Black Friday, Black Accounting, White Christmas

Pic credit – Huffington Post

[Black Friday]  Black Friday–so named due to crowded stores, crowded roadways and bad shopping behavior–is today in the United States.  It gets bad out there, as described in this Huffington post article, “9 Reasons To Stay Home On Black Friday (And Forget The Damn HDTV).”

Why do so many shoppers love Black Friday?  They think they are being served by stores offering unbelievable deals, incredulous sales and stocked shelves.

But are they being served? Stores have an inclination to raise prices because of increased quantity demanded (remember your lessons from Econ 101?).  They offer an occasional bargain against as stark environment.  Shoppers rush in to fight against each other to grab an over-hyped bargain.  There is no excuse for bad shopping behavior, but in truth the retail industry promotes it.

A popular shopping day for many decades, the Christmas shopping period now has expanded over to Black Friday eve, Black Friday week, pre-Black Friday week, and even Black November.

The shopping day was originally named Black Friday by Philadelphia police in the 1960s because it was such a horrible time of year to be serving the public. But the retail industry doesn’t care, it really is there to serve itself.  It’s all about money.  And money always brings out the black in business.

There are many parallels between Black Friday and Black Accounting.

Auditing firms arose in the United States in the early 1900s. The country was expanding and so was business.  Against the context of unregulated financial markets, audit firms sold their services–an independent opinion –as value added.  The investing public trusted these opinions and directed their capital to companies offering assurance about the reliability of the corporate financial statements.

The name of the game was independence, and audit firms were mostly independent.

But conditions changed when the federal government mandated that publicly traded companies had to purchase an audit opinion for their financial statements.  The government did this in an attempt to serve the public as a means to trust financial statements. In reality, if honest audit opinions were for sale then shopping investors would rush to the stores to purchase them.

How did the large audit firms respond?  Not by serving the investing public.  Big audit was there to promote sky high prices, reduced costs (difficulty in suing audit firms for negligence), and barriers to entry (state licensure).  And of course, audit firms always promote their services as independent when they are anything but independent.

This year, large audit firms are so completely in control of their line of business that they have defeated regulatory efforts to instill a minimum degree of independence.  What are these efforts?  Forced auditor rotation and a prohibition against consulting services.  In reality, there can be no auditor independence when the audit firm is a business partner of the audited company.  That is why this season we are afflicted with Black Accounting.

Against this bleak reality, I continue to hope for a White Christmas.  I want to bury the blackness.  As an investor, I hunger for honest financial statements, or at least financial statements with an honest audit opinion.

Dare I check my hung stocking on Christmas Eve?

Debit and credit – – David Albrecht

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Congress Passes Bill About Accounting/Auditing

Congress in session as it passes ‘No Forced Auditor Rotation’ act.

I just received word that the U.S. House of Representatives (Congress) has passed a bill banning mandatory auditor rotation.  Before you start to think that perhaps Congress has done something great and wonderful, a few words of wisdom should be remembered.  I’m posting some of the more accurate descriptions of Congress penned throughout the centuries:

• Suppose you were an idiot, and suppose you were a member of Congress; but I repeat myself. –Mark Twain
• You can lead a man to Congress, but you can’t make him think. –Milton Berle
• We have the power to do any damn fool thing we want to do, and we seem to do it about every ten minutes.” –J. William Fulbright
• There is no distinctly American criminal class – except Congress.
  –Mark Twain
• Being elected to Congress is regarded as being sent on a looting raid for one’s friends. –George Will
• There is more selfishness and less principle among members of Congress than I had any conception of, before I became President of the U.S. –James K. Polk
• When buying and selling are controlled by legislation, the first things to be bought and sold are legislators. –P.J. O’Rourke
• With Congress, every time they make a joke it’s a law, and every time they make a law it’s a joke. –Will Rogers
• I don’t mind what Congress does, as long as they don’t do it in the streets and frighten the horses. –Victor Hugo
• I have come to the conclusion that one useless man is called a disgrace, that two are called a law firm, and that three or more become a congress. –Peter Stone
• This country has come to feel the same when Congress is in session as when the baby gets hold of a hammer.
  –Will Rogers

My generation uses a rhetorical question whenever we spot something particularly loony, “What were you smoking?”  Well, Congress, what were you smoking when you banned auditor rotation?

