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statements to adjust revenues, costs, or expenses or to address securities-
related issues.
• Issues involving revenue recognition accounted for almost 38 percent of the re-
statements.


65
American Institute of Certified Public Accountants, Special Committee on Assurance Services,
www.aicpa.org, 1996.
66
Also see Robert K. Elliott, “The Future of Assurance Services: Implications for Academia,” Ac-
counting Horizons 9, No. 4 (December 1995), pp. 118“127; Robert K. Elliott and Donald M. Pallais,
four-part series dealing with the future of Assurance Services, Journal of Accountancy 183, Nos. 6, 7,
8, 9 (June, July, August, September 1997).
67
U.S. General Accounting Office, Financial Statement Restatements: Trends, Market Impact, Regula-
tory Responses, and Remaining Challenges GAO-03-138, October 4, 2002, www.gao.gov/gao-03-138.
Developments in Business Reporting and Assurance Services 137


• Of the 845 restating companies, 689 companies lost billions of dollars in mar-
ket capitalization in the days around the initial reinstatement announcement.68

Recognizing that these losses have shaken investors™ confidence in the nation™s
financial reporting system, the GAO believes that the Sarbanes-Oxley Act of 2002
addresses the financial statement restatements concerns, including strengthening
corporate governance and improving transparency and accountability to help en-
sure the accuracy and integrity of its financial reporting system.
Given the recent failures of major corporations, such as Enron, WorldCom,
Adelphia, and Global Crossing, the government™s increased scrutiny of the ac-
counting profession and the enactment of the Sarbanes-Oxley Act of 2002 have
triggered many new legal and regulatory reforms, as discussed in Chapter 1 and
Chapter 2. Notwithstanding the demise of the AICPA™s Independence Standards
Board, Public Oversight Board, and the Auditing Standards Board, for publicly
held companies the new Public Company Accounting Oversight Board not only
will have oversight and enforcement authority, but also will promulgate auditing,
quality control, and independence standards for the accounting profession. His-
torically, many of the AICPA™s Special Committees on financial reporting and
POB™s blue ribbon panels and committees have served as platforms for the is-
suance of standards and rules.
It is not known to what extent the new PCAOB will promulgate standards and
rules to close the expectations gap. However, the need for reliable and relevant fi-
nancial information remains of utmost importance to ensure an efficient capital
market system.
In an effort to enhance financial reporting and provide guidance for the partic-
ipants in the financial reporting process (financial statement preparers, auditors,
and audit committees), the five largest accounting firms in he United States and the
American Institute of Certified Public Accountants set forth these recommended
actions as common goals:

Management
• Ensure the proper tone at the top and an expectation that only the highest-quality
financial reporting is acceptable.
• Review all elements of the company™s internal control”control environment,
risk assessment, control activities, information and communication, and moni-
toring”in light of changes in the company™s business environment and with par-
ticular attention to significant financial statement areas.
• Ensure the appropriate levels of management involvement and review exist over
key accounting policy and financial reporting decisions.
• Establish a framework for open, timely communication with the auditors and the
audit committee on all significant matters.
• Strive for the highest quality, most transparent accounting and disclosure”not
just what is acceptable”in both financial statements and MD&A.

68
Ibid., p. 1.
138 The External Users of Accounting Information


• Make sure estimates and judgments are supported by reliable information and the
most reasonable assumptions in the circumstances, and that processes are in place
to ensure consistent application from period to period.
• Record identified audit differences.
• Base business decisions on economic reality rather than accounting goals.
• Expand the depth and disclosure surrounding subjective measurements used in
preparing the financial statements, including the likelihood and ramifications of
subsequent changes.
• When faced with a “gray” area, consult with others, consider the need for SEC
pre-clearance, and focus on the transparency of financial reporting.

Auditors
• Understand how a company is affected by changes in the current business
environment.
• Understand the stresses on the company™s internal control over financial report-
ing, and how they may impact its effectiveness.
• Identify key risk areas, particularly those involving significant estimates and
judgments.
• Approach the audit with objectivity and skepticism, notwithstanding prior expe-
riences with or belief in management™s integrity.
• Pay special attention to complex transactions, especially those presenting difficult
issues of form versus substance.
• Consider whether additional specialized knowledge is needed on the audit team.
• Make management aware of identified audit differences on a timely basis.
• Question the unusual and challenge anything that doesn™t make sense.
• Foster open, ongoing communications with management and the audit commit-
tee, including discussions about the quality of financial reporting and any pres-
sure to accept less than high-quality financial reporting.
• When faced with a “gray” area, perform appropriate procedures to test and cor-
roborate management™s explanations and representations, and consult with others
as needed.

Audit Committees
• Evaluate whether management exhibits the proper tone at the top and fosters a
culture and environment that promotes high-quality financial reporting, including
addressing internal control issues.
• Question management and auditors about how they assess the risk of material
misstatement, what the major risk areas are, and how they respond to identified
risks.
• Challenge management and the auditors to identify the difficult areas (e,g., sig-
nificant estimates and judgments) and explain fully how they each made their
judgments in those areas.
• Probe how management and the auditors have reacted to changes in the com-
pany™s business environment.
Sources and Suggested Readings 139


• Understand why critical accounting principles were chosen and how they were
applied and changed, and consider the quality of financial reporting and the trans-
parency of disclosures about accounting principles.
• Challenge management for explanations of any identified audit differences not
recorded.
• Understand the extent to which related parties exist and consider the transparency
of the related disclosures.
• Read the financial statements and MD&A to see if anything is inconsistent with
your own knowledge.
• Consider whether the readers of the financial statements and the MD&A will be
able to understand the disclosures and the risks of the company without the ac-
cess to management that the committee enjoys.
• Ask the auditors about pressure by management to accept less than high-quality
financial reporting.
• When faced with a “gray” area, increase the level of communication with man-
agement and the auditors.

Management, auditors, and audit committees each must diligently fulfill its own role
and effectively work together with the others through proactive communication and
information sharing. In working together, we can collectively improve the financial
reporting process. This requires renewed commitment by each of the parties to the
needs of financial statement users.69



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American Stock Exchange, American Stock Exchange Fact Book 1991 (New York: ASE,
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69
American Institute of Certified Public Accountants, “Impact of the Current Economic and Business
Environment on Financial Reporting” (2000), pp. 10“11, www.aicpa.org.
140 The External Users of Accounting Information


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Sources and Suggested Readings 141


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