Preventing Your Firm's 'Enron' - Part 1of 4

By Gary D. Zeune, CPA

Enron is the largest bankruptcy in U.S. history. It represented a "shock" to the system. How could a company worth $80 billion go bankrupt in less than a year? Answer: Because it lost credibility. Your personal and firm credibility is the only thing that gives your work value. You can be the most technically competent accountant around, but when people who rely on your work product (called financial statements/tax returns/etc.), don’t believe what you say, it has no value. Thus, we must do everything in our power to maintain our integrity. We will explore a number of our standard practices, which makes it appear to a jury of our peers (called 12 citizens—not accountants) that we are not ethical, nor do we have integrity.

Because of a string of high-profile frauds undetected by auditors, the SEC has instituted an independent board to oversee the profession. How did we get into this mess? How did audit work become so price sensitive? How did auditing become such a commodity that firms have resorted to non-attest work, such as consulting, to stay in business? Answer: Just because the audit has to be done, that doesn’t mean anyone thinks it’s important or valuable. That is, compliance work does not make you valuable. When was the last time a client called you up excited that you were coming out to begin the audit? How many clients do you have that would have the audit done if it weren’t required? One or two? What’s that tell you about the value your clients put on your audit?

As a result of the "Wal-Martization" of audits, our everyday practices can destroy your firm in just one failed audit. The problem is that these procedures have become habits, just like driving to work the same way every day, and thus we fail to ask if our procedures are correct or even whether we should be doing them.

Think you’re not at risk and don’t need to adopt the strategies discussed below? Consider the following scenario. Your firm does 100 audits, mostly small private companies, plus a few nonprofits and a mid-size company or two. Most are required by bank loan covenants or funding agreements for the non-profits. The economy isn’t doing well, and one of your clients gets into financial trouble near the end of the year, but it’s not significant enough to materially affect the current year’s statements, so you don’t detect your client’s deteriorating condition with traditional analytic procedures and give a clean opinion. The bank relies on your work and renews the loan. Six months later the client defaults on the bank loan and you get sued.

Sitting on the stand defending yourself and the firm, the bank’s attorney asks, "Mr. Smith, how many audits does your firm do each year?"

You answer, "Just over 100."

"Now Mr. Smith, how many audit failures did your firm have last year?"

"One, and of course that’s less than a 1 percent failure rate."

"So Mr. Smith, let’s explore that line of reasoning. Let’s say you put your family on an airline, say American, for the flight to Disney World in Orlando. The plane crashes. Your wife and three children are killed so you sue American. The CEO gets on the stand and his defense is, ‘We had 500 flights that day. Only one crashed. That’s only a 0.2 percent failure rate. I don’t know what the big deal is?’ Now Mr. Smith, would that be OK with you?"

Of course it’s not OK with you. You don’t care about the other 499 flights that didn’t crash. They aren’t important to you. The only flight that counts is the one that killed your family. Just like the bank doesn’t care about the other 99 audits you performed. You don’t win 99 to one; you lose zero to one.

There are 35,000 airplane flights every day in the U.S. Can you imagine the outrage if 350 crashed? Would that be acceptable?

Article Continues >> Avoid Procedures That Can Lead to Your ‘Enron’

© 2002 by Gary D. Zeune, CPA, is the CEO of The Pros and The Cons, 3573 Woodstone Drive, Lewis Center, OH 43035. For questions, he can be reached at 614-761-8911 or via e-mail at gzfraud@bigfoot.com.

 

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