A Little Optimism For The Upcoming Decade

Editor’s Note: We are pleased to begin the new decade by publishing the following editorial piece by Michael Kraten, Professor of Accounting at Houston Baptist University. It is the third of a series of three columns that address the theme of The Evolution of the Public Interest in Accounting.

The piece was also published on the Blog of the Sustainability Investment Leadership Council. See SILCNY.com.

We welcome contributions by all members of the academic and business communities who maintain an interest in Accounting and the Public Interest. Please direct your queries to Michael Kraten at mkraten@hbu.edu.

As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.

As the calendar flips from 2019 to 2020, it’s easy to feel a bit depressed about the metrics that have challenged us during the past decade. The aggregate debt of the United States federal government, for instance, has exploded from $13 billion to $24 billion. Wealth inequality has also grown, and the number of American citizens without health insurance has resumed its climb after years of decline. Meanwhile, increases in sea levels, meteorological instability, and ocean temperatures are threatening our natural environment.

It’s a grim set of trends, isn’t it? But if we choose to focus on these dismal metrics, we’ll lose sight of the broader picture. There were, after all, many events that occurred during the 2010s that should encourage optimism among those who support the public interest.

At the start of the decade, for instance, the standards of the Global Reporting Initiative (GRI) merely provided a voluntary framework of reporting guidelines. But they would not remain a purely voluntary framework for long! In 2013 and 2014, the European Union issued a pair of directives on non-financial reporting. They required many of the world’s largest corporations to begin to include a wide variety of non-financial information in their annual reports, starting in 2018.

Furthermore, at the start of the decade, the Sustainability Accounting Standards Board (SASB) didn’t even exist. Launched in 2011, the SASB now promulgates detailed sets of standards for 77 industries, including sample disclosure language for inclusion in corporate annual reports. The SASB’s framework and standards, like the European Union’s directives on non-financial reporting, have served to impose sustainability reporting requirements and expectations on the world’s largest for-profit entities.

Meanwhile, the Task Force on Climate-related Financial Disclosures (TCFD) was launched by the Financial Stability Board in 2016 to recommend voluntary practices. Chaired by Michael Bloomberg, the Task Force presented its final recommendations the following year, and then remained in place to launch a Knowledge Hub, a pair of annual Status Reports, and a Consortium. The TCFD, like the GRI and the SASB, now focuses on developing and supporting private and public initiatives to enhance financial reporting practices.

The most startling development during the past decade, though, may have been the dramatic growth of the ESG investment industry. According to Fidelity, Socially Responsible Investing assets in the United States have quadrupled since 2010, rising roughly from $3 billion to $12 billion; the size of this asset market now exceeds $30 billion worldwide (see fidelity.com/viewpoints/active-investor/strategies-for-sustainable-investing).

If you believe in the power of money, this final metric may be the most impressive one of all. After all, government entities and standard setting bodies may be able to protect the public interest against public apathy and private sector opposition. However, the re-direction of billions of dollars in investment funds can only occur if public opinion and the private sector support the movement.

So let’s try to maintain an optimistic perspective as we enter the next decade of the 21st Century. After all, the decade of the 2010s have produced an impressive array of positive occurrences. It is entirely possible that the upcoming decade of the 2020s will likewise give birth to many new trends that support the public interest.

Stop the Madness: We Need a New Approach to Split-Off Nonaudit Services For Audit Clients

Editorial Note: We are delighted to present this essay by contributing columnist Steve Mintz, Professor Emeritus, Cal Poly, San Luis Obispo. It is the second of a series of three columns that address the theme of The Evolution of the Public Interest in Accounting. 

We welcome contributions by all members of the academic and business communities who maintain an interest in Accounting and the Public Interest. Please direct your queries to Michael Kraten at mkraten@hbu.edu.

As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.

The time has come to revisit the issue whether all nonaudit services should be prohibited for audit clients. The accounting profession continues to struggle with independence issues when both services are provided. The threats and safeguards approach in the AICPA Code does not seem to have reduced the instances of independence violations. Deficiencies in CPA firm quality controls and the failure to communicate independence issues with audit committees have exacerbated the problem.

Recent examples, just in 2019, illustrate a decline in basic ethics and the failure to protect the public interest.

