This paper provides evidence from 578 practicing internal auditors related to current internal auditing practices regarding the assessment of management’s tone.

PricewaterhouseCoopers conducted a survey to develop a composite picture of internal audit by 2012.

Today, in congressional action sure to give every internal auditor recurring nightmares, members of the U.S. House Capital Markets Subcommittee demanded that the Financial Accounting Standards Board (FASB) demonstrate greater flexibility and speed in changing market-to-market (or “fair value”) accounting rules in the face of today’s financial industry crisis, or else. Much of the commentary came across as a congressional call for an IASB-like principles approach in place of the FASB’s detailed rules-based approach.

House Financial Services Committee Chair Barney Frank (D-Mass) and Capital Markets Subcommittee Chair Paul Kanjorski (D-Pa), each in his own way, stated that mark-to-market accounting must be applied differently to different companies and industries based on their respective circumstances that changed must happen now, not later after more “academic” study. In his opening statement, Kanjorski declared:

We meet today to examine the much publicized and hotly debated mark-to-market accounting rules. . . Previously, I have taken the position that the Congress should not interfere through legislation in the area of establishing specific accounting rules. It seemed best that such technical work be left to the regulators, standard setters, and financial experts.

We can, however, no longer deny the reality of the pro-cyclical nature of mark-to-market accounting. It . . . has exacerbated the ongoing economic crisis. If the regulators and standard setters do not act now to improve the standards, then the Congress will have no other option than to act itself.

To say that the Congress will have to act is not to advocate an outright suspension of mark-to-market accounting. If we do away with this standard entirely, accounting will revert to the very kind of subjectivity and sleight-of-hand that made mark-to-market necessary in the first place. The standard does provide transparency for investors, but its strict application in the current environment is, in too many instances, distorting, rather than clarifying, the picture. . .

As our witnesses explain the implications of this standard and offer solutions to improve its application, we must bear in mind that fair value accounting is not one uniform rule affecting all parties to whom it applies in the same manner. . .

Moreover, one industry’s predicament may require a unique accounting treatment or regulatory forbearance that will not solve another sector’s problems. In pursuing improvements, we need to recognize this fact. . .

Frank, as well, made some remarkable statements — some of which will create consternation in the accounting community — in his opening.  Among other things, Frank suggested that write-downs of banks’ asset portfolios should be tied to the particular bank’s level of culpability for the decline in asset value:

We do have to have you move now. It is important that we get some speed. . . You are the FASB . . . cannot be the “slowsb”. First, more realism and flexibility in the mark-to-market . . . Yes, we had irrational exuberance . . . but this is not the time to make up for past mistakes by excessive rigidity .

. . by pretending that there is more reality and certainty in mark-to-market than there is. It should be applied with flexibility . . .

It does seem to me that if you are talking about an asset class that [has traditionally been held to maturity] and is performing and it is providing an income stream, that the case for devaluing that is a lot weaker . . . I do not think we have had enough flexibility in how we apply them.

Second, we need to give you some discretion in how you apply, how you react to these things. I am now asking everybody . . . if anything in existing legislation deprives you of discretion, in how you react in a mark-down-to-market situation, I insist that you tell us. That’s our job. Our job is to think about the extent to which we give you some discretion.

There is no point in having these things be so automatic. It does seem to me . . . if the institution, if a bank, has to mark down its assets, why it had to do that is something you take into account. If they did it because they made a lot of stupid decisions, that’s one thing. If they had to do it because of things that happened in the economy over which they had no control, over assets that are still performing, that’s another. Consequences of a write-down should not be identical in very different situations. . . .

In the context of Frank’s remarks, I can imagine consumers asking, “What about me?” Why, if banks will be treated with so much flexibility, should consumers not be given similar consideration by credit card companies and mortgage lenders who now base their credit limits and interest rates entirely on sterile mathematical formulas that fail utterly to account for the reasons why a particular borrower is financially underwater?

You can watch today’s hearing on video on CSPAN. Witness and committee members’ statements are accessible at the Financial Services Committee website.

Students of risk — as all internal auditors should be — might benefit from reading Nassim Taleb’s book, The Black Swan. In January 2009, Taleb and renowned psychologist Daniel Kahneman got together in Berlin, Germany for a heart-to-heart discussion of how attitudes toward risk may have impacted the banking crisis. Taleb notes, “Banks have never made money in the history of banking, losing the equivalent of all their past profits periodically – while bankers strike it rich.” A video of the full, 59-minute conversation appears below.

During the discussion, Taleb called out business schools for teaching portfolio theory, a view of statistics-based financial management which Taleb equates to iatrogenics. Readers with limited time may find it efficient to start with Taleb’s essay, The Fourth Quadrant: A Map of the Limits of Statistics.

COSO released its monitoring guidance on February 4, 2009. This business guidance more fully develops the monitoring component of the Internal Control – Integrated Framework to assist companies in ensuring the effectiveness of their financial, operational, and compliance-related internal controls. An Introduction of the Guidance is available at  COSO’s website.

Auditing, Accounting and Finance majors at Universities and Colleges throughout the State of Georgia will have a great opportunity, Wednesday, March 4, to get up close and personal with potential employers.  The free event, sponsored by KSU and the Institute of Internal Auditors, is open to all juniors, seniors and grad students interested in summer internships or full-time entry level positions.  Students wishing to participate should email their resumes to atlantaiia@comcast.net.  The event brochure contains additional information.

Last Friday, the Securities and Exchange Commission published a proposed rule laying out a timetable for fully integrating the United States into the world of International Financial Reporting Standards (”IFRS”).  IFRS are  promulgated by the International Accounting Standards Board, a non-governmental body headquartered in London.

What does this proposed rule mean for internal auditors?  At the moment, not much.  It appears that the vast majority of American registrants have little to worry about in terms of mandatory activity.  In this proposed rule, which is open for public comment for 90 days, the SEC falls far short of requiring domestic filers to use IFRS now or in the future.  Rather, the SEC proposes a series of “milestones” that must be met as prerequisites to later rule-making that would require IFRS.  Meanwhile, it is optionally possible for certain large U.S. registrants to use IFRS reporting for years ending after December 15, 2009.

According to this proposed rule, in future rule-making, the SEC “could” decide to require all domestic SEC registrants to issue IFRS-compliant financial statements by 2014.  But this would occur but only “if it is in the public interest and for the protection of investors to do so.”  This approach is far less clear and ambitious than that employed by the European Union in its IFRS rollout which was unambiguously accomplished over a three-year period. 

While it is unlikely that the United States will choose to remain the world’s lone dissenter from IFRS accounting standards, this proposed rule sends a decidedly mixed message to companies trying to decide how much to invest in transitional efforts and when to invest it.

The SEC’s complaint against former KBR executive Albert Jackson Stanley might make a riveting cinema screen play. It describes how Stanley, collaborating with others, arranged for the payment of hundreds of millions of dollars to Nigerian government officials in exchange for the right to build several trains in Nigeria designed to transport liquified natural gas (”LNG”).

The action took place on at least three continents and spanned a decade and a half, from 1990 to 2004. During this time period, clandestine agents from the United Kingdom and Japan were hired to deliver millions in bribes. As is often the case in Foreign Corrupt Practice Act cases, the bribes were disguised as “consulting” contract payments and accounted for as such. More on this story is available in the SEC’s complaint.