With New, United Voice, Auditors Stand Ground On How to Treat Crunch

By DAVID REILLY October 17, 2007; Page C1

This time, the auditors don't seem to be backing down.

After losing public confidence over their failure to warn investors about scandals such as those at Enron Corp. and WorldCom Inc., accounting firms are taking a hard line when it comes to questions that have arisen from the credit crunch.

"There's no question in my mind that the auditors are doing a much better job," said Lynn Turner, a former chief accountant at the Securities and Exchange Commission who is often a critic of the firms. "They're also doing a much better job than they did during the days" of the savings-and-loan crisis.

In recent weeks, the accounting firms, operating through a new industry group, have taken views at odds with at least some of their clients about the use of market prices for hard-to-trade securities and over how banks should deal with their exposure to losses in off-balance-sheet lending vehicles.

This has prompted financial firms to recognize losses in securities that they may have otherwise put down to short-term disruptions in markets. It also prompted, at least in part, moves by large banks and the Treasury Department to bail out structured investment vehicles, or SIVs, which are special lending vehicles that banks keep off their books.

The firms' unyielding stance has pleasantly surprised some longtime critics such as Mr. Turner, who add that auditors seem to have stood firm on proper -- yet unforgiving -- accounting treatments despite the severity of the problems gripping the markets. The auditors' group, for instance, said companies have to use market prices no matter how depressed they are and can't argue that they should be ignored because they represent a fire-sale valuation.

That is in contrast to the accounting firms' behavior during previous crises, particularly during the technology-stock boom, when auditors often acted as partners with management and sometimes caved in to corporate demands for aggressive accounting positions.

The firms have also taken a new approach to thorny questions like those they have recently tackled -- issuing guidance through the newly formed Center for Audit Quality. The industry group was formed earlier this year and has emerged as the voice of the Big Four accounting firms. The recent positions on pricing hard-to-value securities and the treatment of off-balance-sheet lending vehicles were contained in three papers published by the center earlier this month.

That has allowed the accounting firms to speak with one voice, helping prevent executives from playing auditors off one another, or companies taking wildly differing approaches to complex questions.

"We can speak for the profession, and there's strength in that," said Cindy Fornelli, the center's executive director.

Such unity can help especially when the markets are facing the kind of tough questions about valuation that have recently surfaced. "Investors would not be well served by different institutions thinking of these things very differently," said Scott Taub, a partner at consulting firm Financial Reporting Advisors LLC and a former SEC deputy chief accountant.

In spite of the praise, there is unease over the role the center is playing in shaping and communicating the auditors' positions. The worry: The center is taking on a role that should be played by regulators such as the SEC or standard setters such as the Financial Accounting Standards Board. While many accounting observers agree with the positions taken by the center during the current crisis, they worry it represents a tentative first step on the road back to self-regulation of the audit profession.

"They are usurping the roles of the FASB or SEC," said Joseph Carcello, director of research for the corporate-governance center at the University of Tennessee. "Why was this not guidance from the SEC staff?"

Such concerns have surfaced within FASB, whose Emerging Issues Task Force usually deals with pressing issues. "While no doubt well-intentioned, repeated efforts like this contribute to overall complexity in our financial-reporting system and can sometimes serve to confuse rather than clarify the issue," said Gerard Carney, a spokesman for the board.

The SEC hasn't "endorsed or approved" the center's papers, officials said. SEC Chief Accountant Conrad Hewitt said "auditing firms are the first line of defense," in terms of how standards are applied. He added that management, corporate audit committees and auditors should work to ensure that accounting standards are being implemented appropriately .

"We don't need the FASB or SEC to step in to provide detailed applications guidance at every jog in the road," said James Kroeker, SEC deputy chief accountant. Mr. Kroeker added that he discussed with some of the big accounting firms some of the issues that later were addressed in the center's papers, but that the commission hadn't asked the group to draft any guidance. He said that such discussions are routine.

For its part, the center said it was simply trying to get information to the market about pressing issues as quickly as possible. When the papers were drafted, companies were nearing the close of their third quarters.

Ms. Fornelli said the papers "were not forging new ground" in terms of accounting standards. "It was a reminder of what the current literature stated at an important time and at a time that the marketplace needed reminding," she said.

Write to David Reilly at david.reilly@wsj.com1

URL for this article: http://online.wsj.com/article/SB119257816857761266.html

QUESTIONS:

1.) Based on discussions in the article and on information at its web site (see http://thecaq.aicpa.org/) discuss the purpose and organization of the Center for Audit Quality.

2.) What is self-regulation of the auditing profession? When did auditors lose the ability to self-regulate?

3.) Some reactions described in this article are positive about the role that is being played by the Center for Audit Quality, while others are negative. Which view do you hold? Support your position.

4.) Summarize concerns with the complexity of financial reporting guidance in the U.S. How might the work from the Center for Audit Quality contribute to that complexity? How might its work alleviate the issue of complexity in reporting standards?