    • On September 23, 2019, PwC agreed to pay $7.9 million to settle charges that the firm violated the SEC’s auditor independence rules by performing prohibited nonaudit services during an audit engagement, including exercising decision-making authority in the design and implementation of software relating to an audit client’s financial reporting, and engaging in management functions thereby creating a self-review threat to independence.
    • On September 10, 2019, Marcum LLP, one of the largest independent public accounting and advisory services firms in the nation, settled disciplinary proceedings with the PCAOB over advocating numerous issuer auditor clients in connection with the firm’s annual MicroCap Conference. As the host, Marcum praised the presenting companies, which included many of the firm’s auditing clients, as high-quality companies that were selected via a vetting process thereby creating an advocacy threat to independence.
    • On August 27, 2019, the SEC charged RSM US LLP (formerly known as McGladrey LLP), which is the fifth largest accounting firm in the U.S., with violating SEC independence rules in connection with more than 100 audit reports involving at least 15 audit clients for which they provided prohibited nonaudit services including corporate secretarial services, payment facilitation, payroll outsourcing, loaned staff, financial information system design or implementation, bookkeeping, internal audit outsourcing, and investment adviser services. A partner also had a prohibited employment relationship in serving as a non-discretionary member of the board of an affiliate of an RSM US issuer audit client, a management participation threat to independence.
    • On February 13, 2019, the SEC announced an agreement with Deloitte Touche Tohmatsu LLC (Deloitte Japan) to pay $2 million to settle charges that the firm issued audit reports for an audit client at a time when dozens of its employees maintained bank accounts with the client’s subsidiary thereby creating a self-interest threat to independence. An investigation by the firm revealed that 88 other Deloitte Japan employees had financial relationships with the audit client that compromised their independence.

This is just the tip of the iceberg. During the past few years we’ve witnessed the KPMG-PCAOB cheating scandal whereby the firm received inside information about audits to be inspected by the PCAOB from staffers who went to work for the firm. A partner at Ernst & Young tipped off a friend about non-public actions to be taken by an audit client that had the potential of moving the stock price.

It seems the United Kingdom is taking the matter of a conflict of interests seriously. The Financial Reporting Council (FRC), the United Kingdom’s accounting watchdog, has been examining the question of whether the performance of all nonaudit services should be prohibited for audit clients in the aftermath of the liquidation of two large companies, Carillion and BHS. The impetus for the review is FRC’s claims that auditors from KPMG in both instances did not do enough to challenge management and did not maintain their professional skepticism. KPMG, for its part, indicated it would not continue to provide nonaudit services to audit clients but had some qualifiers, such as continuing to provide nonaudit services, such as consultancy, to smaller UK-listed clients, as well as private firms of all sizes. It also failed to give an end date for the changes.

Other firms, including PwC and EY, also said they would stop offering non-essential consulting services to its largest British public audit clients by 2020. The firms stated their goal is to eliminate any perception of conflict between selling audit and consulting work to the same client. The key here is what is a “non-essential consulting service?” Perhaps the firms purposefully left it vague.

Enter the UK Competition and Markets Authority, a government department in the UK, that issued a report on April 18, 2019 recommending an operational split of audit and nonaudit services. The large firms would be split into separate operating entities with respect to auditing and consultancy functions to reduce the influence of consulting practices upon auditing divisions. The split would help to prevent potential conflicts of interest from impairing audit independence and increasing the public trust in the quality of financial statements. However, the watchdog stopped short of recommending a full break-up based on firm services.

A study group chaired by Prem Sikka, a professor of Accounting and Finance at the University of Sheffield, prepared a report on behalf of the UK Parliamentary Labour Party, that concluded an operational split would not go far enough, calling instead for two legally separate organizations. In essence, it calls for a structural break-up of large firms saying that it would be more effective than other options in dealing with conflicts of interest and providing professional skepticism needed to deliver high-quality audits.

The SEC and PCAOB should closely monitor the events in the UK as regulators deal with the issue of how best to eliminate threats to independence that might occur when nonaudit services are provided for audit clients. Regardless of the method chosen, the time has come to split off nonaudit services as a separate unit, at a minimum, and study the issue of legal separation much as is being done in the UK. Nothing short of these remedies is necessary to protect the public interest.

Entering Uncharted Waters

Editorial Note: We are delighted to present this essay by contributing columnist Rick Kravitz. It is the first of a series of three columns that address the theme of The Evolution of the Public Interest in Accounting. 

