investing public -- to recognize that nearly every number on a balance sheet or income statement is the result of a series of estimates, assumptions and accounting choices by managers that are reviewed only to a degree by auditors.
It is now time, the report says, for the accounting profession and independent audit committees to ensure that such judgments are reviewed by experienced professionals who are the best qualified to value complex transactions -- and to spot warning signs of malfeasance. Greater use of judgment also requires changes in the way regulators oversee the profession, and in the relationship between auditors and audit committee members, the report says. Moreover, it concludes, the investing public must accustom themselves to a new reality, one which they may find unpalatable: that the complex economy in which companies do business today makes it difficult for even the most competent of auditors to ascribe a precise value to many corporate assets or transactions. Demanding that degree of precision, the report concludes, is simply unrealistic.
The Assembly's participants' key findings include the following:
Recent accounting scandals arose out of a fierce struggle by managers to meet investors' expectations. In that struggle corporate managers, as well as the accountants, lawyers, analysts and investment bankers working alongside them, lost sight of their responsibility to present a full a fair picture of the financial statements.
On too many occasions auditors yielded to management pressure allowing the publication of misleading financial statements.
Audit committees must take meaningful control over the audit process protecting the independence of the auditors.
U.S. accounting standards should contain fewer rules and permit more judgment than those currently governing the profession.
The balance sheet of the future should be a more flexible instrument able to adapt to a wide variety of industries and circumstances.
The auditors' attestation, in which they vouch for the accuracy of financial reports, should be more flexible, with information that is more subject to individual judgment being given a more limited attestation.
As auditors are allowed and required to exercise more judgment in approving financial statements, regulators should strive to protect those auditing firms and audit partners whose work meets or exceeds top professional standards from frivolous lawsuits.
"These ideas have been expressed by others from time to time," Palmer said of the report's suggestions. "What is noteworthy, even revolutionary, about our recommendations is that the participants with their extraordinary experience reached a consensus about what is wrong with the accounting profession today, what the profession should aspire to become and the steps necessary to get there."
The accounting profession's all-too-well documented failings, coupled with the shortcomings of corporate executives, lawyers, investment bankers and others, have already taken a toll not just on the profession itself but on public confidence in the financial integrity of U.S. corporations, putting at risk the bedrock of the financial system. Lawmakers and regulators have already taken steps to increase the caliber of financial reporting and to boost oversight of the auditors themselves. But conference attendees agreed that the accounting profession cannot leave it to these bodies to rectify matters, but must also be prepared to "act quickly and decisively to reclaim and reassert its professional status" as public protectors of the integrity of financial statements. Failing to do so and ceding leadership to those regulatory bodies, the report warns, means the profession "risks becoming (no more than) a quasi-arm of government agencies."