January 16, 2008 / 12:32 AM / 12 years ago

Top audit firms push to use their own judgment

NEW YORK, Jan 15 (Reuters) - Auditors and corporate finance departments must be able to use professional judgment without being second-guessed if countries continue to adopt principle-based accounting standards, the chief executives of the top six global accounting networks argued in a white paper on Tuesday.

The paper, presented at a Global Public Policy Symposium in New York, urged regulators and other stakeholders to create a system where reasonable auditor judgments are accepted.

“Investors are best served when financial reports are clear and easy to understand and use,” the CEOs of Deloitte Touche Tohmatsu [DLTE.UL], Ernst & Young [ERNY.UL], PricewaterhouseCoopers [PWC.UL], KPMG [KPMG.UL], Grant Thornton, and BDO Seidman wrote.

“In order to deliver on that goal, preparers and auditors must be given the space to exercise professional judgment and to feel confident that their judgment, so long as it is fundamentally sound and documented, will not be subject to second-guessing.”

More than 100 countries are currently using, or plan to use International Financial Reporting Standards (IFRS), which are seen as a more principle-based accounting system. In recent months many have called for the United States to set a national plan to move to IFRS from U.S. Generally Accepted Accounting Principles, which are often viewed as more rule-based.

The widespread use of more principle-based standards, however, will need to rely on judgment from auditors because under that system they cannot look to rulemakers for constant clarifications, interpretations or exceptions, the CEOs said.

“Changes in these high-level, principled standards, I think would be less frequent,” Deloitte CEO James Quigley said in an interview this week with Reuters. “Those standards would be almost timeless.”

The auditors’ calls for a judgment framework follow attempts to persuade lawmakers last year to adopt liability caps that would restrict how much an auditor could be responsible in litigation if it fails to detect a fraud.

The effort failed to gain much traction in the United States, with the U.S. Government Accountability Office saying last week that it sees no compelling need for auditor liability caps.

But auditors have been on the defensive since litigation over accounting at Enron Corp. resulted in the demise of the energy trader’s auditor Arthur Andersen, and the firms are concerned that litigation from an undetected fraud at a large public company could potentially leave them bankrupt.

“The intent of a judgment framework is not to say the exercise of judgment is always correct, but rather, it’s a procedure-based approach,” said Robert Pozen, head of a 17-member committee put together by the U.S. Securities and Exchange Commission to examine financial reporting.

“I don’t think in the U.S. system of caps for liability — I just don’t see it in Congress — but this sort of procedural discipline could break the cycle of endless interpretation,” Pozen said.

While regulators would have to work to ensure comparable practices exist around the globe, the CEOs said they believe principle-based standards and a judgment framework would make it harder for companies to manipulate or circumvent accounting, because they would have to back up their decisions.

“The reality is that under today’s rules-based accounting standards... companies can comply with the strict letter of the law, yet fail to provide the information that provides a clear picture of the economic state of the enterprise,” the CEOs wrote in the paper.

The shift would be a sea change for U.S. auditors, who often prefer written interpretations. It would make accountants more like constitutional lawyers who try to support their actions with already-existing rules.

“We actually have to move to a completely new behavioral aspect,” Sir David Tweedie, head of the International Accounting Standards Board, said at the symposium.

“I remember someone coming up to me, panicking at a conference and saying, ‘What do I do?’ The answer is,’Your best,’ and that’s going to be the key to professional judgment.”

Reporting by Emily Chasan, editing by Leslie Gevirtz

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