Senate Debate Puts Audit Standards on Center Stage

The Senate is scheduled to resume discussion of the Sarbanes accounting reform bill on July 9, 2002, putting audit standards on center stage. A key issue is the extent to which audits can or should uncover major frauds.

Under current and proposed audit standards issued by the American Institute of CPAs (AICPA), auditors are not required to detect major types of frauds. But lawmakers are keenly aware that recent audits have disappointed investors by failing to detect alleged frauds. Rather than try to legislate a definitive statement of the auditor's specific duties for detecting fraud, the Sarbanes bill would shift responsibility for setting audit standards to an independent board that would also set other types of standards and discipline firms that fail to meet the standards.

According to an article published by the Wall Street Journal, there has been criticism of a proposed standard on fraud issued in February 2002 by the AICPA's Auditing Standards Board. This proposal was formulated largely in response to pressure from the Securities and Exchange Commission (SEC) that started about four years ago. ("Accounting-Overhaul Plans Draw Skepticism," July 8, 2002.) The Journal reports that critics say the current proposal falls short because:

  • It makes certain audit steps optional rather than mandatory. "A lot of it has loosey-goosey wording that doesn't say you have to do it," explains former SEC Chief Accountant Lynn Turner.

  • It provides too many loopholes that allow accounting firms' lawyers to argue that properly conducted audits can still miss fraud. Baruch College Professor Douglas Carmichael says the proposed standard "contains at least five or six paragraphs that don't do anything except explain why an audit done in accordance with accounting standards might not detect fraud."

Other professors have concluded that today's audit methodology focuses too heavily on computer programs and internal controls to catch fraud by top-level management. President Bush has indicated that he will urge Congress to pass tougher penalties for senior-level management. Even though Congress has very few weeks left in this session, the current expectation is that a bill will be passed and sent to the President for his signature by the end of the summer.

-Rosemary Schlank

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