on the Good Old Days
2005 - I enjoyed Dennis Beresford’s article “Can
We Go Back to the Good Old Days?” (December 2004). While
I generally agreed with the points he made, I would like to
expand on some of them and offer a different perspective on
of the complexities in today’s rules may be unavoidable
because the subject matter is complex. Derivatives, for
example. Not only are many derivatives inherently complex,
but also, at least in my experience, the terms too often
reflect not current market conditions, but rather a desire
to “cover up” losses on existing contracts,
thus deferring the accounting recognition of those losses
to future periods (or indefinitely). In these circumstances,
detailed rules may be necessary if only to educate companies
and auditors who are not experts in derivative instruments.
the other hand, while fair value is entirely appropriate
to use for recording assets and liabilities that will be
settled on that basis, its extension to other ongoing transactions
introduces pointless complexity, and Beresford covered that
point well. Recording a liability at a hypothetical amount
that an unidentified third party might charge to assume
that liability, rather than the amount a company reasonably
expects to actually pay, results in an amount that is neither
relevant nor reliable.
recent scandals in the insurance brokerage industry illustrate
the difficulty in determining fair values. As reported in
the media, part of the schemes involved obtaining fictitious
quotes from one insurance company to make the overcharges
of a second insurance company appear reasonable. The insureds,
who often were large companies with presumably sophisticated
risk management systems, were unable to detect these overcharges.
Note that these transactions involved the actual outlay
of cash, rather than an accounting estimate. This experience
does not inspire confidence in the use of unsupported estimates
from third parties.
Beresford mentions the trend toward principles-based or
objectives-based standards and asks, perhaps rhetorically,
who can object to them (comparing them to apple pie and
motherhood). Until recently, the answer was: FASB and the
SEC. When I was on the International Accounting Standards
Committee from 1990 to 1994, the IASC strove to write principles-based
standards, an approach that FASB clearly opposed. One of
its senior people (not Beresford) expressed the view that
only scoundrels would support that approach, because they
would use the absence of detailed rules to prepare misleading
financial statements. Similarly, when I served on the EITF,
the then–chief accountant of the SEC often expressed
the desire for “bright lines” for issues we
discussed. Unfortunately, the presence of detailed rules
and bright lines has not, as we have seen, prevented the
preparation of erroneous financial statements. Perhaps naively,
I continue to support principles-based standards, and it
is good to see FASB and the SEC joining the party, even
meaningful accounting principles is a never-ending challenge.
Many thoughtful people have observed that there is an important
distinction between wisdom and intelligence. FASB has demonstrated
that its board members and staff have a high degree of intelligence.
Let us hope that they have the wisdom to adopt standards
that will result in useful, meaningful, relevant, and reliable
J. Murray, CPA (Retired)
Note: The writer is a former member of
the FASB Emerging Issues Task Force (EITF) and Advisory
Task Force on the Consolidation Project, the International
Accounting Standards Committee (IASC), and the AICPA Accounting
Standards Executive Committee (AcSEC).
Firm Rotation and Audit Quality
article “Audit Firm Rotation and Audit Quality,”
by Barbara Arel, Richard G. Brody, and Kurt Pany (January
2005), does a good job of discussing the pluses and minuses
of mandatory auditor rotation. Like most treatises and discussions
on the subject, however, it misses the major points.
audit firms should possess the capabilities to perform an
acceptable audit, given necessary industry expertise and
appropriate size. Once an audit firm determines that it
has the requisite skill set and needed manpower to properly
perform the audit, then the only issue is knowledge of the
specific company it is going to audit. This impacts the
learning curve, and hence the fee (or expenses) involved
in performing an audit that meets professional standards,
but not the ability to do a proper audit or the quality
of the audit performed.
the issue of public perception and impaired independence
that results from the auditor being retained for extended
periods goes deeper than simply rotating auditors. The overriding
issue is lack of independence, whether it is real or apparent.
To frame this issue, a basic, rhetorical question that I
like to ask an audit firm is whether its fee would be different
if it knew it was performing an audit for only one year.
If the answer is yes, then the firm has a real lack of independence,
based on a financial arrangement where it needs future audits
to offset the initial costs. This problem is not erased
by mandatory rotation, unless the rotation happens every
year. The way around this is for a third party (e.g., a
stock exchange, a government entity, or a new body established
for this purpose) to hire, pay, and fire the auditors.
some respects, this is the goal of establishing the audit
committee of the board as wholly comprised of outside directors.
But I question the efficacy of this when the directors are
paid by the company, which makes them very similar to part-time
employees. Documenting your independence is difficult when
you are drawing a substantial fee from the company.
more articles and discussion I see, hear, and read about
the issue of the independent audit, the more I am convinced
we need a new paradigm.
Haber, PhD, CPA
Assistant Professor of Accounting
Hagan School of Business, Iona College
New Rochelle, N.Y.