So what regulatory and audit challenges should be anticipated as the market rebalances and reassesses?
It is a gross oversimplification to suggest that today’s audited financial statements are easy to read, understand, and internalize the implications on the precise meaning of the footnote language. With ever greater post-Enron and WorldCom prescriptive accounting rules, the ability of a non-professional to act on the quarterly and annual statements has been impaired. Yes, the changes enacted were to tighten financial treatments and were sought by regulators and the auditors themselves to denote risks within a corporation and for, let’s face it, post reporting litigation against the auditing and regulatory agencies themselves.
Regardless of the intentions and the outcomes, what has become clear this decade is that with prescriptive standards there is a challenge to react quickly to market demands and financial instrument complexity. In essence, the standards appear to be continually lagging the ability of corporations and their advisors to create and use new forms of currency and “off-balance” sheet items that don’t properly assess the fair market value for assets and risk positions. Post 2007, there is clearly a divergence from intent to reality when it comes to accounting transparency and an ability by the average investor to understand the implications within accounting statements.
With market conditions continually uncertain and auditors in fear of another Authur Anderson series of litigation, it should be expected that the financial statements for 2008 and 2009 will be even more difficult to understand. Why? It has been suggested that with the fear of liability facing the partners of the top 6 international accounting firms (which audit a significant majority of public firms), the caveats facing publically audited firms will be significant as auditors and investors seek to concretely assess asset holdings, valuations and ratios, and of course, risk exposures.
As the top audit firms seek limited liability for any potential litigation by activists or investors seeking to assign blame and retribution for FSI firms in distress or failure, global equity markets are searching for a more uniform method to apply consistency to increasingly globally interconnected operations. Some are terming this “principles-based” auditing, but the markets and the regulating agencies are just now debating the rules and downstream implications of the draft rules. It is unlikely that with continued market pressures, illiquid assets, and struggling operations that new accounting treatments would be quickly adopted. The rising tide of litigation may prevent this. However, fearing the loss of another international accounting firm and even less competition, regulators and government agencies may become the audit firm’s best asset for change.
What’s the net of all these challenges? Auditors and their practices will take a very critical eye towards corporations and the stated valuations that have been historically assigned to such items and SIV’s, CDO’s, MBS’s, and ABS’s. If there is any concern over the fair market valuations of these portfolioed or investment instruments, look for account statement footnotes that try to direct the investor to the “discrepancy.”
From a global sourced operations standpoint, look for additional scrutiny along the entire supply chain and the risks associated with alliances and partners. Sourced processes may be subject to 100% validation rather than just using sample sets resulting in a longer audit response / due diligence, greater audit fees, and increased auditor to management team disagreements. For global sourcing providers, increased regulatory, oversight, and governance demands will be placed into the relationship by corporate personnel. For operating transitions, the impact may be an increase in checkpoints, signoffs, and test cases to ensure conformance especially with latter stage business processes and all knowledge sourcing efforts.
Mark Dangelo
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