kpmg © 2002 kpmg international, a swiss nonoperating association. all rights reserved. 1 auditing...

kpmgkpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved.

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Auditing in the Post Enron World

Phil SchimmelPIC, Assurance & Advisory Services

Western Area (Los Angeles) KPMG LLP

Mid-Year Meeting of the Auditing Section of the AAAHuntington Beach, CA

January 17, 2003


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The Current Environment


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Alleged financial reporting crisis – “infectious greed”

More stringent regulation – globally

Rapid change, increasing complexity and disintegration of Arthur Andersen

Tarnished image of the profession


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Restatements up dramatically

– Approaching 4% of NYSE-listed companies and 3% of NASDAQ-listed companies

92 102

174201

225250

0

50

100

150

200

250

300

1997 1998 1999 2000 2001 2002

Year

Nu

mb

er

of

Re

sta

tem

en

ts

(Projected)


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Percent Restatements by Reason, 1997 – June 2002

– Revenue……………………………………… 37.9%

– Cost/expense………………………………… 15.7%

– Restructuring/assets/inventory…………….. 8.9%

– Acquisition/merger………………………….. 5.9%

– Securities-related……………………………. 5.4%

– Reclassification……………………………… 5.1%

– IPR&D………………………………………… 3.6%

– Related-party transactions…………………. 3.0%

– Other………………………………………….. 14.5%


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The Current Environment Market Cap (Decrease) Increase by Reason, 1997 – March 27, 2002 (In Billions)

– Revenue……………………………………… (56.4)

– Cost/expense………………………………... (4.8)

– Restructuring/assets/inventory…………….. 2.9

– Acquisition/merger………………………….. (19.3)

– Securities-related…………………………… (2.3)

– Reclassification……………………………… (1.2)

– IPR&D………………………………………… (4.4)

– Related-party transactions…………………. (2.1)

– Other………………………………………….(12.6)


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Regulatory trends (global):

– More independent regulatory bodies with more power

– Improved corporate governance and “transparent” financial reporting

– Auditor independence (scope of services, partner rotation, firm rotation, partners/employees joining clients, etc.)

– Expanded auditor responsibilities (fraud, internal controls, laws/regulation compliance, etc.)

– Tougher standards for Firm quality controls and inspection by others for compliance

– Harsher disciplinary proceedings and sanctions impacting firms and individuals


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Increasing complexity for auditors

– Difficult worldwide economy

– Rapidly changing business models

– Troubled and rapidly changing industries

– Increasingly complex transactions

• Tracked by increasingly complex systems

• Accounted for by increasingly complex rules

– Pressure for increasingly quick audit sign-offs


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Market Demands


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Market Demands on Public Companies

Corporate integrity Severe penalties for wrongdoing Ethical corporate governance for benefit of shareholders and

other stakeholders, not management Improved audit committee oversight of financial reporting &

audit processes “Transparent” financial disclosure Reported earnings that reflect reality Reformed executive compensation and incentives, including

expensing stock options More timely and accurate information, including non-financial

information


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Market Demands on Auditors

No audit failures

Detect fraud and senior management misconduct

“Transparent” financial disclosure

Reported earnings that reflect reality

Assurance on internal controls

Greater independence in appearance as well as fact


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What This Means to Audit Firms


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What This Means to Audit Firms

High media/public profile

Cost of future audit failure

Protection from catastrophic events

Audit relationship shift

Effective and independent audit

Increased audit consultation with CEOs & audit committees

Increased legal consideration

Audit scope & fee increases


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What This Means to Audit Firms: Expectations of CEO

Auditor assurances to support CEO certification

– Low/no tolerance for restatements

– Expanded quarterly reviews

– Expanded internal controls assurance

– Assurance on non-financial information in SEC filings

Increased consultation

– Creation of appropriate “tone at the top”

– Risk identification and risk management processes

– Systems and controls to manage risks


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What This Means to Audit Firms: Expectations of Audit Committee

