Overly friendly relationships between corporations and their external auditors were blamed for some of the big financial scandals of recent years. As regulators lean on auditors and post-scandal regulatory changes take effect, companies are starting to experience the new reality: That warm, fuzzy feeling is gone.
Given the changes, auditors are making an effort to keep their clients at arm's length. While auditor independence was clearly one of the goals of the governance reforms, some companies are complaining that it's gone too far. Anecdotal evidence suggests that some companies are finding it hard to get advice from their auditors, while others are getting advice that may be unduly cautious.
"The relationship is definitely changing," says Therese Webb, practice director at Horn Murdock Cole, which offers finance and accounting professional services. "Right now, the external firms are being sensitive to the objectivity and independence issues to the point where they're somewhat reluctant to give specific guidance." Webb says that many audit firms are still willing to give advice, "but we're definitely seeing a trend toward being a little bit more cautious about advice." She adds that some companies that are having a hard time getting the information they need from their auditors are wondering whether they should be keeping another firm on tap to help them deal with technical questions.
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Of course, the audit firms are under equally intense pressure. Many are dealing with lawsuits related to corporate meltdowns, and all of them now have the Public Company Accounting Oversight Board looking over their shoulders. They got a reminder of that in August when the PCAOB released a report on its first annual inspection of audits, which contained plenty of criticisms of the work of all of the Big 4 firms.
As an audit firm, "you don't want to get pulled into potential litigation and you don't want the PCAOB coming in and saying, 'You're not doing this right,'" says Jonathan Duchac, an associate professor of accountancy at Wake Forest University's Calloway School of Business and Accountancy. "The answer is, 'Err on the conservative side, and let the client deal with the fallout.'" Duchac says that the advice that companies are getting on certain accounting issues could end up affecting earnings. "The accounting firms are tending to give some pretty narrow guidance to their clients," he says.
HANDS OFF INFO TECH
Sarbanes-Oxley put in place a number of new rules regarding auditors and their clients, and in part, the rules limit the kinds of non-audit work that firms can do for audit clients. For example, auditors are no longer permitted to plan or implement financial information technology systems for clients. But those rules aren't generally interpreted as keeping auditors from giving advice on accounting questions.
Frank Minter, an executive in residence at Samford University in Birmingham, Ala., says that any overreaction by auditors to the new regulations will fade. "The pendulum swings – when it swings too far in one direction, it will come back," Minter says. In general, the changes in audit firms' practices are for the better, he says. "Auditors have now realized that they probably laid down and rolled over too many times in the past. Maybe they're now doing what they should have been doing all along."
"The net result of this is a positive," agrees Wake Forest's Duchac, who says the peer reviews that audit firms used to undergo were ineffective. "Prior to the PCAOB, the only substantive control mechanism over auditors was the potential for an SEC investigation or enforcement action." Sarbanes-Oxley attempts to get auditors to approach an audit as the investigation of a business, rather than the completion of an audit checklist, Duchac says. And after all, that's what investors and regulators want them to do.
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