Chapter 15. Audits and Accounting Fraud
In This Chapter
Trying to prevent misleading financial reports
Interpreting the auditor's report
Dealing with managers who massage the numbers
Coping with fraud (if you can find it)
Auditing the auditors
Suppose you're one of the external shareowners of a business or one of its lenders. You depend on its financial reports for the information you need about your stake in the business. How can you be sure that its accounting methods conform with established standards? How do you know whether the business makes adequate disclosure in its financial reports? Is the business playing by the rules in measuring its profit and in releasing financial information? You trust the managers, or you wouldn't have put your money in the business. But you still have these nagging questions. Well, in business, as in politics, the answer is: Trust, but verify.
Many businesses hire an independent CPA (certified public accountant) to audit their financial reports. An audit provides assurance that the financial report of the business is correct and not misleading. The CPA examines the evidence and renders a report. The auditor's report says that the business uses proper accounting methods and its financial report provides adequate disclosure. Or not. Things get messy when the auditor finds fault with the accounting or financial disclosure of the business. But it's better to be warned than to continue on your merry way and be unaware of the deficiencies in the business's financial report.
A financial report can be wrong and misleading because of innocent, unintentional errors, or because of deliberate cold-blooded fraud. Errors can happen because of incompetence and carelessness. Fraud happens when the company's accountants and managers are crooks. The CPA auditor should definitely catch all significant errors. The auditor's responsibility for discovering fraud is not as clear-cut. You may think catching fraud is the purpose of an audit, but I'm sorry to tell you it's not as simple as that.