The most important profession after medicine and law is
accounting.  I am not expressing this opinion because it’s my
profession, but rather because when auditors fail to properly
perform their duties, we all pay a heavy price.  Let me give you
an example going back to the great depression.

Towards the end of the 1920s, the stock market was on a joy
ride.  The thinking was that there has never been a better time
to invest.  Financial statements of many corporations brought
tears of joy to one’s eyes.  They were not printed on pink paper,
but, oh, everything was so rosy.  In time it was realized that
they should have been printed on red paper, for there was so much
red ink behind the stated figures.

There were too many factors behind the great depression, one
of them was that the auditing methodology of those days was
flawed.  Two examples follow.

Auditors accepted the receivables figure on nothing more
than the verification of supporting documents.  They accepted the
inventory figure by referring to back-up invoices, establishing
reasonability via calculating applicable ratios, and discussions
with management.  They were in effect largely accepting these
critical figures sight unseen.

After the market crashed in 1929, the financial world came
to realize the hollowness of many so-called blue chip companies.
Window dressing and outright fraud was behind many of the figures
reported on their financial statements.  Were the auditors asleep
at the switch?  Indeed they were.  The profession was to learn
lessons that were never forgotten.

The audit methodology from that day on included, among other
things, an independent confirmation of the receivables and a
physical verification of the inventory.

On a test basis (and with an eye on materiality) you write
to the customers of your client and ask them to confirm the
receivable figure.  The answer comes to the CPA office and not to
the client!  (The idea is to ascertain that these clients really
exist).  All other procedures such as verifying supporting
invoices are still carried out.

Back in those heroic days, near empty warehouses were
sometimes behind a reported inventory figure of million of
dollars.  Therefore, now, on a test basis, auditors carry out
their own count.  They do not merely count, they check the goods
to determine that they are in a good state, that they are not
obsolete, and so on.  Again all other necessary procedures are
still carried out.

What follows may be considered by some of you as snooze
material.  But remember this, the job you hold, the bank(s) you
trust with your money, the funds you invest, the pension
(including government pensions) you will rely on when you retire,
the taxes you pay, what the government does with your taxes, and
a host of other financial duties that affect you directly or
indirectly are carried out or monitored (audited) by your
friendly CPA (CA or CGA in Canada).  You want him or her to be
sharp.  And you want to be wide awake while you read what will
follow.  I have tried to make it interesting, but there is only
so much you can do with accounting!  (There are so many engaging
programs on TV on issues affecting doctors and lawyers, but have
you seen a program regarding dramatic events unfolding in a CPA
office?!)

What do auditors do?

Auditors express an opinion on the financial statements.
What this means in simple terms is that the figures reported on
the statements are checked back to the ledgers and to a sample of
the supporting documentation.  As well, a variety of ratios are
calculated to determine the reasonability of the reported
figures.  Finally, as discussed above, a confirmation of the
accounts receivables and a physical verification of the inventory
take place.  Many additional procedures are carried out, they
will vary according to the nature of the entity being audited.

Auditors will have numerous discussions with the staff and
with management.  Management will explain the estimates,
assumptions, and interpretations made, and the auditors will
decide on the reasonableness of the explanations offered.

Once the audit is completed, and the auditors and management
agree on all material items, the auditors will issue an
unqualified opinion (a clean bill of health).  Needless to say,
there is rarely, at the onset, a meeting of minds between
management and the auditors.  There is a give and take process
that goes on until both parties reach a compromise they can live
with.

If management and the auditors cannot agree, or if the
auditors have encountered problems regarding a material item(s),
the auditors will issue a qualified opinion; for instance they
may say in their report that the inventory should be valued at
$xxx instead of the amount reported on the financial statements,
and they will explain how they have arrived at their valuation.

In more extreme cases, they will issue an adverse opinion,
or a denial of opinion, if the financial statements do not
reflect the true financial status of the corporation, or if they
were unable to conduct a proper audit because adequate records
were not kept.

While the auditors report to shareholders, there are third
parties who have a stake in the financial affairs of the
corporation; examples:  bondholders, banks, and major suppliers.
Can all concerned have peace of mind once the auditors have
issued an unqualified opinion?  Not exactly!  There are three
problem areas I want to address.

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