We welcome contributions by all members of the academic and business communities who maintain an interest in Accounting and the Public Interest. Please direct your queries to Michael Kraten at mkraten@hbu.edu.

As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.

Disclaimer by author Rick Kravitz: The comments and opinions expressed in this article represent the writers’ own personal views and not necessarily those of his employer, or of other organizations that are affiliated with the author. The opinions of this author do not reflect the opinions of the CPA Journal, the New York State Society of CPAs, its board, its executives or its membership.


Over the past two years, the PCAOB, a nonprofit corporation established by Congress, has replaced all five of its board members. Its new chairman, William Duhnke [a former Republican Senate Aide, according to Fortune Magazine], will receive a salary of $673,000 a year.

As a result of the changing of the guard, the PCAOB is now in a perfect position to look back at its accomplishments over its past seventeen years [in 2010, funding was established through annual accounting support fees assessed on public corporations and broker-dealers] and determine its correct path going forward.

This article examines whether the PCAOB, in its 17 year history, has achieved its objectives. Has it improved investor protection? Has it improved financial reporting by auditing auditor work papers? Has it been open, honest and transparent in the reporting of its results? Or was PCAOB’s establishment as a nonprofit corporation, designed to shelter its activities from the public and from FOIA requests?

Other questions need to be answered. Are the deliberations by the PCAOB open to the public or held behind closed doors? Does the public know how much has been collected in penalties or settlements and even the criteria for distributing penalty funds to their merit scholarship program [students in accredited accounting programs]?

The mission of the PCAOB is noble:

“… Oversee the audits of public companies, protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports…”

But, over the last nine years, the PCAOB has spent over 2 ½ billion dollars. Has this money been spent wisely in service to the public in support of its mission?

(1) The PCAOB Inspection Process

PCAOB inspections [2016 of auditors and brokers] observed deficiencies in 97% of the firms inspected in 2016, compared against 96% in 2015. PCAOB inspectors publicized these deficiencies online and in the press. This nonprofit also reported a 48 % deficiency rate in attestation engagements in 2016, compared against a 55% deficiency rate in 2015. [Fact Sheet: Annual Report on the 2016 Inspections of Broker-Dealer Auditors, August 18, 2017]. For non-broker audits, Audit deficiencies rates [particularly internal control deficiencies] averaged from 32% to around 35% over a five year period [Summary of Inspection Findings of the Big Four and Next Six, August, 2017, the CPA Journal, page 54].

So, let’s go back to the mission of the PCAOB and ask the following; how, exactly, do these findings inspire confidence in the capital markets…and in addition, how do these findings improve investor protection? Were there follow up inspections on these work paper audits -to demonstrate to the inspectors that these error rates could be reduced substantially now that they were identified? I think not. Also, what did the inspectors do to ensure that the auditors corrected these deficiencies? Did they report these to the senior execs of the company, the board of directors, internal auditors and audit committees? If they did, why is it that we don’t see public responses, auditor changes, and responses by the board in public statements regarding these critical audit deficiencies? Were they not told or is there something else in play?

The critical question is whether the work of CPAs is so poor, so inferior, so incompetent, that in its 100 years of audit history and seventeen thousand pages of audit guidance [including the use of specialized audit and risk assessment programs, compliance software, proven statistical and cumulative monetary sampling techniques], that CPA audits are deficient from 30% to almost 100% of the time? Do we actually believe that this 147 billion dollar global industry has product defects in excess of 50%? That licensed practitioners with master’s degrees and specialized training and education failed 1/3 to ½ of the time? Can you imagine if PCAOB extended their review to the AMA, ABA or Society of Mechanical or Electrical Engineers and generated failing grades at this level? What rational organization would accept this? Is this in any way credible, believable – or even make any sense — so 2.5 billion dollars reveals tens of thousands of critical audit deficiencies —will a ten time higher budget of 25 billion dollars then reveal hundreds of thousands more deficiencies? I think not.

I would argue that an accounting firm[s] should be allowed to inspect the inspection reports. I suggest that they would find that most of the identified deficiencies were of little or no material value.

Suggestion: allow an outside accounting firm to audit the PCAOB audits based on GAAS and to determine whether the identified deficiencies have any impact or material effect on the financial statements or whether they were “gotcha” items to justify the $2.5 billion in expenditures.

(2) Should A Public Agency Make Its Information Public?

