Now, let's get to something that is a little bit more particular to the audit,
and that is a little bit more opaque to investors.
And that is, what does the auditor,
and management, and the audit committee, collectively decide?
Although at the end of the day,
it is management's financial statements.
What was the materiality of these adjustments that the auditors proposed?
Now technically, the auditors cannot require an adjustment.
They can ask management to adjust these books, their books,
and if management refuses
the auditor can similarly refuse to sign an opinion, okay?
These are management's financial statements.
But is materiality used by
the audit committee or by management as a reason
for not booking an audit proposed adjustment.
And what I would like to emphasize here,
is that the best rejoinder to that,
if you're the auditor, if it's truly materiality.
If the only reason you're not making the adjustment is because
it's not going to be material to the users of the financial statements.
Well then that's all the more reason to make the adjustment, isn't it?
Because as you just said,
it's not going to affect the users.
So there probably is,
when management says this materiality,
that's the main reason, what they really mean is that,
we don't want to adjust these numbers.
Or there could be a legitimate,
it's very costly to go,
and I know you're making this one overarching debit and overarching credit.
But, I mean, these credits and debits exist in companies all over the world,
and as it turns out, they're not even using the same accounting system.
So it's a costly adjustment to make
and it's not material.
That to me, is much more persuasive than to saying it's not material.
And then you also want to know,
if the proposed audit adjustments that would be made,
either suggested by the external auditor,
or internal auditors had been recorded.
Collectively or individually, you start wanting to
know what would have been the impact on earnings?
This is something that never sees the light of day, okay?
You don't see this as an investor.
This is something that is discussed among the audit committee, auditors in management,
and in the auditor's report, you just don't,
today see anything about these waived and executed adjustments.
You could ask yourself why,
and I really don't have a great answer for you.
In fact, I could even show you an old audit report by Arthur Anderson,
when it was probably the auditor's auditor firm.
It had probably arguably, the best reputation of any audit firm,
with all respect to the existing firms today.
They have audit reports where they actually lay out.
Here's where we adjusted your earnings,
you were improperly accounting for overhead,
we fixed that. Blah, blah, blah.
Then that tells the user that the auditor did something.
You want to know how the recording of
the proposed adjustments would have altered the company's earnings situation,
in relation to meeting analyst's expectations,
to management's plans, to debt covenants or compensation.
Same idea. Now, there is
some relatively recent guidance in the last decade, decade and a half.
SEC Staff Accounting Bulletin 91
was a really good piece of regulation if you ask me,
because it lets the auditor say,
you know it's not me, it's the rules.
The guidance tells you that,
if you have detected misstatements that management can't use,
if it's a public company,
if it's truly a direct misstatement,
they can't use materiality as the sole guide for not booking it.
It also tells you that,
when you assess the quality of earnings,
you ask yourself, does there appear to be any intentional misstatements,
and do the misstatements collectively change
the earnings from one side of the threshold to another side of a threshold?
These thresholds would be accounting loss, accounting net income.
Income that is as big or bigger than last year's same quarter,
or less than last year's same quarter.
Income that is above,
at or above, analyst's earnings expectations
or below analyst's earnings expectations.
Even though it's not on the slide here,
another big help for Staff Accounting Bulletin 99 is that,
if you have actually located misstatements for public company,
managements cannot use materiality
alone as the basis for failure to book the adjustment.
So hopefully this lesson has helped your thinking in
thinking about the overall quality of earnings, as auditors
think about it and audit committee members think about it.
And as they, along with management get to see this
and that investors at large,
third party investors, do not get to see.
It's kind of behind the veil in corporate reporting today.
Mark E. Peecher, PhD, CPAAssociate Dean of Faculty and Deloitte Professor of Accountancy
