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By AARON ELSTEIN
THE WALL STREET JOURNAL ONLINE
August 1, 2001
Auditing firms are more likely to compromise and stretch the
bounds of accepted accounting practices when they are receiving
substantial consulting fees from the firms they audit, according
to an academic study to be released Wednesday.
The study -- by professors at Massachusetts Institute of Technology,
Michigan State University and Stanford University -- is one
of the first to pore through financial filings to answer empirically
one of the key questions facing the accounting industry: How
objective can an accounting firm be in an audit when it is
also making millions of dollars providing the same client
with other services?
Even as securities regulators in the past year have sought
to toughen auditor-independence standards, accounting firms
have been adamant that there isn't evidence to support claims
that consulting work interferes with their ability to conduct
an honest review of a client's books.
"Our study suggests that paying an accounting firm more
for non audit services impairs auditor independence and reduces
the quality of earnings," said Karen Nelson, a co-author
and accounting professor at Stanford. The report is based
on a review of 4,200 company filings with regulators since
February, when the Securities and Exchange Commission began
requiring disclosure of fees to auditing firms.
Al Anderson, a senior vice president at the American Institute
of Certified Public Accountants, a trade group, said the group
as of Tuesday hadn't had time to assess the study in detail.
In general, he said, it is "unfair" to conclude
that auditors are "less independent" if they work
for the same firm as the company's consultants.
The study defined auditors as potentially compromised if clients
pay them less for their annual audit than they do for consulting
and other services. Some 47% of the firms surveyed fell into
this category.
When accounting firms depend on consulting fees, their clients
are more likely to carry substantially higher discretionary
reserves, which are balance-sheet accounts that can offset
earnings shortfalls, the study said. One way to build discretionary
reserves, the researchers said, is to take a bigger charge
against earnings than necessary when doing a merger, then
dip into this "cookie jar" to increase future earnings.
The SEC has expressed skepticism of these discretionary reserves
because of their ability to be tapped to help companies meet
or beat earnings estimates. Auditors who are afraid of jeopardizing
consulting relationships may have an incentive not to question
what the SEC considers "earnings management," the
study says.
Write to Aaron Elstein at aaron.elstein@wsj.com
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