Audit Effectiveness - Worrisome Trends.

No doubt you've read about SEC concerns over "earnings management" and recent high-profile cases of accounting misstatements. Part of the SEC's reform is to scrutinize the audit process; the commission has charged the Public Oversight Board to study the issues and prepare a formal report. The POB held public hearings in October; FEI gave the corporate perspective.

Our testimony, posted as text and as a PowerPoint presentation at www.fei.org, stressed four points:

* FEI members want and need a critical, independent audit. It provides a valuable, third-party cross check in producing accurate financial statements.

* Many members sense that the auditing and assurance business has diminished in prestige and emphasis. The auditing profession needs to turn this trend around.

* CPA firms must reestablish their leadership roles in the development, analysis and interpretation of accounting standards. We sense a shift in the balance of authority in accounting and auditing, with auditors relying too much on the SEC and the FASB to solve difficult accounting issues.

* Regardless of the market pressures on management to deliver results, those pressures shouldn't affect the outside auditor's ability to complete an objective, independent, well-executed audit.

Generally speaking, the audit process isn't broken; there's no objective evidence that audit or financial reporting failures are up. But we can do more to maintain high quality and enhance the stature of this important function.

One problem is the perception that audit work is less desirable than consulting. Traditional auditing is essentially a line of business with finite potential, not one of dynamic growth. So understandably, audit firms have leveraged their core skills into other, more lucrative, areas. But does that translate to less qualified personnel and fewer resources being devoted to audit work? And for how long will it be possible to attract capable new entrants to the audit side, if the prestige and rewards are better elsewhere?

An inability to get tough questions answered by the local audit team also troubles many members. Audits now almost always involve checking with the firm's national office and, often, "no-name consultations" with the SEC. There are many reasons for this; some are valid. And there's no doubt accounting rules are more complex. But the authority and confidence of audit firms are too often undermined when the SEC renders opinions. We encourage the Big Five to retake the high ground here - it will benefit all parties and make for more efficient capital markets. CFOs can help by encouraging more leadership from their local audit partner. And CFOs shouldn't encourage appeals to the regulators if the local answer isn't attractive.

SEC Chairman Arthur Levitt has called auditing "the very soul of the profession, not a loss leader as a foot in the door for higher-fee consulting services." That's worth remembering. The financial statement audit is essential to capital formation and corporate governance. More than any other activity, the audit lends credibility to a company's published results. Those involved must strengthen and enhance it - not undermine it. As long as companies seek investor capital, we'll need high-quality audits.