How to Handle the Five Habits of Difficult Auditors

In previous columns here, I’ve often talked about how to handle difficult accounting issues. I have not, however, talked about how to handle auditor issues. It’s time that I do.

Working effectively with your external auditors when accounting questions arise is important not just because the auditor needs to opine on the financial statements, but also because auditors generally have knowledge and experience that, if used correctly, can lead to a more efficient and effective resolution. Unfortunately, my anecdotal evidence suggests that in many cases, when tough issues come up, the client-auditor dynamic doesn’t work as well as everybody would like.

In this column, then, are my thoughts on the top five complaints about working with external auditors when addressing accounting issues. Perhaps my thoughts will help reduce these complaints, but if nothing else, some readers may take comfort in knowing that at least they’re not alone in their frustrations.

No. 5: They Won’t Help Support Our Accounting!

At times, companies may turn to their auditors in the hopes that they can find an interpretation of GAAP that supports a particular accounting treatment. This usually comes up when a potential problem is noticed after financial statements have been filed, or when the accounting treatment is pivotal to the decision to enter into a business arrangement. Auditors, however, often wind up confirming that indeed the potential problem is a real one.

This is not a happy event for the company, but getting upset at the auditors isn’t fair. Auditors are not advocates for their client’s accounting positions. They must form their own view as to the appropriate accounting and ought not to focus on only the one preferred interpretation or to help structure a transaction around the accounting literature. Good auditors don’t engage in these activities, and companies that expect them to do so have unreasonable expectations. So don’t expect your auditor to be a supportive friend.

Of course, the auditors are not your opponent either. Auditors don’t “win” by objecting to clients’ accounting, nor do companies “win” because their auditors agree with them. Instead, both the company and the auditor win if the accounting is right; both lose if it is wrong. Companies should expect that the auditors will consider their view of the accounting, but they will also review the issue objectively and bring their own considerable experience and expertise to the analysis. That’s their job, and they do it on behalf of the shareholders, not management.

No. 4: They Won’t Talk to Us When We Need Help.

My clients are often frustrated by their auditors’ unwillingness to help them think through an issue early on. Typically, the auditors indicate they are concerned they could lose their independence by getting involved too early, or that the company must deal with this issue itself to show adequate internal controls. Although I tend to get more consulting business when auditors take this position, I think companies are right to complain about it.

Neither independence nor internal control rules are meant to impede conversations about accounting issues. The Securities and Exchange Commission and its staff have been trying to correct this erroneous interpretation of the rules for years. So long as the company is considering the issue on its own, as opposed to simply trying to outsource the accounting decision to the auditors, consulting with auditors should be seen as a good practice, not an indication of an internal control or independence problem. Financial statement quality is improved when the auditors weigh in with their views earlier rather than later; auditors should welcome these inquiries, not turn them away.

No. 3: They Just Send Us a Big Bill.

Auditor time is not cheap. One way to keep extra bills from the auditors to a minimum is to bring them into a problem only after the company has done a complete analysis of the issue, reached a conclusion, and documented it in a nice little package. This can be effective particularly when the company has high-level technical accounting expertise in-house or has access to such expertise from somewhere other than its auditors. It also avoids the independence and internal control concerns discussed earlier.

Despite the potential cost savings, I tend to favor getting the auditor involved as soon as the company has a reasonable idea of the facts. Why? There is a pretty good chance that an issue that’s novel to you is something your auditors have seen before, particularly if the national technical group is consulted. In addition, your audit team and their technical people are used to thinking about and dealing with tough issues. This means that they can often speed the resolution of the issue.

Some companies wait to see if the auditor “catches” the issue, instead of bringing it to their attention. This is a shortsighted and high-risk strategy. While it may save time and money in the short term, if the issue comes up at a later date—perhaps due to an SEC review—he fact that the company knew about it but never brought it to the auditor’s attention could have severe consequences. In addition, there is always the risk that the auditor will indeed catch the issue, but at the last minute—delaying the completion of the audit and increasing pressure on everybody.

No. 2: They Change the Rules

I’m sure every reader of this column can cite an example where an auditor has objected to an accounting treatment that has been used for years. Sometimes the auditors had never really considered the accounting in question, and probably would have objected to it years ago if they had. But there are plenty of situations where auditors become uncomfortable with something they explicitly accepted in the past.

Obviously, this shouldn’t happen. But just about every time an issue like this arises, the new position taken by the auditors is the right one. So the solution isn’t to stop the auditors from raising the issue when they finally realize the accounting is wrong; the solution is to take steps to ensure the accounting is done right in the first place, and that the auditors thoroughly consider important accounting decisions when they are initially made.

Management can help by bringing issues to the auditor’s attention as they arise, by documenting its own analysis and conclusions thoroughly and ensuring its auditors agree with those conclusions, and by taking steps to ensure key accounting policies are understood fully by the audit team. When the auditors do object to accounting that has been used for several years, the dissatisfaction should be with the audits that missed the issue, not the one that catches it. And the time to consider the implications of the prior audit failure is after the immediate problem (which is getting the corrected financial statements completed) has been addressed.

No. 1: They Won’t Explain Themselves

I can’t count how often clients have called me lamenting that their auditors have explained an accounting conclusion only with a vague, “That’s the national office’s interpretation” or “That’s what the SEC expects.” That’s really unacceptable. If the SEC really does expect things to be done a certain way, there is a reason, and if the audit firm has reached a particular interpretation, there is a reason for that as well. The auditors should explain their reasoning, and if the local engagement team can’t do it, management should ask to speak with those who can. Audit committees also should understand the resolution of difficult accounting issues, and they too should press auditors to explain their positions.

One reason for this, of course, is that the company must take responsibility for the accounting in the financial statements, and it can’t truly do that if management doesn’t understand the basis for a significant accounting position. More importantly, when management doesn’t understand the auditor’s position, it is sometimes because the auditor doesn’t fully understand the transaction. Whatever time and expense it takes to make sure both sides know the facts and understand the accounting analysis—it’s well worth it. I’ve seen many client-auditor disagreements dissolve during an all-hands meeting where people realize they have been working with different assumptions.

A Few Final Thoughts

So let’s say you’ve read this column and thought “Yep, that’s our auditors!”—but my words haven’t reduced your dissatisfaction. What next?

First, talk with your audit partner. I’ve met a lot of audit partners in my career, and I don’t know any that would refuse to talk with their client about concerns along the lines of the ones I’ve discussed here. The next step is to talk with your board’s audit committee. After all, the audit committee is responsible for hiring the auditor.

In the end, however, remember that a little bit of conflict between the auditor and the audited is both normal and healthy. Those companies that never have any difficulties dealing with their auditors are the ones that should be concerned.