GOVERNANCE

Accounting and Auditing

Historically, Accounting has been the function of gathering, compiling, reporting, and archiving a firm's business activities. Management or managerial accounting is primarily focused on the development of information for insiders and their decision making. Financial accounting is focused on the development of information for those external to the firm including banks, other creditors, investors and employees who are concerned with their careers and future retirement plans. In either case, the three main financial statements of the balance sheet, income statement and statement of cash flows are developed under the standards set by the AICPA, the IRS and the the SEC. Each of these agencies may have different views on specific accounting issues which gives rise to the fabled "multiple" financial statements.

As with any type of record-keeping, there are potential problems such as unintentional errors, difficulties in interpretation and the possibility of fraud. The purpose of internal auditors is to oversee the firm's financial and operating procedures, to check the accuracy of the financial record-keeping, to implement improvements with internal control, to ensure compliance with accounting regulations, and to detect fraud. Many firms have implemented internal auditing procedures after the passage of Sarbanes-Oxley and the associated requirement that senior management personally vouch for and are liable for the accuracy of financial statements. Additionally, many firms also employ external auditors in order to:

1. conduct interviews with employees to veryify the quality of the internal audit system.

2. make their own observation of firm assets such as inventory

3. check sample balance sheet transactions

4. confirm with customers and clients that the firm is accurately portraying short term assets and liabilities

5. conduct their own financial statement analysis to aid management in seeing trends in financial jperformance of the firm

The external auditors are supposedly independent of the firm (there is an inherent conflict of interest any time you are reviewing the same party that is paying you) and explicityly confirm that the financial statements are in compliance with GAAP. External auditors are required by the SEC to ensure the financial statments adhere to GAAP which are now controlled by the Public Company Accounting Oversight Board (PCAOB) after the 2002 passage of Sarbanes-Oxley. All public held firms are registered with the PCAOB and must meet its standards which effectively are those of the SEC. The PCAOB also oversees public accounting firms with the AICPA now primarily representing the Certified Public Accountants (CPA's) and their development of standards for individual accountants.

The difficulty posed for the profession is the emphasis on internal targets and managing earnings to meet those targets. The line between fraud and "aggressive" accounting becomes very thin when companies are desperate to meet stated earnings targets as seen in the ENRON debacle and other similar financial disasters. The more critical issue involves the issue of auditors operating on that thin line between aggressive accounting and accounting fraud. They typically claim they were lied to or otherwise misinformed by management when it is their very job to ensure management is open and above board in its financial dealings. The linking of accounting, auditing and consulting within the same organization leads to a conflict of interest problem that is difficult at best to overcome without external pressures.