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Lender Contracted Auditors - A Hypothesis

Jul 2nd 2008
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By Alex Vuchnich, CPA, CFE - Francine McKenna posted a recent entry on her blog that pointed out some of the flaws in the current audit model. Flaws included the usefulness and relevance of the information provided to financial statement users. It also seems to hint at the flaws around auditor independence which have been debated ad nauseum since the inception of the profession. Where as that post was largely focused on the top tier accounting firms (primarily the Big 4) it seems that there are many takeaways here for smaller firms as well. From an independence stand point I have often wondered whether in the small business attest environment if it makes sense for the banks requiring audited financial statements as part of the loan agreement to independently contract with accounting firms to perform the audit for the organization receiving the loan. I would have to guess that this idea has been considered or tried before but I was unable to identify any cases through a quick Google search. It seems like this sort of arrangement would be ideal considering that the ability to maintain independence from the financial statements would be increased. Fees would continue to be paid by the borrower, however now it would simply be done through an escrow arrangement. The lender would select the audit firm, negotiate the fee and the auditor would report the results of the engagement to the lender. A report to the company's board or management would still be part of the attestation as well. On numerous financial statement audit engagements I worked side by side with the lender's internal bank auditor. It comes across a little redundant and it points out that for the lender the audited financial statements are not fulfilling their need for relevant and useful information.

Wouldn't this type of arrangement result in both increased auditor independence and professional skepticism? Also wouldn't this better align the goals of the target end-user of the financial statements and the auditor? In a public company the audit committee serves to create this type of arrangement with the audit firm, but in many smaller organizations no audit committee will exist to serve this function. It would seem logical that lenders would want to step in to fill this void in their smaller lending customers. One tremendous benefit from this is that it would also help to alleviate some of the pressure on fees for smaller engagements. Often this pressure is the result of a few 'bad apple' professionals making unrealistically low bids on engagements to win them and then performing deficient audits. Lenders would generally be more likely to be wary of firms that came in with the lowest bid in fear that those firms would attempt to cut corners to realize higher margins exposing the bank to more risk. That in connection with market forces to keep lending rates and fees low would establish an equilibrium price for engagement fees that would be reasonable for all parties (lender, borrower and auditor).


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