Audit Accounting

Professor John Cousinsjjcousins@gmail.com

What is Auditing• Accounting• Third Party review• Testing• Meets standards• Good accounting

principals• Financial Statements and

Presentation• No:

– Fraud– Latent liabilities

AuditThe general definition of an audit is an evaluation of a person, organization, system, process, enterprise, project or product. The term most commonly refers to audits in accounting, internal auditing, and government auditing, but similar concepts also exist in project management, quality management, water management, and energy conservation.

Auditing is defined as a systematic and independent examination of data, statements, records, operations and performances (financial or otherwise) of an enterprise for a stated purpose. In any auditing the auditor perceives and recognizes the propositions before him for examination, collects evidence, evaluates the same and on this basis formulates his judgment which is communicated through his audit report.

What is the purpose• Insure accounting is

accurate:• No:

– mistakes– Fraud– Omissions

• GAAP• FASB• Latent liabilities:

– Lawyers– Banks

Public Company Reporting

• Financial Statements• Notes• Clear and transparent• Represent an accurate

picture of the enterprise

• So intelligent investors can make decisions relative to ownership of stock

SEC

• Their job is to police markets and enforce regulatory standards to ensure that investors have confidence and trust in the security markets.

• Auditing standards and practices are fundamental to maintaining fair and transparent markets.

Historical Context

Stock Market

• Foundation of Capitalism

• Concentrate capital and focus it on projects

• Greed overcomes Fear with promise of returns

• Risk• Ticker Tape• Railroad stocks• Rumors move stocks

Liquidity and Speculation

Crash!

• 1929• Loss of Value• Loss of investor

confidence• Money evaporated out

of markets• Great Depression• Political instability• Worldwide crisis

Great Depression

• Capitalism Flawed• Communism?• Socialism?• National Socialism?

Securities and Exchange Commission

• Regulate and oversee the stock market

• First Chairman: Joseph P. Kennedy

• Appointed because he was a nefarious stock manipulator: he knew all the tricks of the trade

• Brilliant move by FDR• 1933 & 1934

SEC purpose

• Transparency of listed company operations

• Regain investor confidence

• Concern that Markets were fixed and rigged

• Importance for capital markets and investment and economic growth

Graham and Dodd• Stock valuation based on

business fundamentals• 1934• Security Analysis stands for the

proposition that a professionally-trained investor can determine the intrinsic value of a company from a full financial analysis of the corporation, make purchases in stocks when the market price is selling below its value, and earn a satisfactory return

• Review 10Ks and reporting

Post War Boom

• 1950s boom in public companies

• Stock Market rise• 60s Go Go Years• Economic Expansion

Crashes and Regulation

• 1973 Oil Crisis• 1974 Stock Market

Crash• Recession• S&L Crisis late 1980s

Tension

• Capital markets• Companies and

Valuation• Regulation• Accounting and

Auditing• Competing agendas and

conflicts of interest

Glass-Steagall

• Separate Investment Banking from Commercial Banking

• Restricted affiliations between commercial banks and securities firms

• Why?• Removal of Regulation• Danger: systemic risk• Moral Hazard

Moral Hazard

• a situation where a party will have a tendency to take risks because the costs that could incur will not be felt by the party taking the risk

Dot Com Boom

• Monitization of Business Models

• Growth• Earnings• Bubble• Bubble burst and

exposed problems

Enron and Arthur Andersen• Auditing and Consulting• FASB• Money and clients• Conflict of interest• CFO: jail• Jeff Skilling CEO: jail• Chairman Ken Olson died• AA convicted shredding

documents related to Enron audit

• AA disbanded; bankruptcy

SOX

• Sarbanes Oxley• Reaction to Enron,

WorldComm• New Audit standards• New audit and

accounting regulatory board (no more FASB self regulation)

• More rigorous• Costs of being public

CFO and CEO

• Requirements to sign financial statements

• Arms length relationships with auditors

• Why?• 10K and 10Q reporting

10Ks and 10Qs

• SEC.gov• Financial Statements• Notes• Reporting

The Great Recession• Causes• Derivatives

– Speculation• Rating Agencies• AAA rating to securitized

subprime mortgage portfolios

• Systemic problems• Regulators behind curve

– Best brains chase $• Investor confidence

challenged

Auditing

• Foundational to Free Market Capitalism

• Provides investor confidence in:– standardization,

accuracy of financial reporting

– absence of fraud and misrepresentation