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

by Gary Zeune, CPA

Continued from Preventing Your Firm's 'Enron' - Part 3

11. Understand the clients’ business: So you think you know your favorite client’s business? Then write down the top three reasons your clients’ customers buy from your client instead of a competitor.
1. __________________________
2. __________________________
3. __________________________
If you can’t name the three reasons, you don’t understand the client’s business and you’re auditing in a vacuum. Only if you understand the client’s business can you fill in the blanks of what’s NOT there. For example, in the ZZZZ Best Carpet Cleaning fraud, the auditors accepted the client’s representation that one insurance job would require 300,000 square feet of carpet to restore the top four floors of the Capitol Bank building in Sacramento. The plaintiff ’s attorney showed 300,000 square feet would have carpeted a 60- to 80-story building. The numbers multiplied out so they must be OK? WRONG.

12. Risks: Paragraph 26 of SAS 82 says, "The risk of fraud is ALWAYS present to some degree." (Emphasis added.) So don’t design the audit program or begin the fieldwork until you read the AICPA current year’s audit risk alert for your client’s industry.

13. Unreasonable Compensation: The CEO of ZZZZ Best paid employees more than they could ever earn anywhere else and never let them forget it. California Micro Devices demoted CFO Steven Henke to Treasurer —but gave him a pay raise when auditors found significant cutoff problems. Make sure you understand the behavior the compensation system drives. If a significant portion (30 percent or more) of an employees pay is incentive based, make certain there are proper controls over the measurement system that drives the pay calculation. It’s not just how much, but WHY is the pay that much.

14. Attention: Be aware of someone who can’t stand NOT being the center of attention. This is way beyond liking to be the center of attention. We all like to be the center of attention. Barry Minkow, CEO of ZZZZ Best, started the company so he could get a date in high school.

15. The Hockey Stick: When suing you for a failed audit, every plaintiff’s attorney knows about the "Hockey Stick" data pattern. It occurs when business people are desperate to "make the numbers. The Hockey Stick pattern is a graph of "normal" sales versus "current year sales" (the variance often looks like a hockey stick). It is the graph the attorney will show the jury, with a comment such as, "Even a blind man can see it makes no sense." Do you know the sales pattern for each of your clients, so you can recognize when it doesn’t look right?

16. Qualify clients: Have you ever asked yourself why clients want you to do the work, when you don’t have a client in this particular industry? Has it ever occurred to you that the client hires your firm because you are the easiest one to fool? How will that sound on the witness stand? Especially if you had the low bid for the work and so maybe minimized the hours so you wouldn’t lose your shirt on the first year’s work.

17. Ethics: Hold up your hand if you think you’re an ethical accountant. Do you prepare or review your clients’ tax returns? Do you have any clients that treat the company like their own personal piggy bank? YOU DO? Now there’s a surprise. So why do you overlook the personal expenses on the company return? Because they are small, insignificant? Just because the deductions are insignificant, they are still illegal. If deductions are illegal, by definition they are unethical. By being associated with such returns you can’t say it’s not OK the client cheats on their tax return. So what do you say when the attorney asks how big the tax fraud has to be before it’s not OK with you? The attorney has backed you into a corner because there’s no right answer that will get you out of trouble. Taking or allowing small illegal deductions is not OK.

Protect Yourself

For most of us, independence isn’t the complicated stuff in the Enron-type cases. It’s the easy stuff discussed above. Don’t make it easy for plaintiffs’ attorneys to sue you and win. Don’t look stupid. Stop thinking you’re protected just because you put check marks in all the right little boxes. GAAP and GAAS don’t have the weight of law. Juries can do anything they want. Do you REALLY want to take the risk? Is it worth the risk?

© 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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