‘Did They Fix the Root Cause? No’
Don A. Moore, an assistant professor at the Graduate School of Industrial Administration at Carnegie Mellon University, argues that not only do auditors favor their clients, they’re not aware that they are doing so. So the main source of bad audits isn’t fraud and intentional corruption, but unconscious bias. Because accountants are paid by the companies they audit and can be fired for issuing unfavorable opinions few accountants are willing to bite the hand that feeds them, Moore argued in an article he co-wrote for the Harvard Business Review: “Why Good Accountants Do Bad Audits.”
Kate Berry
Question: You seem to be arguing that accountants aren’t necessarily corrupt, but the system is.
Answer: That’s right. I don’t think accountants think they’re corrupt. Most accountants are honest people who try to do the best at their jobs and, like most people, they resist the idea that psychological and monetary pressures influence their decisions. But the fact is that auditors can’t say they are truly independent, which is a cornerstone of their profession. We need far greater changes in the way they do business for that to be true.
Q: What are some ways in which accountants can run into trouble?
A: One of the common problems involves how a company books revenue. If you sell something and the consumer says the check is in the mail or they’ll pay in installments, when does a company count receiving the revenue? It might be in the interest of shareholders to know the truth about when the money is coming in. But most companies are run by managers who have interests that are very different from shareholders. They want to pump up their performance to get a bonus or so shareholders will continue to employ them.
Q: Of all the accounting scandals of the past four years, which was the biggest shock?
A: WorldCom was a jaw-dropper. The financial restatement for WorldCom was between $9 billion and $11 billion, which is just enormous. And the single biggest issue was the misclassification of expenditures as capital investments. That is, instead of counting salaries as a one-time expense, they counted everything as a capital investment. It’s tough to understand how their auditor (now-defunct Arthur Andersen) signed off on that.
Q: Did the Sarbanes-Oxley legislation go far enough?
A: Sarbanes-Oxley introduced some good changes, including making it harder for accounting firms to consult for clients they are auditing. More than that was the series of high-profile scandals and the demise of Arthur Andersen that was quite sobering for the accounting profession. The remaining Big 4 firms were completely aware of the fact that they were doing the same things and were vulnerable to the exact same outcome. Did they fix the root cause? No. They’ve continued to protect the industry.
Q: What solutions do you propose for the long term?
A: The structure of the auditing system virtually ensures biased audits. There needs to be incentives to make full disclosure in the best interests of both the auditor and the client. Auditors should have fixed and limited contracts with all fees specified up front. Also, the client should be prohibited from rehiring the same firm again, which would allow for rotation among the major firms. There should also be a provision to prevent clients from firing an auditor.
Q: How much resistance is there to further reform?
A: The accounting firms have tried to mitigate the laws and have stymied reforms. They have fought tooth and nail against all sorts of reasonable reforms. They have strenuously resisted any change in the way they do business, even though the very foundation is corrupt. In most companies, auditors are hired or fired by management not by the board of directors. The managers want to hire auditors that are helpful.
Q: In the end, is audit work more art than science?
A: If auditing were simple mathematics and all you had to do was plug in the right numbers, it wouldn’t be a profession that paid very well. There are all sorts of complex accounting rules that require interpretation and that’s why there are so many ways to err.
