Tipping Point Sidebar: Should the Big Four audit firms prepare GAAP financial statements and have them audited?
Should the cobbler’s children have shoes? It's unbelievable but, in the U.S., the auditors don't prepare GAAP financial statements and are not audited!
A Note from Francine McKenna, Editor: In his post on Nov. 28, Jim Peterson proposed a way to look at the “tipping point” for another Big Four audit firm leaving the playing field - — whether from litigation or a regulatory enforcement action. We know it will never come from a government, if the U.S. and U.K. can help it, but there are always cases bubbling up and judges that didn’t get the “too few to fail” memo. In this Sidebar we look at a fundamental problem: We have no way of even knowing if any large global firm is in a precarious financial position. You say that the SEC or PCAOB are monitoring firm financial viability? Don’t count on it!
The basic proposition lays out simply, by applying straightforward assumptions about human risk aversion from the behavioral economists to the limited financial information published by the Big Four: It is clear that the international networks are not capable, by structure or financial resources, of surviving a litigation shock on the scale that killed Arthur Andersen.
Better data would support analysis more refined and granular. Except that the Big Four, for their own reasons, offer only the barest top-line numbers on their own financial performance and condition. For want of completeness, transparency and comparability, the information on which to make like-for-like comparisons and more nuanced assessments is simply not available.
It’s to be emphasized that the Big Four have been allowed to choose the quantity and format of the information they provide to their interested public, operating as they do as assemblages of private local-country partnerships and not as listed companies with required reporting to outside capital providers.
That being said, however, there would be two reasons to consider the desirability of change, either under the interests of the Big Four themselves or as deemed desirable by the profession’s regulators: an improved basis for the on-going discussion of the Big Audit model itself, and the credibility of the profession as it defends against its critics.
The Data Beneath the Fragility Discussion
First is the significance of the issue of financial fragility explored here. If the public debate about the fitness for purpose of the Big Audit model is ever to move beyond the misplaced notion that the large firms are “too big or few to fail,” it will be necessary to have in view the data underlying the compelling generalization that they are “too fragile to survive.”
A sampling of the issues that confront a reviewer.
Lines of practice are not consistently described, making comparisons difficult. PwC and KPMG maintain the traditional three-some of Assurance, Advisory, and Tax & Legal. Deloitte breaks itself down to Audit & Assurance, Consulting, Financial Advisory, Risk Advisory and Tax & Legal. EY’s categories are Assurance, Tax (without reference to Legal), Consulting, and Strategy and Transactions.
Practice regions are generally consistent for three regions –- the Americas, Asia-Pacific and EMEA – but without clarification of the regional boundaries. PwC alone provides actual revenue figures by region, and high-lights certain sub-areas, but by percentage changes only and without displaying regional or country revenues by practice line (and, for whatever reasons, PwC’s UK results include its practices in the Middle East). The other three report regional year-on-year results by percentages, but without including the baseline numbers, thus obscuring the ability to observe shifts in practice mix.
Exchange rates are referenced generally, as each network converts its local-country results and reports its top-line figures in US dollars. But none of the networks actually operates under an integrated or cohesive profit-and-loss model for its widely scattered local-country partners, nor do they disclose the pricing mechanisms or transaction amounts for engagements performed on a multi-country basis, making cross-border comparisons of efficiency or profitability invisible to an outsider.
And, to the central theme here of exposure and fragility, the statements are uniformly opaque on:
· The quantification of litigation claims and contingency exposures, reflecting the modus vivendi between the accounting standards-setters and the litigation defense lawyers that has forever permitted a shroud of confidentiality over the uncertainties of publicly predicted litigation outcomes.
· The extent and particulars of available insurance either commercial or “captive.”
· The existence and extent of cross-network undertakings or commitments to support a local firm in financial distress.