Debit and credit – – David Albrecht

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No Fireworks For Me On This Independence Day

[July 4, Bowling Green, OH] The July 4th holiday used to be known as Independence Day. Ever since I became an accountant, on this day I’ve been celebrating the notion of auditor independence from the corporations for which they are hired to provide an opinion on the financial statements.  Every time a rocket would explode into a flash of color, I’d say, “Hooray for auditor independence!” (OK, I’m a bit weird.) But no more.

This Independence Day, I’m reflecting on the lack of independence between large CPA firms and the corporations that employ them.  And I’m mourning.

More than ever, CPA firms view themselves as a company’s partner.  All of the largest firms are creating huge consulting arms that are to provide billable services to their audit clients.  But problems with audits and opinions have led to world-wide calls for increased regulation of the largest firms.  I guess investors and auditors don’t see it the same way.

This July 4 there is no independence for CPAs.

The auditing profession sees this as a good thing.  I don’t.

Debit and credit – – David Albrecht

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Followup to the Spanish Non Sequitur

Earlier this month I wrote, “Spanish Non Sequitur.”  Non sequitur is Latin for, “it does not follow.”

As is commonly reported, Spain is experiencing a sovereign debt crisis.  Sovereign debt is when a government borrows to finance spending in excess of tax collections.  A sovereign debt crisis comes about when said government cannot make timely payments to those from whom it has borrowed.

As Spanish banks have invested in Spanish sovereign debt, and Spanish banks are still not fully recovered from the financial crisis of the past few years, it is widely thought that many are in extreme financial distress.  How much financial distress is unknown, because it is widely thought that Spanish banks have been less than candid when issuing financial statements.

Earlier this month I wrote about a Spanish government announcement (actually, an authorized leak) about the first two parts of a three part plan to deal with the sovereign debt crisis.  First, two consultants had been hired to evaluate how close to insolvency are the banks.  Second, all of the Big 4 audit firms had been hired to perform audits to clean up the bank financial statements so that the government would have accurate information.  The third part of the plan was unveiled a few days later when Spain appealed for a large bailout to pay off debt about to come due.

The second part of the plan is a non sequitur because the large audit firms are part of the problem.  Previously, they had issued clean audit opinions for bank financial statements that didn’t deserve them.  There is no way for government officials to know for certain that the information provided this time by the audit firms is any better than their earlier audit opinions.  Unless, of course, the audit firms have been threatened with a return of the Spanish inquisition.

Earlier today two conflicting reports have appeared in the press.  First, David Roman of The Wall Street Journal writes in, “Spain Delays Full Bank Audit Amid Rise in Yields,“ that, “The deadline for a group of auditors to present full reports on the capital needs of Spain’s financial sector has been postponed to September from July 31, a person close to the situation said Tuesday.”

Second, a Reuters report says,

A [Big 4] detailed audit of Spanish banks will remain on schedule and release its findings on July 31, a spokesman for Spain’s economy ministry said on Tuesday, denying an early report the assessment would be pushed back to September.

“There won’t be any delay in completing the audit of Spain’s banks,” the spokesman said.

Earlier, a source at the Bank of Spain had told Reuters the second audit would be delayed to September to give organizers more time to gather information on each bank’s loan books.

I don’t know for sure what is happening in Spain, because insufficient disclosures have been made public.  Therefore everything I say is a guess.  However, I think it is the most interesting development in years to arise in the accounting/auditing world.

Debit and credit – – David Albrecht

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Spanish Non Sequitur

In other parts of the world, large accounting firms took heat for giving clean audit opinions to banks that were floundering or dying.  In Spain, though …

Julien Toyer (Reuters) reports in a news brief (published on IBNLive and Yahoo Finance) Spain’s government is hiring all of the Big 4 audit firms to conduct a review of distressed Spanish Banks:

MADRID (Reuters) – Spain has picked the ‘Big Four’ accounting firms KPMG, PwC, Deloitte and Ernst & Young to carry a full, individual audit of its ailing banks, a source with knowledge of the decision told Reuters on Saturday. The review, which should take a few months, will complement an ongoing exercise to stress test Spains banking sector by consultors Oliver Wyman and Roland Berger, whose first results are expected around mid-June. ‘I can confirm (the names),’ the source said.

