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Kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 1 Auditing in the Post Enron World Phil Schimmel PIC, Assurance.

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Presentation on theme: "Kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 1 Auditing in the Post Enron World Phil Schimmel PIC, Assurance."— Presentation transcript:

1 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 1 Auditing in the Post Enron World Phil Schimmel PIC, Assurance & Advisory Services Western Area (Los Angeles) KPMG LLP Mid-Year Meeting of the Auditing Section of the AAA Huntington Beach, CA January 17, 2003

2 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 2 The Current Environment

3 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 3 The Current Environment Alleged financial reporting crisis – infectious greed More stringent regulation – globally Rapid change, increasing complexity and disintegration of Arthur Andersen Tarnished image of the profession

4 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 4 The Current Environment Restatements up dramatically – Approaching 4% of NYSE-listed companies and 3% of NASDAQ-listed companies (Projected)

5 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 5 The Current Environment Percent Restatements by Reason, 1997 – June 2002 – Revenue……………………………………… 37.9% – Cost/expense………………………………… 15.7% – Restructuring/assets/inventory…………….. 8.9% – Acquisition/merger………………………….. 5.9% – Securities-related……………………………. 5.4% – Reclassification……………………………… 5.1% – IPR&D………………………………………… 3.6% – Related-party transactions…………………. 3.0% – Other………………………………………… %

6 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 6 The Current Environment Market Cap (Decrease) Increase by Reason, 1997 – March 27, 2002 (In Billions) – Revenue……………………………………… (56.4) – Cost/expense………………………………... (4.8) – Restructuring/assets/inventory…………… – Acquisition/merger………………………….. (19.3) – Securities-related…………………………… (2.3) – Reclassification……………………………… (1.2) – IPR&D………………………………………… (4.4) – Related-party transactions…………………. (2.1) – Other………………………………………….(12.6)

7 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 7 The Current Environment Regulatory trends (global): – More independent regulatory bodies with more power – Improved corporate governance and transparent financial reporting – Auditor independence (scope of services, partner rotation, firm rotation, partners/employees joining clients, etc.) – Expanded auditor responsibilities (fraud, internal controls, laws/regulation compliance, etc.) – Tougher standards for Firm quality controls and inspection by others for compliance – Harsher disciplinary proceedings and sanctions impacting firms and individuals

8 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 8 The Current Environment Increasing complexity for auditors – Difficult worldwide economy – Rapidly changing business models – Troubled and rapidly changing industries – Increasingly complex transactions Tracked by increasingly complex systems Accounted for by increasingly complex rules – Pressure for increasingly quick audit sign-offs

9 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 9 Market Demands

10 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 10 Market Demands on Public Companies Corporate integrity Severe penalties for wrongdoing Ethical corporate governance for benefit of shareholders and other stakeholders, not management Improved audit committee oversight of financial reporting & audit processes Transparent financial disclosure Reported earnings that reflect reality Reformed executive compensation and incentives, including expensing stock options More timely and accurate information, including non- financial information

11 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 11 Market Demands on Auditors No audit failures Detect fraud and senior management misconduct Transparent financial disclosure Reported earnings that reflect reality Assurance on internal controls Greater independence in appearance as well as fact

12 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 12 What This Means to Audit Firms

13 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 13 What This Means to Audit Firms High media/public profile Cost of future audit failure Protection from catastrophic events Audit relationship shift Effective and independent audit Increased audit consultation with CEOs & audit committees Increased legal consideration Audit scope & fee increases

14 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 14 What This Means to Audit Firms: Expectations of CEO Auditor assurances to support CEO certification – Low/no tolerance for restatements – Expanded quarterly reviews – Expanded internal controls assurance – Assurance on non-financial information in SEC filings Increased consultation – Creation of appropriate tone at the top – Risk identification and risk management processes – Systems and controls to manage risks

15 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 15 What This Means to Audit Firms: Expectations of Audit Committee The Committee is the client; hires and fires the auditors Real dialogue and tough questions Consultations on business risks, audit risks & audit scope required to reduce audit risk to a low level Frequent communications on interim audit findings & interim changes to audit scope Information/assurance on - – Critical accounting policy choices – Financial reporting quality – Resolution of issues with management – Senior management integrity and misconduct – Completeness of information from management – Internal controls

16 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 16 Causes of Audit Failures

17 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 17 Causes of Audit Failure Audit failures frequently relate to inadequate industry expertise Failure to - Industry-related Understand the entitys business model Understand changes in the entitys operating environment Fully understand the nature and business purpose of transactions Perform appropriate client acceptance/continuance procedures Reconsider prior year judgments or assumptions Involve specialists Other Be sufficiently firm with client Corroborate explanations given by client Appropriately consider corporate governance Consult on issues and judgments Arrange realistic deadlines Audit failures are generally execution failures, not methodology failures

18 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 18 KPMGs Response – Post Enron

19 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 19 KPMGs Response – Post Enron Task force of senior partners (U.S. and International) to took a fresh look at KPMGs BMP audit methodology in the light of current environment and professional issues Task force conclusion: BMP methodology is sound and even more appropriate in todays environment. Focus should be on continuous improvements to execution.

20 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 20 Other KPMG Responses Increase professional skepticism Learn from audit failures – ours and those of our competitors Expand audit program that addresses risk of fraud Adapt controls evaluation and testing methods, policies and procedures for attestation on managements reporting on internal controls New model for audit committee collaborations & deliverables More involvement of experienced audit team members More involvement of specialists, particularly IT and Forensic specialists Recruit, develop and retain the best people More hours more fees

21 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 21 Proposed Authoritative Guidance Aligns GAAS with BMP

22 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 22 Proposed Guidance Aligns GAAS With BMP Exposure draft on Understanding the Entity and Its Environment and Assessing the Risk of Material Misstatement Examples of proposed requirements under the ED aligned with BMPs business modeling, strategic analysis and process analysis methodologies: – Obtain understanding of: Objectives and strategies and the related business risks, including the entitys risk assessment process Industry, regulatory & other external factors Measurement & review of the entitys financial performance (KPIs) Controls relating to operations & compliance pertaining to data the auditor uses in applying analytical procedures How transactions are generated within the entitys business processes

23 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 23 Proposed Guidance Aligns GAAS With BMP ED also: – Recognizes that information obtained and evaluated to assess the risk of material misstatement constitutes audit evidence – Requires iterative revisions to risk assessments when additional audit evidence contradicts prior assessments – Requires exchange of information about risk assessments through discussions among audit team members to achieve shared awareness – Requires the auditor to document the: understanding obtained through risk assessment discussions among audit team members and how and when they occur risks identified results of the risk assessment linkages between identified risks and additional audit procedures

24 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 24 Support for Higher Education KPMG Foundation Programs – – Matching gifts – PhD Project – Minority Doctoral Scholarships – Sponsorship of Key Conferences & Organizations – KPMG/UIUC Business Measurement Case Develop & Research Program

25 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 25 Support for Higher Education Cases are available from the KPMG/University of Illinois Business Measurement Case Development & Research Program to assist you in helping students develop the critical systems-thinking and business analysis skills needed to perform risk assessment effectively in todays complex audit environment. To-date, over 70,000 copies of the cases have been downloaded from the Programs web site. MBUSI – 10,522Reiter – 4,883Trigon – 2,980 Loblaws – 7,295Lincoln S&L – 4,332Qantas – 4,826 IDEC – 5,412CVS – 17,300U.S. Prem. Beef – Wells Fargo – 8,706VCC – 3,268

26 kpmg © 2002 KPMG International, a Swiss nonoperating association. All rights reserved. 26 Thank You


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