Auditing: A Profession at Risk

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Auditing plays a unique role in our economy. By law, all companies whose securities are available to the general public through U.S. exchanges are required to have their financial statements audited by an independent registered public accounting firm. The goal has historically been to provide confidence to investors and bring standardization and discipline to corporate accounting, thereby increasing the liquidity and economic potential of U.S. capital markets.

While there are legitimate debates about the meaning of financial statement audits, there are certain facts about the auditing profession that are hard to deny:

• Not only is auditing required by law, but recent regulations and legislation (most notably the Sarbanes-Oxley Act of 2002) greatly increased its role in public companies. The political determination has been made that auditing is central to public confidence in our capital markets.
• The pressure for auditors to "do more" when conducting audits means that the auditor-client relationship is becoming more involved and continuous, with much more frequent interactions, rather than simply holding periodic discussions geared around financial statement reporting cycles.
• The auditing profession faces a number of significant legal challenges. It is subject to new regulation under the auspices of the Public Company Accounting Oversight Board (PCAOB). More important, the profession finds itself the target of a difficult litigation and regulatory enforcement environment, where business losses by a client can result in lawsuits, and a single indictment — even without a conviction — can result in the destruction of thousands of jobs.
• Because of the Sarbanes-Oxley Act and other requirements, auditing expenses have increased tremendously. At the same time, many clients believe that they are receiving less overall advice and support from their auditors. Audit firms feel that they are caught in a no-win situation between the demands of regulators, law enforcement, the plaintiffs' bar, and their clients.
• The process of developing accounting principles remains in flux, even as business transactions become ever more complex. In addition to the respective roles of FASB, the PCAOB, and the SEC, there are many emerging issues related to international harmonization and the IASB.
• There remain significant misunderstandings about the meaning and nature of accrual accounting systems and the level of precision inherent in such systems. Changes of 1 or 2 cents per share in a company's earnings can have a great market impact — and create significant litigation risk — even if such changes indicate nothing about the health of a company's underlying business.
• The profession — through voluntary mergers as well as through the elimination of Andersen — is severely contracted, with only four major firms serving a large majority of the listed and actively traded public companies in the United States. While four appears to be a sustainable number, any further contraction in this industry would present a major challenge to the viability of the profession, with potential for a negative effect on public confidence in our markets. William McDonough, former chair of the PCAOB, said, "None of us [regulators] has a clue what to do if one of the Big Four failed." He also said that if one of the Big Four were to collapse, the best accountants could choose to quit the profession(1).

There continue to be debates about the role that the auditing profession itself has played in bringing about some of these circumstances, and what it can do on its own to address the current challenges. Nevertheless, the simple facts are that (i) confidence and stability are critical to the success of capital markets, and (ii) auditing helps bring these attributes to our markets. Instead of risking a crisis, it is important to act now to try to bring some stability back to the auditing profession. At the same time, action must be taken to ensure that the needs of companies are met and that they have access to high-quality, reasonably priced auditing services.

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