Should the new board now disclose the names of companies that they review; make the information public? Clearly, the reputation of an auditing firm impacts a company’s decision to choose an outside auditor. If an outside auditor behaves badly, shouldn’t the company’s investors know this? Shouldn’t the public who invests in these companies and the institutional investors and the 401k plan participants know this? Clearly, reputation has a critical impact on auditor choice – The significant number of changes in auditors in South Africa informs us of this –bad audits have significant consequences.

Suggestion: provide the names of the companies whose work papers were audited to the public in the spirit of free and open capital markets.

(3) The Connection Between PCAOB Inspections And The Detection/Prevention Of Fraud

Can we connect the PCAOB audits of auditor work papers to the accuracy of the company’s financial reports? Can we correlate PCAOB inspections to financial restatements? Why do we not know what impact PCAOB audits have on financial restatements and the behavior of the reporting entity? Is there any? Is this not of critical importance to the public that should be made public?

The greatest corporate failures in global history occurred during the existence of the PCAOB. So if their risk assessment techniques were valid, then PCAOB audits ought to have selected many of these failed or failing enterprises [ERM risk assessments, internal control risk, materiality risk, independence risk and others]. In fact, there should be a close relationship between the PCAOB’s ‘picks” of failed companies such as AIG [arguably one of the largest global failure in corporate history], Lehman Brothers, Merrill Lynch, MF Global, Countrywide, GE, Chipotle Grill, Wells Fargo, Steinhoff, Satyam, Mattel and others.

So, public disclosure of these work papers would affirm that PCAOB selection criteria was correct; their methodology for picking companies was valid; their risk assessment programs were accurate and it was auditor failure that allowed fraudulent financials….that PCAOB audits of auditor work papers had been ignored.

And if PCAOB audited the audit work papers of say Toshiba, Colonial Bank, Clayton Homes, and Miller Energy, or looked at internal control and Enterprise risk of Carillon, how could they have failed to uncover audit deficiencies that led to audit failures of these failed institutions who falsified their financials?

The public should know where the multibillions of dollars were spent. And that in their reviews, PCAOB uncovered weaknesses in internal controls at Wells Fargo, cyber risk failures at Equifax and fraud at the top at Colonial Bank. If PCAOB methodology was of great value, shouldn’t investors know this, in order to make more informed investment decisions? Why is this information not public?

Suggestion: make this information public.

(4) Regulation In Perspective

Perhaps, with the new board, it is time to look for a better regulatory model other than self-regulation or government oversight by PCAOB. John Coffee, Corporate Governance Law Professor at Columbia University Law School [Gatekeepers, Oxford University Press, page 365], argues that “the SEC’s experience with both attorneys and accountants suggests that it is difficult for a regulatory agency to supervise a profession for long…as scandals subside, a return to normalcy becomes predictable, and professional autonomy return is re-established. “

Is there a blended form of regulation that might work? Might a process similar to that in the UK of supervised self-regulation be looked at more closely in the States to improve outcomes? Especially if the findings of the PCAOB were made public and the judgment was that PCAOB’s audits of the auditor’s work papers failed miserably in their mission to protect the public interest and uncover defective or fraudulent financial statements of public corporations?

Suggestion: look at other governance and oversight models at other international stock exchanges and determine whether any are of greater value to the investing public.

(5) Board Compensation: Does This Make Sense?

But let’s go further into this self-regulatory body and ask what else does not make sense. If we were recruiting for the board, would we look for competency in auditing? Would we then pay each former board member an average of $540,000 a year in salary – more than the SEC Chair, more than the president of the United States? Would we compensate an attorney, a Senate and White House aid with little or no auditing experience over $672,000 a year? Does this make sense? Should public accounting firms, who pay their salaries, have no input whatsoever on who governs the governed or is presided over other than by their peers.

Suggestion: align compensation with the expertise and qualifications of the candidate.

(6) Board Composition: Does This Make Sense?

What else does not make sense? The composition of the new board, three attorneys and two CPAs stills leaves voting control in the hands of attorneys. This is remarkably similar to the composition of the last board. In the current Board, two members had audit experience and none had recent audit experience. Only one Board member has any recent experience in auditing public companies. Another was controller of a corporation. The Director of Inspections, with 14 years of institutional memory resigned effective May, 2018.

Suggestion: in a democratic society, the board should reflect its constituency. Their prior decisions should be the principle indicator of the ethical decisions they would be making in the future.

