February 23, 2024
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Oh, auditing
Recently, we discussed how auditing might have a future if it could detect fraud and maybe if it also threw in some tidy reports like:
“Your security score was zero out of ten.”
Or:
“Your products are catastrophically deficient.”
These are clear and meaningful, and if someone were to read them, they’d be able to draw a conclusion pretty quickly. Yes, most organizations being audited are likely to get better results than a hastily constructed cryptocurrency. Still, I think most of us would find a “security score” and a clear assessment of a product (or financial statement) useful and helpful.
Historically, though, audit opinions don’t usually do that, as many of you reading well know. It’s a standard report with standard language, and it’s pass-fail—there’s no grade or score. Yes, yes. I know about the “critical audit matters,” and while those are nice, they’re more like the auditor’s chance to say, “These were the important and/or tricky parts.” Nothing about them fundamentally changes the audit report. We still get the pass-fail boilerplate opinion.
But I’m not entirely cynical; I can appreciate the presence of an audit opinion. It means that some auditors showed up, did some audit work, asked questions, etc. That’s something, right?
But then when you think about it—the report isn’t all that useful. Like, if a company doesn’t pass, that’s easy—clearly, there’s a problem. But if a company passes, you can’t help but wonder—did they pass with an A+ or a D-? And if they passed with a D-, did they earn extra credit by taking someone to a fancy dinner and a ballgame?
So, with all these shortcomings, it’s understandable why many people have called the value of an audit opinion into question. And last December, the Second Circuit Court of Appeals put this question to rest, at least in one instance:
One of the country’s most influential courts has asked the nation’s top securities regulator for its views on an uncomfortable subject: whether audit reports by outside accounting firms actually matter.
The court already ruled that, at least in one case, they didn’t. That case, where an insurer overstated profits and an auditor signed off on its books, led to an investor lawsuit against the auditor that was dismissed. In its ruling, the court said the audit report was so general an investor wouldn’t have relied on it.
“The notion that the standardized language is essentially meaningless raises larger questions about whether audit reports serve a useful purpose,” writes Jon Weil at the Wall Street Journal. And, man, that is a savage sentence, Jon.
At least part of the reason that some people might wonder if audit opinions are worth the paper they’re printed on is because they haven’t changed much over the past 90 years. That is weird.
Business practices of all kinds have evolved greatly over the last 90 years. Over the same time, technology has disrupted virtually every aspect of our lives many times over. Even government has changed significantly over the past 90 years.
But the audit opinion hasn’t. And people have taken notice by basically ignoring it, and the Second Circuit has basically said the quiet part out loud. Not everyone believes this, though, and some former Securities and Exchange Commission (SEC) officials asked the court to reconsider its ruling because—and this is sorta awkward—requiring public companies to get an audit opinion is a big part of what SEC does. One of these former officials said:
“investor reliance on the audit opinion has a long history in practice, regulation and law.” Audit opinions that warn of problems often send stocks tumbling. “This observable fact in the marketplace seems to directly contradict the court’s position that the current audit report is not material to investors,” he said.
It’s true. People do tend to freak out when a company doesn’t get a clean opinion. That suggests pretty strongly that an audit opinion is worth something to investors. And that’s the whole point of a public company audit is to be of service to investors. The audit work and the resulting report are the product of audit firms.
But if one of the most powerful courts in the country says that your product is “so general that an investor wouldn’t have relied on it.” Given an auditor’s responsibilities to investors, you might interpret that as someone saying that the product is “catastrophically deficient.”
IRS audits
As you may have heard, the Internal Revenue Service (IRS) has had its troubles over the years with customer service. And upgrading its technology. And hiring and retaining employees. And being used as a convenient scapegoat for opportunistic politicians. Among other things.
This has all happened despite the fact that it is responsible for funding the largest and most complex government that has ever existed. A well-functioning IRS would benefit everyone, including vastly improving the lives of many accountants.
This is all known. So, as part of the Inflation Reduction Act of 2022, $80 billion in funding was earmarked for the IRS to upgrade its operations, including customer service, technology, and, yes, enforcement. The nod to enforcement got quite a few people’s knickers in a twist, with breathless rants about an army of agents harassing regular hard-working people with audits of their tax returns. Although widespread audits of middle-class taxpayers were never even remotely part of the plan, don’t try telling Aunt Ginni that.
Nevertheless, you can send her this if it’ll make you feel better:
The Internal Revenue Service said on Wednesday that it would begin cracking down on corporate jet owners that abused the tax code by claiming millions of dollars in deductions on airplanes that were sometimes being used for personal travel.
The scrutiny of corporate jet use will involve new data analytics tools, which the I.R.S. has been developing with the $80 billion in funds it was granted through the Inflation Reduction Act of 2022, to determine when executives or other company officials might be using corporate planes for vacations and private trips. The agency plans to begin dozens of new audits that will focus on large companies, partnerships and wealthy taxpayers.
“These aircraft audits will help ensure high-income groups aren’t flying under the radar with their tax responsibilities,” Daniel Werfel, the I.R.S. commissioner, said in a briefing to announce the initiative.
I included the quote with the pun just for you, Aunt Gin.
This just in: accountants not perfect
From an actual press release:
Eighteen percent of accountants make financial errors at least daily, with a third making at least a few financial errors every week, and over half (59%) making several errors per month, according to a recent survey by Gartner, Inc.
Congratulations to those 41 percent of you making fewer than four mistakes a month. Your mother must be proud.
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