Offering Up Monopoly Status

Earlier this week, the CPA Technology Advisor reported on Intuit’s fall 2010 release of its forecasted trends for the profession. Forgetting for a moment that the report fails to break any new ground and to this reader, at least the summary reflects work performed and summarized by the AICPA in its Vision Project, the blogosphere including the redundant Twitter posts repeated the future is changing mantra. Also ignore the fact that projecting the future is akin to Astrology, people appear to enjoy contemplating what our profession may be like 20, 30, 50 years into the future.

If Intuit wants to support research about the future of the profession, I suggest they start with considering the Elephant in the middle of our proverbial room. The Monopoly status of Auditing and Attest work. This isn’t a new VeraSage idea as my my colleague Ron Baker has certainly advocated a true free market in ideas and services. But with the Intuit’s influence at gaining attention – who better then to ponder the more significant questions of our era?

What really is the value of the Monopoly? Common knee-jerk responses include the proverbial and menticidal response of protecting the public. Well Enron, WorldCom, and Madoff all had audits and look how the public was so protected by those audits. Audits have value, but they lack any predictability about the future. This lack is endemic in what an audit is…..that being an historical report about the past. These historical financial core financial statements (balance sheet, income statement, and statement of cash flows) are like the 3 Blind Mice – in that they see, hear, and say nothing of importance. Like the review mirror on my car, these statements have the value of looking behind, but my dashboard and windshield help me avoid danger and illuminate where I am headed.

We should give up the Audit Monopoly. There, I said it. We should give it up so that competition from outside will help raise the innovation of services, reports, opinions, and opportunities for suppliers and users alike. Businesses, bankers, regulators, stock markets, bonding agencies, etc. would be free to perform their own attest services, direct the standards of services they deem fit for their uses, and be open to alternatives to the current one-size-audit approach we have today.

For example, auditors that are driven by creativity and customer-focused information, might provide opinions that read like movie reviews where they render commentary about the qualitative measures of management, assumptions, and valuations. These audits would replace mere checklist driven drones with knowledge worker judgements. And ultimately as users of financial statements, wouldn’t it be an improvement to have the auditor report on the qualitative metrics of an enterprise. For example – if the auditor believes that although management is compliant with GAAP regarding inventory reserves, the auditor might also stress that management’s reserve analysis is soft and subject to being wrong for the following reasons.

Other innovations lacking in today’s reports include reporting what materiality means in the context of the audit. Although the current standards do not prevent disclosing the materiality level used, Auditors I mention this concept to vehemently fight back that 1) their malpractice insurance wouldn’t allow it (probably BS – but we’ll ignore that for a moment) , 2) no one does it (so lack of innovation is rampant), and 3) they believe that expressing a definite value would be both informing management the threshold and therefore management would create fraudulent transactions below the materiality threshold, create a litigation risk for attack on the value, and that users would be confused by the value and therefore believe the financials are less valuable since there would a known swag amount.

The auditor fears are just that. Fear. As the character Frank Burns from M*A*S*H once said to Hawkeye Pearce , “there is nothing in the dark that isn’t in the light”, it is time for auditors to move into the light of the world. If an auditor believes that management isn’t already aware of materiality games, then they clearly underestimate the intelligence of their customers. Never underestimate the intelligence of an entrepreneur as they generally earn more money then auditors and they change the world. Additionally, if an auditor believes that management will create transactions to avoid detection based upon knowing the materiality threshold, then isn’t that a leading indicator of poor customer selection? I mean, come on, if an auditor believes that with an expressed materiality threshold, then they should believe it with a silent level and hence are carrying a risk that, like Enron, could destroy the firm. Auditors that continue to service customers that are that risky are like street prostitutes that prove bare-back services. Risky death for the exchange of money. Auditors should be better then this.

Regarding litigation threats because of a stated materiality level. The litigation threat exists already. And, wouldn’t it be a superior defense to state that the user of the financial statement had clear knowledge about the swag values and relevant ranges of values then the current structure where the materiality level is hidden. Users today may not know what that value is and may make their own guess and act accordingly. When results are bad (e.g. stock prices fall or company files for liquidation) – then the auditor is now going to defend the value chosen. The value will be disclosed in court anyway – and attacked by an opposing expert with the benefit of hindsight. Audit litigation risk is important so why not figure out a way to lower the exposure and hiding behind a report with qualitative language without expressing some form of basis is always dangerous.

Regarding the malpractice related issue, again I think this is hyperbole. The provisions of malpractice relate to risk management and malpractice carriers know that better communication and customer service leads to lower risks. And malpractice carriers aren’t in the auditing business, they simply defend the results and work product of its insureds.

All of the above examples of innovations and barriers to their implementation can be linked to the continued practice of protecting the Profession from the Public. The Public rarely, if ever, seeks protection from their auditor. It is usually the other way around. The various Boards of Accountancy and other regulators propagate a cycle of isolationism, self-preservation, and barriers to entry. All of these are anti-public service. More choice leads ultimately to lower pricing, service options, and innovations. There will always be bad audits and poor services. There will be blood spilled and money lost. These costs would be worthwhile as the value of innovation and freedom is always worth the price of some pain and suffering.

Back to Intuit and forecasting the future. Low hanging fruit discussions that lack a true conversation about how best to move the profession fail to be of true value. Failure by the Profession to head the true changes occurring in our global economy will ultimately set the Profession to drift toward the role of the Scribe – valued in its day but where are they today? Nowhere and that is where we will be if we avoid one of the Bull Elephants in the middle of our room.

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