Mr. Toyer said that the source did not specify from which country the auditors would come.  ABC.es reports that the audit reports are due by July 31.

I wonder if the eventual reports to the Spanish government will differ from previously issued audit opinions.

Debit and credit – – David Albrecht

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10 Years Later – Did Andersen Die in Vain?

On Wednesday, March 14, 2012 (10th year anniversary of audit firm Arthur Andersen’s felony charges), the Chicago Tribune published an editorial titled, “Andersen Died in Vain.”  As is the way with all editorials, what followed is the editor’s opinion.

Take heed, the Chicago Tribune and its editor are wrong on this. The Arthur Andersen audit firm didn’t die to accomplish a great purpose, or to make the world a better place.  It died because it couldn’t survive its punishment.  And if anyone or anything has ever deserved punishment, it was Andersen.

Arthur Andersen’s death was not intended to prevent defrauded investors from being  victimized in the future.  The death was intended to prevent Andersen from doing it again.  And in that Andersen’s punishment has been successful.  Its death was not in vain.

In the editorial, the  Chicago Tribune does a fairly decent job of summarizing the history surrounding Andersen’s demise:

In the beginning, Andersen was a watchdog. Founder Arthur Andersen made the firm’s name stand for something nearly a century ago, when he refused a client’s demand to approve a ledger that falsely inflated profits. For decades thereafter, an auditing opinion from Andersen was the gold standard for corporate books and records. If Andersen said the numbers were solid, then investors, bankers, regulators and the public at large could count on it.

Over time, greed corrupted Andersen. Its leaders became more devoted to collecting hefty fees than keeping books straight. Clients paid a fortune for Andersen’s consulting services, making its basic function of auditing into little more than an afterthought. The firm’s most experienced accounting technicians, the sticklers who maintained its principles, saw their status plunge in the partnership’s hierarchy. As Enron ran wild, Andersen’s Professional Standards Group proved too weak to intervene. Money had trumped honest services.

Enron’s executives were able to lie about their business performance and prospects because Andersen went along. When the lies caught up with its client, instead of admitting its failure to safeguard the public trust, Andersen engaged in a cover-up. Its employees shredded not just a few Enron-related documents, but box after box, day after day, for a period of weeks.

The Enron debacle followed a series of debacles at Andersen, which had bungled audits atWaste Management Inc.and Colonial Realty Co., to name but two prior scandals that cost investors dearly. Prosecutors who previously had stopped short of bringing charges against Andersen came to believe that its leaders considered civil penalties and promises of reform to be mere speed bumps on the road to ever-greater profits.

A decade ago this month, Andersen’s brass arrived in Washington for Enron-related settlement talks — myopic, arrogant and devoid of remorse. Justice Department officials concluded that the repeat offenders across the table would offend again if they weren’t stopped.

If anything, the Tribune is underplaying the wrongdoing.  Andersen was dirty, very dirty.  Charged with protecting the public interest, Andersen instead unzipped its pants and metaphorically peed all over it.  There ought to be a law.  Shouldn’t justice prevail in the end?  In this case it did.

The Tribune goes on to say,

Did Andersen’s demise serve the public interest? No.

There were thousands of innocent victims, the out-of-work employees.  … [The resulting] Sarbanes-Oxley legislation … has proven to create problems, substantially raising compliance costs for law-abiding public companies, which pay more now in audit fees to Andersen’s onetime competitors.

The greatest tragedy of Andersen’s fall? It fell for nothing. What a loss for Chicago, and what a disservice to all those like Arthur Andersen himself who never would sell their integrity, at any price.

The world is worse off because Arthur Andersen and the other largest audit firms forsook their duty to investors and the American public.  If Arthur Andersen had been doing the right thing in the decades preceding its death, perhaps I wouldn’t have lost much of my life’s savings in 2001-2002.

Andersen deserved its punishment.  I shed no tears for it.  Its death was not a tragedy.  Its forsaking the public trust was the tragedy.  There ought to be a special place for those who violate the public trust.

Andersen’s death means only that it was not allowed to continue making the world a worse place.  A positive from its death is that there have been no Andersen audit failures since 2002.

