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Accountants, auditors adopt new rules

In the wake of U.S. corporate scandals that put accountants and auditors under fire, the profession is establishing new standards and practices, including the creation of a new organization charged with overseeing the auditors of public companies.

The Canadian Public Accountability Board was created in July with the mission of contributing to public confidence in the integrity of financial reporting and promoting high-quality, independent auditing. That includes establishing and maintaining the requirements of firms auditing public companies.

"I'm not aware that there are serious problems out there," says Gordon Thiessen, former governor of the Bank of Canada and CPAB's new chairman.

"But I think it's important to achieve the highest possible auditing standards in Canada. The financial system doesn't work well if people don't have confidence in statements. That's crucial."

CPAB's National Inspection Unit will inspect firms that audit public companies to determine whether the firms are complying with professional standards, rules and relevant regulatory requirements.

CPAB will also ask major chartered accountancy firms that audit public companies about their quality controls and their incentives for partners to live up to them, Mr. Thiessen says.

"I like the current emphasis on independence [of auditors], and I'm pleased to see less involvement by auditors in other consulting work for a corporation."

Establishing high-quality control at a national level will benefit individual firms, he says, which might otherwise find themselves at a competitive disadvantage since "high-quality audits cost more."

Al Rosen has been an outspoken critic of accounting and auditing practices in Canada. A leading forensic accountant and founder of Rosen & Associates Ltd., a forensic and investigative accounting firm, Mr. Rosen has criticized generally accepted accounting principles (GAAP) as inadequate in fairly reporting company finances, and allowing for manipulation of profit figures.

Likewise, generally accepted auditing standards (GAAS) are failing to catch frauds and serious deficiencies in accounting, he says.

Mr. Rosen charges that auditors are not giving company directors the information that they require, and "from an investor and creditor point of view, the [financial] information is just useless most of time."

One study showed that using U.S. accounting rules in audits of Canadian public companies left two-thirds of the companies showing lower profits than those using Canadian accounting rules, he says. "These are huge differences."

Mr. Rosen's charge is that auditors have been acting in the interests of the companies that hire them rather in the interests of the shareholders, as required under the Companies Act.

Furthermore, accountants set the accounting rules in Canada, unlike in most other countries, where the rules are independently set, he says.

His recommendations: First, the law must be changed so that auditors cannot argue, as they did successfully before the Supreme Court of Canada in Hercules Management Ltd. versus Ernst & Young, that they have no individual "duty of care" to shareholders.

Second, he says, accountants should not be allowed to set their own rules any more. "There's no responsibility to shareholders, but on the other hand, they argue they have to set the rules? It doesn't make sense."

A national security commission is needed, as well as governance education, and the requirements and responsibilities of directors and officers need to be clarified, he says.

"We need some responsibility, some enforcement. Otherwise, why invest in Canada?"

Meanwhile, accountants' professional organizations have been actively initiating projects to improve auditing and other governance functions. In September, the Canadian Institute of Chartered Accountants co-hosted a forum in Toronto for more than 100 of the country's top corporate directors to discuss audit committees after the Enron Corp. scandal, and, in January, it released Integrity in the Spotlight: Opportunities for Audit Committees, billed as "the first post-Enron guide for audit committees, management and auditors."

The book describes the audit committee's key responsibility in overseeing the external auditor, and the recognition that the external auditor works for and is accountable to the audit committee and board of directors as representatives of the shareholders.

"One of the things that's very different today is that the auditing firm no longer reports to management but [to] the audit committee. So the audit committee hires and fires the auditor," says Bill Swirsky, vice-president of knowledge development for the CICA.

The CICA's public interest and integrity committee also began an examination of audit independence standards in Canada and issued a draft last fall proposing a more rigorous "principles-based" code based on a proactive approach.

In co-operation with the U.S. Financial Accounting Standards Board, the CICA's Accounting Standards Board has also established new guidelines for the use of special-purpose entities, which have been used in the past to keep liabilities off balance sheets.

The CICA says it has taken a North American lead in creating new standards that require disclosure of stock options on income statements. Many companies are already voluntarily recording stock options as expenses, says Bob Rutherford, CICA vice-president of standards.

The association has also released a new guide as to what companies should include in management's discussion and analysis, documents intended to complement financial data in annual reports, setting out corporate vision and strategy.

Last October, the auditing profession got another new, independent board -- the Auditing and Assurance Standards Oversight Council -- to oversee the activities of the Assurance Standards Board.

Headed by lawyer and corporate director James Baillie, it will propose, debate and draft changes to the thick book of auditing rules in Canada. Where the Accounting Standards Board oversees accounting rule changes, the AASOC will similarly oversee audit rule changes.

In November, Certified Management Accountants of Canada issued guidelines for company boards and CEOs in the form of a "scorecard." Measuring and Improving Performance of Corporate Boards addresses "enterprise governance," a combination of corporate governance and performance management, says CMA Canada president Robert Dye.

"The other organizations seem to want to focus on developing new regulations to enhance auditing structures and mandate changes in relations between the CEO and the board chair," Mr. Dye said.

"We agree those initiative are important, but they're only a small part of the solution.

"Corporations will continue to fail if they focus exclusively on mandating structural changes on the board without judging whether these changes will improve the performance of the board."

The balanced scorecard for evaluating corporate performance covers four dimensions: financial, customer, internal business processes, and learning and growth.

The big issue for boards is not corporate scandal and fraud, says Mr. Dye, but failed strategies. In the case of Nortel Networks Corp., for instance, "there was no fraud, but a clearly failed strategy, where they had built their business to react to what they saw was an ever-growing market."

On the balanced scorecard, the board of directors questions the CEO when expansion plans and new strategies are proposed and put into place, Mr. Dye says.

© The Globe and Mail

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