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> reliability of a company's financial statements I don't really understand the difference. Can you give an example of accounting fraud in which the company's

by acchow 8y ago

> reliability of a company's financial statements I don't really understand the difference. Can you give an example of accounting fraud in which the company's financial statements are still reliable?

Tyrek 8y ago
The difference is one of scale. For example, a Walmart sized company could easily have some fraud going on the scale of a couple million dollars - the financial statements are considered to be materially correct (i.e. in that investors would not consider numbers off by a couple million to be a big deal), but there would still be fraud going on. You have to understand that the underlying concept of audit that a small team of auditors is responsible for ensuring that a huge (relatively) company is going about things correctly - there's no way to obtain a 100% assurance with that scale of manpower, and there's no appetite from companies to significantly increase the audit fees to obtain that level of assurance. Instead, a sampling/risk-based approach is taken in order to ensure that there cannot be a large error within the financials.
- UK-Al05 8y ago
  But the point is that auditors didn't catch massive amounts of fraud either. Where financial statements did not match reality at all.
- acchow 8y ago
  Ok, I think I understand now. The layers are: reality -> accounting books -> financial statements The auditors don't look at the first mapping "reality -> accounting books" but only at the second one "accounting books -> financial statements"? And even in the second mapping, they check with a sampling-based approach?
  - sithadmin 8y ago
    >The auditors don't look at the first mapping "reality -> accounting books" but only at the second one "accounting books -> financial statements"? That's not entirely correct. A good portion of SOX audit efforts in the US, for instance, is spent on examining configuration of the various systems on which financial reporting is dependent (e.g. examining exactly how segregation of duty controls are implemented in the ERP system). A good portion of time is also spent examining if human-executed processes (e.g. employee on boarding/off boarding, granting permissions to data and financial system capabilities, manual review of backup job reports, etc) are actually being carried out in a manner that complies with the organization's SOX controls.
  - Tyrek 8y ago
    No, all testing is down all the way down to 'reality'. But testing is statistically scaled to detect large errors. The threshold for 'large' shifts with how large the audited company is. i.e. a couple million dollars is a rounding error at Walmart. Additionally, pretty much 90% of an audit flows through a limited number of client contacts. Audits are not designed to defend against a concerted effort to prevent the auditors from seeing 'reality' (i.e. un-doctored documents), due to the manpower requirements to validate information at that level. Conceptually, it's the difference between 'I-trust-you-but-I-need-to-check-that-you-did-your-homework' and 'Trust no one, everything you see is a lie'.
bigjimmyk3 8y ago
What Tyrek said. Also, I could have phrased it better as "assurance that the company's financial statements accurately portray the activity in their accounting ledger(s)." An audit is about matching the financial statements to "the books" rather than looking for impropriety.
- 0003 8y ago
  Audits also check that the book's transactions are correct, but this is done through a risk based approach. In my opinion, most practitioners do not understand risk quite well enough.
c3534l 8y ago
Think of it as the difference between undergoing code review versus trying to find instances of malware and hacking on a person's computer. An auditor makes sure that when GE releases financial statements, it's the same kind of thing as when Ford releases financial statements. They're making sure that when a manager at the factory gets equipment on an installment plan that the company is going to report that as debt, rather than pretend its a rental agreement (and when it's one over the other is complicated which is why you need accountants). If investors and creditors are going to get any use out of financial statements, Ford has to prepare its financial statements in the same way and according to the same principles that GE does. In order to make sure they're doing that, someone (an auditor) has to periodically make sure they're doing that. What might show up on an audit is if the accounting department is inherently dysfunctional and not keeping proper records. What they're not going to do is figure out if someone is intentionally trying to deceive an auditor. Accountants are experts in how you're supposed to prepare financial statements so that everyone follows the same standard of what should be reported as what. But unless they're specifically forensic accountants, they're not private investigators uncovering crimes.

by acchow 8y ago

> reliability of a company's financial statements I don't really understand the difference. Can you give an example of accounting fraud in which the company's financial statements are still reliable?

Tyrek 8y ago

The difference is one of scale. For example, a Walmart sized company could easily have some fraud going on the scale of a couple million dollars - the financial statements are considered to be materially correct (i.e. in that investors would not consider numbers off by a couple million to be a big deal), but there would still be fraud going on. You have to understand that the underlying concept of audit that a small team of auditors is responsible for ensuring that a huge (relatively) company is going about things correctly - there's no way to obtain a 100% assurance with that scale of manpower, and there's no appetite from companies to significantly increase the audit fees to obtain that level of assurance. Instead, a sampling/risk-based approach is taken in order to ensure that there cannot be a large error within the financials.

UK-Al05 8y ago
But the point is that auditors didn't catch massive amounts of fraud either. Where financial statements did not match reality at all.
acchow 8y ago
Ok, I think I understand now. The layers are: reality -> accounting books -> financial statements The auditors don't look at the first mapping "reality -> accounting books" but only at the second one "accounting books -> financial statements"? And even in the second mapping, they check with a sampling-based approach?
- sithadmin 8y ago
  >The auditors don't look at the first mapping "reality -> accounting books" but only at the second one "accounting books -> financial statements"? That's not entirely correct. A good portion of SOX audit efforts in the US, for instance, is spent on examining configuration of the various systems on which financial reporting is dependent (e.g. examining exactly how segregation of duty controls are implemented in the ERP system). A good portion of time is also spent examining if human-executed processes (e.g. employee on boarding/off boarding, granting permissions to data and financial system capabilities, manual review of backup job reports, etc) are actually being carried out in a manner that complies with the organization's SOX controls.
- Tyrek 8y ago
  No, all testing is down all the way down to 'reality'. But testing is statistically scaled to detect large errors. The threshold for 'large' shifts with how large the audited company is. i.e. a couple million dollars is a rounding error at Walmart. Additionally, pretty much 90% of an audit flows through a limited number of client contacts. Audits are not designed to defend against a concerted effort to prevent the auditors from seeing 'reality' (i.e. un-doctored documents), due to the manpower requirements to validate information at that level. Conceptually, it's the difference between 'I-trust-you-but-I-need-to-check-that-you-did-your-homework' and 'Trust no one, everything you see is a lie'.

bigjimmyk3 8y ago

What Tyrek said. Also, I could have phrased it better as "assurance that the company's financial statements accurately portray the activity in their accounting ledger(s)." An audit is about matching the financial statements to "the books" rather than looking for impropriety.

0003 8y ago
Audits also check that the book's transactions are correct, but this is done through a risk based approach. In my opinion, most practitioners do not understand risk quite well enough.

c3534l 8y ago

Think of it as the difference between undergoing code review versus trying to find instances of malware and hacking on a person's computer. An auditor makes sure that when GE releases financial statements, it's the same kind of thing as when Ford releases financial statements. They're making sure that when a manager at the factory gets equipment on an installment plan that the company is going to report that as debt, rather than pretend its a rental agreement (and when it's one over the other is complicated which is why you need accountants). If investors and creditors are going to get any use out of financial statements, Ford has to prepare its financial statements in the same way and according to the same principles that GE does. In order to make sure they're doing that, someone (an auditor) has to periodically make sure they're doing that. What might show up on an audit is if the accounting department is inherently dysfunctional and not keeping proper records. What they're not going to do is figure out if someone is intentionally trying to deceive an auditor. Accountants are experts in how you're supposed to prepare financial statements so that everyone follows the same standard of what should be reported as what. But unless they're specifically forensic accountants, they're not private investigators uncovering crimes.