The Chicago Tribune errs in labeling Andersen employees as victims.  The employees were part of a seedy culture, and it was the culture that supported the actions which merited the punishment.  The employees could have left.  If anything, Andersen principals should have been banned from ever serving American capital markets as corporate officers or auditors.

The death of the Arthur Andersen audit firm marks the end of a sad chapter in American history.

Debit and credit –  – David Albrecht

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Ernst & Young Data Breach at Regions Bank

This tears me up, it absolutely rips me.   Ernst & Young lost extremely sensitive data while auditing Regions Bank (15th largsst). I consider this a significant data breach.

Unless you subscribe to the Birmingham News, you probably missed this.   Russell Hubbard reports on January 31, 2012, that, “Regions Says Employee 401k Data Lost When Auditor Ernst & Young Mailed Flash Drive and Code Key Together.”  Info Security Magazine provides additional information.

Ernst & Young mailed the data from one of its offices to another.  The envelope contained an encypted flash drive with employee personal identity and 401K data, and a sheet of paper containing the decryption key.  During transit the envelope was ripped open.  At the destination, the flash drive was gone, but the decryption key remained.

There are three documents that ProfAlbrecht is trying to obtain:  (1) letter from Ernst & Young to Regions Bank explaining the incident, (2) letter from Regions Bank to its to its employees explaining the incident, (3) letter from Ernst & Young to employees.

Hubbard reports that Ernst & Young regrets any inconvenience and concern that Regions employees might experience.   Both Hubbard and Info Security Magazine quote one of the Ernst & Young letters as saying, “… we deeply regret that this incident occurred,”

EY regrets that the incident’s consequences but not having caused the incident.  I strongly dislike such non-apologetic apologies.

Regions has a reputation for lock-down tight data security.  Unfortunately, Ernst & Young doesn’t.

I wonder if Ernst & Young will get fired over this incident.

I’ll report more on this in the future.

Debit and credit – – David

David Albrecht

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CAQ Releases Second Cartoon

The Center for Audit Quality (CAQ), a special interest group that lobbies for and promotes the audit industry, has issued a second video, “The Financial Statement Audit.”

These videos are appropriate for high school and college students taking introduction to financial accounting, who desire to learn a few simple basics about what auditors do.

As you would expect, the videos provide no discussion of how the audit profession is attempting to deal with the many intractable problems limiting auditor effectiveness.  In the videos, auditors are vigilant servants of the public interest who never fail.

The first video in the series was called, “The System of Investor Protection.”

Thanks to Bob Jensen for the tip.

Debit and credit – – David Albrecht

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Nomadic Accountants

The EU and the United States are considering mandatory auditor rotation.  Some have opined that this will lead to nomadic accountants, auditors who move every five years in search of green fields of audit clients to graze upon.

Bob Jensen (Trinity University retired professor) is a prolific web surfer who posts his finds on AECM, the e-mail listserv for accounting professors.  His finds relate mostly to accounting.

Jensen has occasionally wondered about lifestyle issues for auditors forced into a nomadic life.  Today he suggests that housing issues can be solved by building a Mongolian Ger (call a Yert in Russian).  The following Dan Grossman video shows how a Ger can be built in about one hour.

But what about the inside?  Could it possibly be spacious enough for the 21st century auditor and all his/her toys?

However, we all know that large firm auditors stay in luxury hotel accomodations:

Lowell Hotel, NYC

I ask my auditor readers.  Where would you rather live, Ger or luxury hotel room?

Debit and credit – – David Albrecht

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Sen. Levin Supports PCAOB Proposal

Potty Mouth Carl Levin (Senator and Chair of Senate Permanent Subcommittee on Investigations), famous for his “sh*tty deal” comments to Goldman Sachs executives, has sent a letter (Jan. 3, 2012) to the PCAOB in support of a proposal to require that the lead partner’s name be disclosed (with signature) within the audit opinion attached to annual corporate annual financial statements and listed in an audit firm’s annual report to the PCAOB.

Levin prefaces his support with the following statement,

Poor quality audits of public corporations continue to plague the U.S. investment community, allowing misleading accounting, outright frauds, and substantial losses to occur … These prominent audit failures indicate that more needs to be done to encourage accurate and effective audits of public corporations and increase accountability for poor auditing practices.

