RESEARCH Business Industry

ACCOUNTING
Law professor warned of accounting profession’s ethical conflicts

Mark Reutter, Business Editor
(217) 333-0568; mreutter@uiuc.edu

4/1/02

Photo by Bill Wiegand In a prescient 1987 article, University of Illinois law professor Richard L. Kaplan warned that coziness between auditors and managers and pressure to sell consulting services to corporations were distorting the "core standards" of large accounting firms.

CHAMPAIGN, Ill. — Published 15 years ago, the words sound prescient today: "Conflicts in the critical area of auditor independence must be resolved before significant credibility can be restored to the profession."

In a 1987 article, a University of Illinois law professor warned that coziness between auditors and managers and pressure to sell consulting services to corporations were distorting the "core standards" of large accounting firms. Unless the profession returned to its "public watchdog" role – as mandated by the 1933 Securities Act – it risked congressional investigations and "huge" stockholder lawsuits.

Richard L. Kaplan reached these conclusions from working for one of the international accounting firms and from teaching a course titled "Accounting Issues for Lawyers." He found serious problems with the dual loyalties that accountants face. "They must be rigorous in determining the financial statements’ reliability but not so rigorous that corporate management seeks out a more compliant firm." This conflict of interest is aggravated when accountants lose "the appearance, if not the fact, of independence" by doing consulting work for the very companies they were auditing.

The profession's shift from "watchdog to lapdog" accelerated over the next decade, Kaplan said. In his 1987 article in the Journal of Accounting and Public Policy, he cautioned, "Far too many accountants seem to shun the unglamorous role of skeptical guardian of the public for the more charismatic posture of business adviser and confidante. They apparently see themselves as assisting corporate management, not monitoring them. So if a company needs to get around some accounting pronouncements, the letter of the edict may be twisted to derive a result that is at odds with its spirit."

When a company with an auditors' seal of approval unexpectedly collapses, he continued, the profession is "horrified" that its work is "judged with a result-oriented application of 20/20 hindsight," while "everyone else is incredulous that an audit could possibly satisfy 'generally accepted standards' and yet be so deficient in actual fact."

Feeding this "trust-me-but-don’t-blame-me" mindset, according to Kaplan, were efforts by the big firms to "educate" the public about the limitations of audits. "The public won't accept educating itself as the answer. Besides, if the financial public really understood the limitations of the 'generally acceptable' audit, they might conclude that such audits are not worth requiring or obtaining."

Expectations should be met the other way around, Kaplan wrote – "by accountants providing the audit that the public wants and apparently thinks it is getting already."

The UI scholar said that a thorough audit of a company’s finances should not be prohibitively expensive, especially if accountants re-examined some of their arcane procedures. "Perhaps, for example, more time should be spent on asset verification procedures and less on simply replicating last year’s paperwork without much regard to the continuing utility of the exercise."

The bottom line according to Kaplan: "If accountants are not catching fraud, why do we have them?"