(7) Cost Of Inspections

Does this make sense? The PCAOB spent over 2 ½ billion dollars on audit inspections between 2010 and 2019. The big four handle public audits of U.S. issuers, accounting for more than 98% of global market capitalization [August 2017, CPA Journal, pg. 52, Boland, Daugherty, Dickins and Johns-Snyder].” A result of strong quality control and peer review at all large firms, has PCAOB determined whether it is actually the standardized audit programs and uniform work papers within the firm that are deficient according to their audit manual and the audits themselves

Suggestion: open the PCAOB audit inspection manual and examine the inspection steps to determine whether their manual actually is in accordance with generally accepted auditing standards and generally accepted accounting principles and conforms with standards and practice promulgated by the global standard setters.

(8) PCAOB Budget Creep

If we were overseeing the budget of the PCAOB, we would notice that their budget grew by over 18% during between 2010 and 2018. Their staff grew by over 30% [to over 851 staff members]. In contrast, auditor concentration increased during this time and the number of registered firms with PCAOB declined by almost 20%, while the number of listed publicly traded US companies decreased by the same amount. Moreover, during PCAOB’s existence, publicly traded firms declined by almost 50%. How can this then be justified in terms of workload and staffing

Regarding staff, on the other hand, might we conclude that there is a correlation between the number of PCAOB staffers, the number of audits and the increasing number of deficiencies? Do staff auditors at PCAOB have to fill a quota of auditor dings?

A crucially important outside of the box question, however, is whether the public interest is served by PCAOB when, the explosive growth of non-public enterprises [out of the regulatory system in what my former corporate securities attorney/author, Larry Ribstein calls ‘going dark’] owned/managed by hedge funds, private equity, and other institutional investors remain unregulated and uninspected? Does this make any sense at all from a regulatory perspective?

Suggestion: expand PCAOB reach to the unregulated but audited private investment sector similar to the CMA in London. If it touches the shareholder investor over a certain dollar amount it requires auditor oversight.

(9) Auditing Internal Control

Internal control audit deficiencies were the highest in the top three areas in PCAOB’s Staff Inspection Brief [Previewing 2016 Inspection Findings, PCAOB November, 10, 2017] from 2016 inspections and other years.

Internal control over financial reporting deficiencies were in the 30% plus range [Auditing the Auditor: Insights from PCAOB Inspection Reports/GAAP Dynamics, 6/9/2015]. Studies regarding public expectation is that auditors uncover fraud, principally through an examination of internal control. Perhaps it is worth noting Lee Seidler’s comments from the classic forensic and fraud text [Crumbly, Heitger, page 405, Forensic and Investigative Accounting, 4th edition]. “…Much of the auditor’s work and examination time is based on a faulty assumption that separation of duties within the corporation prevents fraud…an albeit unsupportable assumption.” So was the time spent by PCAOB in finding deficiencies in the audits of internal controls, money well spent – spent wisely? To what end? Does it make sense, when uncovering fraud is a principal obligation no longer assumed by auditors? And if PCAOB identified weaknesses, did they uncover the fraud that impacted investors in the insolvent or bankrupt companies mentioned earlier?

(10) Giving Voice To Consequence

PCAOB levies fines against auditors for audit failures. But in its 16 year history, has bad behavior ever been deterred by the PCAOB, especially when the largest corporations self-insure and use offshore captives and receive special tax breaks? Just a cost of doing business? What if there were additional consequences to bad behavior? Might the PCAOB consider other penalties other than civil fines? Is jail time an option? Certainly other regulatory bodies in the UK, Germany and South Africa apply this?

Many years ago, around the time of the Public Oversight Board, it was suggested that an NTSB type board of experts could be assembled to look at each audit failure; report on what exactly occurred, determine the causes of failure, call out the violators and make this information public –put the issue before a tribunal who would adjudicate on a case by case basis, which would, as well, provide guidance on future audits….Would this not provide better guidance on prevention than secret inspections drawn from a secret inspection manual?

Another suggestion is that a new Board might be comprised of auditors, government overseers and outside investor representatives. Would a trial board review audit failures, base its decisions on precedent, adjudicate fairly and impartially in a public forum, and have the ability to apply civil and criminal provisions from an expanded tool bag? Might this improve audit quality? All in the public domain?