Well said, Senator Levin.  It is not only bloggers that note the poor quality of large audit firm audits of large publicly traded corporations, it is also key members of governmental oversight.  The only people who don’t agree are the leaders and partners of the large audit firms that provide the poor quality audits.  They state that audit quality is fine, and nothing should be done that could negatively affect it (such as naming the lead audit partner or mandating auditor rotation).

Levin notes five reasons for supporting that the lead auditor’s name be disclosed:

1. It would increase audit quality.  Lead auditors would now perceive that they are more accountable for their work, and would strive to avoid generating poor audit opinions.
2. It would strengthen audit transparency by shedding light on the audit process and key communicators.  It would make it possible for the public to evaluate senior audit officials.
3. It would strengthen partner and audit firm accountability for audit failures.  This would signal regulatory intent that both firm and partner are to be held accountable.
4. It would increase auditor independence by making it possible to identify when changes in key personnel are made.
5. Key corporate officers now must sign public reports and disclosures.  This proposal would increase auditor accountability so that it would be in line with other financial professionals.

Senator Levin, I think you have done an excellent job in reasoning through a controversial issue.

Thanks to Caleb Newquist of Going Concern for the tip.

Debit and credit –  – David Albrecht

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The Wrong Quality

Let's put the focus on the correct quality

The PCAOB is receiving comments on its proposal to require auditor rotation.  Most of the comments are against auditor rotation.  Written by corporate executives, CFOs, audit committees and auditors, the claim is made that a change in auditor will result in lower quality audits for at least three years.

Three years is selected because it is alleged that it will take at least that long for a new audit firm to get up to speed (that’s an insult to the successor audit firm).  And, if the company had previously employed the best auditor, then being forced to change auditor will result in a permanent decrease in audit quality.

As a small investor, I am insulted.  The issue is not about audit quality.  It is about the quality of the audit opinion.  It is almost a certainty that in most cases, a change in auditor will result in a higher quality opinion.  At least, it it won’t produce a lower quality opinion.

How is that?  Currently, the large audit firms that audit the largest public companies have little credibility to produce believable, trustworthy and valuable audit opinions.  A sizable number of investors don’t even read the opinion, passing over it because so many audit scandals have destroyed faith in the auditor.  And many more investors find the audit opinion to have hardly any information content, and hence, hardly any value.

I would expect a large audit firm to produce a high quality audit.  Let’s say that the fee for a large audit totals $40 million USD.  If 80% is spent on labor and related expenses, then I would hope that $32 million USD would be sufficient to test everything that needs to be tested.

However, in today’s world of big audit, there is frequently a disconnect between data from the audit and the opinion that is eventually rendered.

And audit opinion quality has too often sucked.  Big time.  How could it get any worse?

That’s what auditor rotation is all about.  And if big audit and big business are successful in beating down this reform movement in all its symbolic glory, then big audit and big business will have won a battle but lost the war.  It is a significant possibility that defeating investors on this issue will drive them permanently from the market.  Then we all will be losers.

Debit and credit – – David Albrecht

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Miscellany

Miscellany — interesting items that caught my eye during the week.

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Tom Selling (The Accounting Onion) writes about folk hero judge Jed Rakoff in, “Is the Judiciary about to Give the SEC a Backbone?” Some day I’m gonna be like Jed.

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Jim Peterson of re:Balance talks about how a relatively small judgment could potentially lead to the demise of a Big 4 firm in, “The Big Four Accounting Firms’ Financial Tipping Point — Time for a Fresh Look.”

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Francine McKenna (re:TheAuditors) discusses how Deloitte is pretty bad off, in “At Deloitte, More Pain Before Any Quality Gain.” What a mess over there.

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Lisa Du of the Embargo Zone blog writes about the information sifting habits of the New York Times’ Andrew Ross Sorkin in, “Andrew Ross Sorkin Reveals What He Reads At The Gym And His Favorite Twitter Account.”

Sorkin and I are a lot alike.  He’s young, famous, rich, smart and good looking.  I’m not.

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Search engines give biased results to your queries?  You betcha.  Please watch this video filmed by Mark Schaefer of {Grow}.  Helen Brown talks about Google’s filter bubbles and how to minimize the effect.

Schaefer consistently publishes must read content at {Grow}. Subscribe today.

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Debit and credit — David Albrecht

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