Big Changes in Europe?

The European Union has created plans that would require splitting their consulting business apart from their auditing business to avoid a conflict of interest.  Also, the new plans would make audit rotation a necessity, in which one firm could not audit a company for more than six years, with a four year gap between the next time the firm could audit the same organization.  The European Union believe these measures would help audit firms maintain their independence.

In the EU, the “Big Four” firms make up about 85 percent of all audits conducted.  The EU financial service commissioner, Michael Barnier said, “We need to restore confidence in the financial statements of companies.”  The audit firms argued that the customers would be worse off, as the quality of audits would decrease.  A statement from PriceWaterhouseCoopers said that Europe would be ”at a competitive disadvantage” if these new rules were enacted.

I think Europe is on the right track with their new audit regulations.  It seems that an audit rotation really would create more independence between the audit firm and their client.  I also like the idea of splitting the consulting business from the audit business.  A firm shouldn’t be able to say how they think a business should be run, then go in and audit that same business.  Clearly they would lose independence in this case, as they would want to retain the customer and not want to make their own consulting recommendations look incorrect or inefficient.

Hopefully these plans become a reality for the EU countries.  I think it would lead to more accurate and useful audits, and better business overall.  Hopefully the US and other major countries will learn from this as well.  Europe is at the forefront of a big change in the audit world.  If it works well there, I don’t think it will be long before audit practices are changed globally.

Playing the Game

A state audit in Nebraska identified a number of benefits and services Revenue Department employees received from vendors of state lottery tickets.  The Revenue Department is responsible for the state lottery system.  The lead auditor, Mike Foley, thought the finding was significant enough that it may create a conflict of interest among the state employees. 

The Nebraska Tax Commissioner who oversees the department confirms that nothing illegal was done.  The benefits include a $1,600 dinner, $115 for lunch and a movie and a charity golf outing, in which eight employees missed a day of work to play.  The total amount of these perks from the three largest vendors was up to $7,344 in 2008, but dropped considerable to $1,004 for the 2010 year.  The tax commissioner has identified the recent decline as a conscious effort by the department to limit the benefits they receive.

The main controversy here comes down to what are standard perks that go along with this type of work.  In other words, were the employees doing anything that was out of the ordinary, or unreasonable given the nature of their jobs?  When you first read the story, you instantly think this is crazy that they get these benefits, especially those during working hours.  As I reread the article, however, I don’t think the employees or the department acted inappropriately.  The events all had sound business reasons and did not have unreasonable expenses.

The one problem I have with the benefits the employees took is that some of them took a full work day off to attend a golf outing.  The article then went on to say that six out of the eight employees in attendance did not put in extra time at work that week to make up for the missed time.  These employees should be told that it is not wrong for them to attend the event, as long as they make up the work time they miss.

PWC and KPMG Weaknesses Identified

The Public Companies Accounting Oversight Board (PCAOB) identified weaknesses with two of “The Big Four” auditing firms in its 2010 report.  Many deficiencies found were said to be significant enough to conclude that the firm did not have enough evidence to make a recommendation.  The 28 of PWC were out of 75 that were inspected by the PCAOB.  In 2009, only nine audits had the same outcome.  KPMG had 12 audits identified with weaknesses out of a potential 54, up from eight in 2009. 

Most of the problems found were testing of fair value, revenue and receivable testing and testing of goodwill and other intangibles.  The PCAOB will only release part of the report, while the rest will remain confidential.  The firms will then have one year to address all of the issues before they are made public.

This is a similar situation to another blog entry I wrote earlier this month.  In that instance, Deloitte was the firm being investigated.  This article is different in it identifies two firms, both which have numerous deficiencies presented.  PWC and KPMG provide services to thousands of clients each, so this sample size may be skewed in favor of the PCOB.  It is also not necessarily a bad thing that these were brought to the firms’ attention.  A good firm will look at what was presented to them and make the necessary adjustments.

Often times, I think the large public firms think they need to present a positive audit outcome to the managers of their clients.  They think retaining customers is their biggest challenge, and audit leaders risk losing their jobs if they can’t retain clients.  This is a flawed perception, though.  Auditors should act professionally, so others looking for information are able to find it accurate and reliable.

I believe the audit world will change considerably in the near future.  I believe there will be some kind of regular rotation (yearly possibly), so no audit manager feels as though they need to “please” the organization they happen to be auditing.  I certainly hope this is something that is addresses with more of these cases being presented.  For now, the PCAOB is doing as well as it can to make sure audit firms are acting appropriately, and doing the work as well as they can.

Overtime on the Metro-North

 New York State Comptroller Thomas DiNapoli said Metro-North Railroad workers received over $1 Million in overtime payments by abusing work rules in 2010.  Supervisors gave workers overtime for working nights and weekends, when most work occurs.  The long hours required employees to take a 10 hour rest period, which cut into most of the next work day, which employees got paid for.

Supervisors intentionally used the system to their advantage.  They would award themselves overtime, and took the same rests as their assistants, which they are not scheduled for.  The Comptroller’s Office declared this activity as fraudulent, but the railroad disputed.  The Metro-North President, Howard  Permut , argued the findings, saying that they were looking into controlling the overtime.  He also said it is hard to change the way overtime is earned, with Federal rules and a strong labor union. 

Pension payments were driven up by the overtime worked.  Employees working in their last years would use the overtime to get a higher pension.  Overtime payments from the audit were estimated to have a value of $5.5 million impact for pensions of six employees.  One employee said, “"If I had to name the top five jobs in the country, this would have to be, hands down, number one."

This finding from the State Comptroller’s Office seems to be quite significant.  I think this is clearly the supervisors using the system to their advantage.  They found a loophole in the system and weren’t afraid to use it, as it wasn’t “illegal”.  I think it is the responsibility of the internal auditors in combination with other finance members to identify this weakness in the system.  There should have been controls in place to identify the overtime paid, and a recommendation by these employees to implement a system that allocated overtime based on times most workers did not work historically.

I find it interesting that the President defended his employees in this article, rather that looking out for the tax payers and other employees not earning overtime.  It will be interesting to see if any other developments come from this audit.

Trouble at Deloitte

A 2008 report from the Public Company Accounting Oversight Board revealed that Deloitte had deficiencies in their work to the effect of the possibility that “important issues may exist”.  The main concerns were auditors not performing their work thoroughly and they were not skeptical enough.  The PCAOB reviews companies’ audit performance and compliance with rules and regulations.  This is the first time a Big Four firm has received such a warning from the board.  The main issues with Deloitte were auditors were too willing to take management at their word and didn’t question management when they should have.

Auditors must go into an audit with the idea that there is a problem, and verify that they are wrong.  This is known as professional skepticism, and is a characteristic that defines auditors.

We had talked in the Internal and Performance Auditing class about Auditors who may not report a significant issue, as long as they retain the client.  For some auditors, one large company may be their only client.  The manager needs to retain this client to keep their position, and they fear if they upset the client, they will hire another firm.  This happened to be the case in the scandals and subsequent bankruptcy of WorldCom, Tyco and Enron.  Auditors need to understand the importance of their work, and act with professional care to verify their work.  This is easier said than done, however.  With the pressure of an auditor’s career on the line, and the opportunity to give the “all clear”, it is no wonder these types of issues occur.

Solutions to these problems are difficult to identify.  We currently do not have a system in place to prevent audit firms from lying when they know there are risks or misleading information present.