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The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis.

Apr 20

Written by: Jack Ciesielski
4/20/2005 7:05 AM 

You think about what happened a few years ago during the corporate meltdown of 2002, and you wonder "Whatever happened to the perpetrators? Or the auditors? What's the rest of the story?" The world now focuses on the Bernard Ebbers trial and the trials of assorted Enron characters, but there's been a lot of settling-up on other cases, as you're reminded in these postings: EasyLink, Chancellor, Global Crossing, and Coca-Cola.

The SEC tear continues... it announced yesterday that it settled litigation with KPMG for its audits of Xerox. [Heads-up disclosure: KPMG subscribes to The Analyst's Accounting Observer.] Total tab: $22.475 million. Of that amount, $9.8 million represents the KPMG audit fees from 1997 to 2000; $2.675 in interest; and a $10 million civil penalty. Ouch. What did they do to deserve such punishment?

According to the release, KPMG "willfully aided and abetted Xerox's violations of the anti-fraud, reporting, recordkeeping and internal controls provisions of the federal securities laws. The Order also finds that KPMG violated its obligations to disclose to Xerox illegal acts that came to its attention during the Xerox audits." How bad did it get?

Again, from the release: "KPMG permitted Xerox to manipulate its accounting practices to close a $3 billion "gap" between actual operating results and results reported to the investing public. During this period, Xerox used topside accounting actions at the end of financial reporting periods to increase equipment revenue and earnings through the improper acceleration of revenue from long term leases of Xerox copiers and through manipulation of excess or "cookie jar" reserves. Most of Xerox's topside accounting actions violated generally accepted accounting principles (GAAP) and all of them inflated and distorted Xerox's performance but were not disclosed to investors. These undisclosed actions overstated Xerox's true equipment revenues by at least $3 billion and overstated its true earnings by approximately $1.5 billion during the four-year period.

According to the Order, in each of the years 1997-2000, KPMG issued audit reports containing unqualified opinions stating that KPMG had applied generally accepted auditing standards (GAAS) to its review of Xerox's accounting, that Xerox's financial reporting was consistent with GAAP and that Xerox's reported results fairly represented the financial condition of the company." Which they did not.

This is an example of what I think of as "compliant auditing" - conforming to the wishes of the client - instead of "compliance auditing" - figuring out whether the audit client hewed to accounting standards in communicating with investors at large and its shareholders. And it makes me think of these windy sentences from yesterday's Wall Street Journal editorial "Sox And Stocks:"

"The greatest Sox irony is that its main beneficiaries are the same big accounting firms that the politicians blamed for Enron, WorldCom and the other scandals. The Big Four accounting firms audit the majority of public companies, and by some estimates up to 30% of 404 costs will be paid to these external auditors. Nice work if you can get it."

My question to those critics of the re-spined audit profession: what do you want? Compliant auditors like we had during the golden age of financial scamming - ones who used audits as loss leaders to get more lucrative business? Or a prickly, self-sufficient audit profession that acts like compliance auditors? I prefer the latter. If auditors are doing what they should, I have a hard time faulting them for making a buck while they do it.