Monday, June 25, 2007

Floyd Norris: Notions on High & Low Finance

An obscure government study of audit quality — in audits that are not regulated by much of anybody — has found that most audits conducted in 2002-’03 were not of sufficient quality to be relied upon.

The report was released last week with little fanfare. It concerns a requirement that recipients of federal grants and contracts provide the government with a “single audit” covering their financial statements and their use of the federal funds.

Based on analyses of 208 such audits, the study concluded that 21 percent of the audits were done correctly, and that another 28 percent were acceptable even though there were deficiencies. That adds up to less than half.

Of the others, it estimated that 16 percent were of limited reliability and 35 percent were completely unacceptable.

The study, conducted by the wonderfully named President’s Council on Integrity and Efficiency, did conclude that problems were less likely among big contractors, but such large firms were also where it found the most material reporting errors — where it appeared the auditors got numbers significantly wrong — as opposed to cases where the audit papers showed inadequate work.

Operations that received contracts from the Department of Education tended to have good audits, but those with contracts from the Department of Housing did not, partially because of problems at public housing agencies.
Two contracts were reviewed from Indian Tribal government entities, and both were unacceptable. Of nonprofit agencies, 26 of 76 had unacceptable audits. That compared to 5 of 30 colleges and universities — and 6 of 10 public housing agencies.

The auditing profession historically is among the least regulated on a national basis. State boards are primarily responsible, and have never done much to discipline inadequate work. The Public Company Accounting Oversight Board, established in 2002, only covers auditors of public companies.

The report recommends required education for such auditors, and it recommends some type of discipline, perhaps including fines for bad auditing. Now, there are penalties — rarely invoked — for the audited entities that submit bad audits, but none for the auditors themselves.