The Committee is the client; hires and fires the auditors

Real dialogue and tough questions

Consultations on business risks, audit risks & audit scope required to reduce audit risk to a low level

Frequent communications on interim audit findings & interim changes to audit scope

Information/assurance on - – Critical accounting policy choices – Financial reporting quality– Resolution of issues with management– Senior management integrity and misconduct– Completeness of information from management– Internal controls


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Causes of Audit Failures


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Causes of Audit Failure

Audit failures frequently relate to inadequate industry expertise

Failure to -

Industry-related Understand the entity’s business model Understand changes in the entity’s operating environment Fully understand the nature and business purpose of transactions Perform appropriate client acceptance/continuance procedures Reconsider prior year judgments or assumptions Involve specialists

Other Be sufficiently firm with client Corroborate explanations given by client Appropriately consider corporate governance Consult on issues and judgments Arrange realistic deadlines

Audit failures are generally execution failures, not methodology failures


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KPMG’s Response – Post Enron


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KPMG’s Response – Post Enron

Task force of senior partners (U.S. and International) to took a fresh look at KPMG’s BMP audit methodology in the light of current environment and professional issues

Task force conclusion:

“BMP methodology is sound and even more appropriate in today’s environment.”

“Focus should be on continuous improvements to execution.”


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Other KPMG Responses

Increase professional skepticism

Learn from audit failures – ours and those of our competitors

Expand audit program that addresses risk of fraud

Adapt controls evaluation and testing methods, policies and procedures for attestation on management’s reporting on internal controls

New model for audit committee collaborations & deliverables

More involvement of experienced audit team members

More involvement of specialists, particularly IT and Forensic specialists

Recruit, develop and retain the best people

More hours more fees


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Proposed Authoritative GuidanceAligns GAAS with BMP


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Proposed Guidance Aligns GAAS With BMP

Exposure draft on Understanding the Entity and Its Environment and Assessing the Risk of Material Misstatement

Examples of proposed requirements under the ED aligned with BMP’s business modeling, strategic analysis and process analysis methodologies:

– Obtain understanding of:

• Objectives and strategies and the related business risks, including the entity’s risk assessment process

• Industry, regulatory & other external factors

• Measurement & review of the entity’s financial performance (KPIs)

• Controls relating to operations & compliance pertaining to data the auditor uses in applying analytical procedures

• How transactions are generated within the entity’s business processes


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Proposed Guidance Aligns GAAS With BMP

ED also:

– Recognizes that information obtained and evaluated to assess the risk of material misstatement constitutes audit evidence

– Requires iterative revisions to risk assessments when additional audit evidence contradicts prior assessments

– Requires exchange of information about risk assessments through discussions among audit team members to achieve shared awareness

– Requires the auditor to document the: • understanding obtained through risk assessment

• discussions among audit team members and how and when they occur

• risks identified

• results of the risk assessment

• linkages between identified risks and additional audit procedures


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Support for Higher Education

KPMG Foundation Programs – – Matching gifts

– PhD Project

– Minority Doctoral Scholarships

– Sponsorship of Key Conferences & Organizations

– KPMG/UIUC Business Measurement Case Develop & Research Program


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Support for Higher Education

Cases are available from the KPMG/University of Illinois Business Measurement Case Development & Research Program to assist you in helping students develop the critical systems-thinking and business analysis skills needed to perform risk assessment effectively in today’s complex audit environment.

To-date, over 70,000 copies of the cases have been downloaded from the Program’s web site.

MBUSI – 10,522 Reiter – 4,883 Trigon – 2,980

Loblaws – 7,295 Lincoln S&L – 4,332 Qantas – 4,826

IDEC – 5,412 CVS – 17,300 U.S. Prem. Beef – 1.034

Wells Fargo – 8,706 VCC – 3,268


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Thank You

kpmg © 2002 kpmg international, a swiss nonoperating association. all rights reserved. 1 auditing...

Documents

kpmg international

swiss nonoperating association

current environment

profession slide

market demands slide

complex transactions

relatedparty transactions

firm rotation