GAO report gives accounting profession good marks.

In late September, the General Accounting OFfice made public a report on the actions and progress of the accounting profession over the past two decades. The report, The Accounting Profession--Major Issues: Progress and Concerns, lauded the actions taken by the profession from 1972 through 1995 to improve accounting and auditing standards and the performance of independent audits, but it stressed the need for continued action to ensure the profession upholds public confidence in the fairness of financial reporting.

The report, which was requested by Congressman John D. Dingell (D-Mich.), ranking minority member of the House Committee on Commerce, examined the specific actions taken by the American Institute of CPAs, the Financial Accounting Standards Board and the Securities and Exchange Commission to respond to unexpected business and financial institution failures and large government bailouts. It also looked at how recent business trends, such as globalization and the use of advanced technology and complex financial instruments, would affect the future of financial reporting and the auditor's role in serving the public interest.

Facing the issues head on

According to the report, the accounting profession made changes necessary to improve auditing and financial reporting. It commended the profession for instituting quality control programs that ensured professional standards were being met, and it supported the self-regulatory work of the Public Oversight Board. The report also supported efforts by the FASB and the SEC to include more public representatives on the Financial Accounting Foundation.

"It is clear the profession is dedicated to dealing with the major issues it has faced in the past two decades," said Robert W. Gramling, GAO director of corporate audits and standards, who was responsible for the preparation of the GAO report. "The central message is that the profession has continuously addressed the issues of auditor independence, internal controls, fraud and standard setting; however, the actions taken to date have not totally resolved those issues," said Gramling, who wrote much of the report.

Facing tomorrow's challenges

The report emphasized that the independence of public accountants, both in fact and appearance, was crucial to the credibility of financial reporting and the capital formation process. It acknowledged the steps taken by the profession to strengthen independence, such as the AICPA's revision of its code of ethics, to help ensure auditor objectivity. Despite these measures, the GAO said concerns continued to be expressed by the SEC Chief Accountant's Office and study groups that objectivity and independence were threatened, especially with the growth of new consulting services.

Although the report supported recommendations by the POB to strengthen the independent auditor's relationship with the board of directors as an alternative to voluntary action, it called on the SEC to exercise more authority by clearly defining the roles of the board and audit committee as they relate to the independent auditor.

In a letter to Charles A. Bowsher, comptroller general of the United States, Ronald S. Cohen, chairman of the AICPA board, said the AICPA agreed with the POB's recommendations and that the AICPA SEC practice section had pledged to work with the POB in developing an appropriate plan of action. He also said SEC registrants and other publicly accountable organizations should be required to have audit committees composed entirely of independent directors.

Fraud and internal controls

Referring to the gap between what the public expects of the accounting profession and what the profession believes is its proper role, the GAO said it did not believe the gap had narrowed--even though the profession issued a number of standards to address auditor responsibilities.

The report said the auditor's responsibility for detecting fraud and internal control problems overlapped, and that weak controls, given the large volume of derivatives activity among major brokers and dealers, posed a risk to the stability of the entire financial system. According to the GAO, one means of reducing that risk would be legislation to require management and auditor internal control reporting for all public companies similar to that required of banks and savings and loans by the Federal Deposit Insurance Corporation Improvement Act. The GAO said SEC support was critical, and that in the long run it expected to see audits included in internal control reporting, either because of market demand or some systemic crisis. "We recommended that the SEC be more involved because we felt the current auditor-client relationship places the profession in a very difficult position to move forward on these issues," said Gramling.

The standard-setting process

The report said the FASB and the AICPA have made efforts to include the participation of financial statement users when setting standards but that user participation was still lower than other groups. The GAO said the SEC's recent efforts to add more public members to the FAF were a step in the right direction. The report pointed to the FASB's actions to address concerns over the quality and timeliness of accounting standards--the development of the FASB conceptual framework and the emerging issues task force, for example--but said it still takes an average of two years to issue specific standards. The GAO therefore again urged the SEC to continue to monitor the standard-setting process and to play a major role in improving the efficiency of the FASB's operations.

A new reporting model

The report said historical cost-based financial statements were not fully meeting users' needs and were inadequate for investment and credit decisions, especially as technology had improved both the timeliness and accessibility of information. The GAO said the fact that the investment and credit communities have been using nontraditional financial data has raised important questions about the auditor's role in providing assurances fbr information in a new expanded reporting model. However, the report said it was important that new assurance services offered by auditors should not be simply a function of management demand--assurance services should also ensure information that affects capital markets is reliable. Again, the GAO called for strong leadership from the SEC, as well as the FASB and the AICPA, to achieve a comprehensive financial reporting model while providing the assurance that information affecting the capital markets was reliable.