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Auditors Adjust to Not Being There in Era of Six Feet Apart

June 16, 2020, 8:46 AM

Auditors gather a lot of their evidence by dropping into clients’ offices, stopping by cubicles, reading facial expressions and body language in response to their questions.

They hover over shoulders as finance team members demonstrate controls intended to ensure the accuracy of financial reports. They travel to warehouses and plants to inspect inventory, opening boxes to see what’s inside.

Those in-person checks can’t happen, though, while businesses are shuttered or corporate staff work from home during the still circulating coronavirus. The pandemic has effectively stripped away a key check auditors use on management: being in the same room.

The largest U.S. audit firms say they’ve been preparing to work remotely for years, and have already been auditing some clients remotely to some degree. They say they have new tools, training, and capabilities to compensate for the lack of hands-on interaction, and will ensure that investors have financial statements they can rely on.

But being one step removed from clients increases the chance that sloppy accounting might slide and mislead investors, or that signs of fraud could go undetected in 2020. Some of history’s most infamous accounting frauds occurred when auditors didn’t, or couldn’t, verify how the business operates in person.

“That’s the nature of fraud, it’s just very hard to anticipate in advance what’s going to happen,” said Sal Graziano, managing partner with Bernstein Litowitz Berger & Grossmann LLP, one of the top plaintiffs’ firms in the country. “I think that should be the attitude across the accounting firms. They also don’t know, and I think they just have to be vigilant.”

Layers of Risk

Auditors say they are aware of the pandemic-sized risks and are taking steps to fill in those blind spots with more testing, a fresh look at the reshaped business, alternative forms of evidence, and extra sets of hands to help frontline auditors with the most complex work.

The list of potential pitfalls is long and includes internal controls, valuations like goodwill, and going-concern assessments.

The Public Company Accounting Oversight Board, which oversees the audit industry, in April highlighted some of those trouble spots and reminded auditors of their responsibilities, noting that their work will require more time and effort this year.

“Auditor judgment becomes even more critical to high quality audits under these unique circumstances. While we will not second guess reasonable judgments, we will confirm that those judgments are consistent with our standards,” according to a statement by board Chairman William Duhnke.

But those audit challenges largely reflect how the economic shift hit clients’ business, not that firms are auditing remotely, said Jen Haskell, chief auditor at Deloitte LLP.

The technology and the ability to work from anywhere aren’t new. How auditors think through assumptions and data that their clients rely on hasn’t changed, Haskell said.

Audit processes and checks already in place—Deloitte, for example, has specialized teams that step in to tackle certain complex areas of the audit—will help to ensure effective auditing regardless of a client’s financial challenges, Haskell said.

“We’ve got a lot of things working in our favor,” she said.

Face Time

Still, there are some risks to auditing from a distance, including that auditors might miss nonverbal cues that the client might be lying. To adapt, the firms are relying on technology during fraud inquiries and other critical steps.

“Our approach is not to replace the human interactions as we conduct an audit, not by any stretch,” said Jim Estes, Ernst & Young LLP’s vice chair of professional practice for assurance. “Even in this environment, we would have a requirement for those to be a video communication. You still are looking the person in the eye.”

Auditors are beginning to sketch out how they will handle inventory tests this year. They could delay the checks, but live video feeds with location tracking information are a common workaround being considered.

PwC LLP said staff in some cases are still heading out to a client’s property for in-person inventory counts.

EY too would prefer to be on site, and the firm is looking for ways to introduce unpredictability into the checks to ensure a count is valid, Estes said.

A Partial Picture

“If you cannot count the inventory for whatever reason physically, I’d be worried about that. History tells us that when the auditor isn’t able to observe and count inventory bad things can happen,” said Lynn Turner, former chief accountant for the Securities and Exchange Commission.

Lapses in basic on-site checks have led to extreme fraud cases like ZZZZ Best Co., which created a fake contract site as part of an elaborate effort to dupe its auditors, and consumer-electronics retailer Crazy Eddie Inc., which overstated inventory and skimmed cash in the 1980s. MiniScribe Corp. masqueraded bricks as disk drives, and the clothing retailer Ann Taylor didn’t write down excess inventory.

With retailers shuttered for months, there should be significant writedowns on inventory that’s past its prime, especially in fashion, Graziano said, calling it a high risk this year if not accounted for correctly.

Joe Schroeder, accounting professor at Indiana University’s Kelley School of Business and a former EY auditor, questioned whether video feeds and video conferences are suitable substitutes for being there in person.

“If you’re not actually in the warehouse, you’re not going to see the obsolete inventory. You’re only going to see what they want you see on the webcam,” Schroeder said.

Auditors are working on their game plan for internal controls testing too, work that often takes place during the summer.

But they have options including interviewing staff about how they put the controls to work, even inspecting documents. The extra evidence and testing add to an audit term’s burden, Estes said.

“It’s not as easy as standing there watching them do it,” he said.

A Digital Audit

In one key area, new technology is letting auditors get a giant step closer to their clients: pulling transaction-level data directly from a company’s accounting systems.

That information is key to auditors’ work, from risk assessments to verifying the vendors and customers on the other side of transactions. But convincing companies to give auditors direct access to raw data has been a slow process.

Many companies didn’t have the ability to provide a direct link to their auditor, were concerned about data security, or simply didn’t want to give auditors the keys to their accounting systems.

Over the past two months, however, companies have been far more willing to share the raw data because it’s a time-saver for them, said Jim Burton, partner-in-charge of audit methodology and standards at Grant Thornton LLP.

Better than a spreadsheet, the raw data gives auditors an unvarnished view of the company’s financial state and allows them to keep tabs more frequently. It’s an example of how the pandemic has sped up adoption of new techniques and platforms auditors have at their fingertips, Burton said.

The firms have invested millions of dollars to put cutting edge technology, including robotics process automation and cloud computing, into the hands of auditors and to digitize the audit process. That foundation made the move to auditing from dining rooms and basements possible.

That doesn’t mean there aren’t challenges, said Jon Raphael, Deloitte’s chief innovation officer. “In terms of just execution and the transition, that’s been a huge enabler for us to be able to really continue. You know, on one day, it all changed quickly.”

“The question is not, are audits different, it’s really, have audits changed forever. And I think they have,” Burton said. “I think firms are going to find that idea of continuous auditing, the idea of working remotely, the ability to gather evidence that is just as persuasive as sitting in the client’s facility, is absolutely possible.”

To contact the reporter on this story: Amanda Iacone in Washington at aiacone@bloombergtax.com

To contact the editors responsible for this story: Jeff Harrington at jharrington@bloombergtax.com; Bernie Kohn at bkohn@bloomberglaw.com

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