Might a modified form of self-regulation then work? Would Colonial Carter, former president of the NYSSCPA, [who was the only CPA to testify before Congress and the SEC in support of our grant of a monopoly to audit public companies] once more provide the right answer as to who audits the auditor? Would we all be morally and ethically correct if we responded in unison “Our conscience” as did Colonel Carter unabashedly before Congress in 1933?

From Gatekeepers to Gateway Constructors – the social role of credit rating agencies

Editorial Note: We are delighted to “go global” and welcome the following contribution by Dr Stewart Smyth of the University of Sheffield, UK. 

We welcome contributions by all members of the academic and business communities who maintain an interest in Accounting and the Public Interest. Please direct your queries to Michael Kraten at mkraten@hbu.edu.

As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.

Over the summer Critical Perspectives on Accounting published a paper I co-authored on the role of credit rating agencies in the process of financialising social housing providers in London. In the style of the TV show, Jeopardy!, the paper is the answer to the question – What is the research outcome when a geography, a housing studies and an accounting academic collaborate?

During our initial discussions credit rating agencies (CRAs) barely warranted a mention, we were more focused on the impact that large amounts of debt finance was having on the provision of below market-rents accommodation in a city that has become a location to store excess capital for the global billionaire class. However, two UK-based colleagues – Thomas Wainwright and Graham Manville – beat us to the punch, publishing an excellent article on innovation in the social housing bond market.

Rating agencies hone into view

The innovation Wainwright and Manville explore is the manner in which not-for-profit organisations, often with a charitable heritage, are increasingly turning to the capital debt markets for finance and issuing their own corporate bonds. In England, up to the turn of the century a social housing provider issuing a corporate bond was almost unheard of – by 2017 there was a cumulative total of 84 bond issues by 58 housing providers, worth £17.1 billion.

The increased activity in this form of finance comes from a combination of severe cuts in government grants during the austerity years and a reluctance by the traditional financers of this sector, banks, to fund over the long term (i.e. a 30-year business plan) after the financial crash of 2008.

Of course, every bond issued by a social housing provider requires at least one credit rating and an ongoing relationship with a rating agency afterwards. However, my co-authors and I were aware that credit rating agencies had been implicated in the 2007/08 credit crunch and following financial crash, and we wondered what impact their rating methodologies have had on the operation of social housing providers.

Rating agencies – a history

For much of their history CRAs have been considered peripheral to the operation of business, often having a quasi-academic image. With roots in the commercialisation of emergent business financial information during the nineteenth century, CRAs started to become key actors in capital and financial markets from the 1970s, in the main due to changes in regulation by the SEC and subsequently under the Basel capital adequacy rules for banks.

In that decade CRAs also changed their business model by securing fees from those issuing financial instruments, (rather than those buying them). This change created similar relations to those in the auditing industry with related conflicts, such as being paid by those you are forming an opinion on and the opportunity to sell ancillary services.

However, it is in recent decades, with the increasing financialisation of the world economy, that CRAs’ revenue and power has grown substantially. For example, in the fifteen years to 2015 Moody’s global revenue grew by US$ 602 million to total US$ 3.5 billion. Further, Moody’s describes themselves as “… an essential component of the global capital markets” which contributes to transparent and integrated financial markets.

Yet, CRAs have been criticised not just in relation to the 2008 global financial crisis but also for not being able to predict the 1997 Asian currency crisis or the collapse of Enron. For example, in the wake of the Enron bankruptcy, Senator Joe Liberman said,

The credit-rating agencies were dismally lax in their coverage of Enron. They didn’t ask probing questions and generally accepted at face value whatever Enron’s officials chose to tell them. And while they claim to rely primarily on public filings with the SEC, analysts from Standard and Poor’s not only did not read Enron’s proxy statement, they didn’t even know what information it might contain.

Not only gatekeepers …

Despite this history and the central role now afforded to CRAs in the operation of the capital markets we know very little about their operation in general and specifically with regards to the impact their work has on the operation of those they rate. Much of the research completed to date places CRAs in a principle-agent relationship, where they act as a reputational intermediary to reassure financial investors.

In this way CRAs are seen as gatekeepers for those entering the capital markets to secure bond (or other) finance.

In our paper we seek to understand the role of CRAs by drawing on the smaller stream of work that utilises a political economy understanding. In this understanding credit ratings are, as Timothy Sinclair has argued, a surveillance system for secure capital mobility across geographical and cultural space.

This idea of capital’s mobility across cultural space is particularly relevant in our case study with ratings being provided for not-for-profit organisations delivering a public service. The idea of movement also allowed us to flip the gatekeeper metaphor round and look at the rating activity from the perspective of the finance providers.

but gateway constructors

Hence, we were able to theorise, and show empirically in the paper, that credit rating agencies also construct gateways that enable private capital’s movement into a new space, i.e. social housing.

The gateway construction occurs through a number of activities but a central one is that through the process of securing a rating the debt issuer learns to speak the same language as the finance provider. As one of our interviewees stated,

I mean it does educate us when we go out to investors … [to] do a road show. So, we would have had the experience of a credit rating before one of them and when you go into the investors you’re talking the same language.

Alongside, the new language we show how the social housing providers internalise the priorities of finance capital, through the rating process by changing their internal reporting and decision-making activities. For example, taking key accounting ratios that are preferred by the CRAs into their new build and development decisions.

The financialisation of everything

Since the turn of the century, research on financialisation has tended towards either macro studies of changes in the global processes of capital accumulation or a micro-level focus on individual companies where the short-termism of the shareholder value revolution pre-dominates. Our study focuses on a fine-grained analysis of financialisation processes at a meso-level (i.e. the social housing sector), where credit rating agencies play a crucial, even decisive role.

The members of this sector have been described as hybrid organisations – as the 2014 front cover of one social housing provider’s annual report proclaimed “Socially hearted, commercially minded”. The policy and funding environment over the past ten-years has increased the commercially-minded activities of the social housing providers by securing finance from the capital markets and is enabled by credit rating agencies.

Ultimately this leads us to conclude that credit rating agencies do not play a neutral or independent role in verifying accounting and commercial information but are active participants in the extension of financial logics and practices to ever more areas of human activity; in other words, CRAs facilitate the financialisation of everything.


Dr Stewart Smyth works at the University of Sheffield, UK where he is director of the Centre for Research into Accounting and Finance in Context (CRAFiC). Stewart is also the chairperson of the Interdisciplinary Perspectives Special Interest Group, of the British Accounting and Finance Association (BAFA).

The paper this blog is based on is freely available under open access rules at the following link:

Smyth, S.; Cole, I. and Fields, D. (2019/forthcoming), “From gatekeepers to gateway constructors: Credit rating agencies and the financialisation of housing associations”, Critical Perspectives on Accounting

A Public Interest Debate!

On March 14, 2019, our Contributing Columnist Rick Kravitz, the Editor In Chief of the CPA Journal, authored a blog post entitled “Reimagining a More Ethical and Sustainable Management Accounting Curriculum.” In that post, he asserted that:

The accounting curriculum, while relevant 40 years ago, has lost much of its relevance today in our post-modern global economy. Accounting education fails to account for the real drivers of enterprise growth in the digital economy.

That drew a rebuttal from Dr. Lawrence Murphy Smith, CPA, a Professor of Accounting at Texas A&M University-Corpus Christi. According to Murphy:

Since I was an accounting student more than 40 years ago, people within and outside the profession have lamented that accounting and financial reporting isn’t doing a good job of providing useful information.

In the editorial column, “Reimagining a More Ethical and Sustainable Management Accounting Curriculum” by Richard Kravitz, this complaint appears once again. On the upside, accountants should be constantly working to ensure the usefulness of accounting and financial reporting. On the downside, this article way overstates the lack of value of accounting information.

The most important piece of accounting information, I would argue, is net income/profit. That number is still calculated, just as it has been through the centuries. To a very large extent the current value and future projected value of net income/profit drives the market value of virtually every modern-day company, whether that market value is 100 times the book value or one times the book value. So, accounting/financial reporting is still relevant; it always has been.

Of course, there will always be exceptions to the predictive power of financial reports. Exceptions result from new technologies, innovative new products, economic cycles, fraudulent financial reporting, brilliant and dismal company leadership, politics, and unexpected events. For example, before the Internet, few people could predict its massive impact on business, which enabled Amazon to become the second largest retail store in the U.S., second only to Walmart. After reading about a very profitable airline company in the summer of 2001, I invested. There was no public awareness that Islamic terrorists were plotting the attack on the World Trade Center. Not long after September 11, 2001, my airline stock was worthless.

The past cannot always predict the future, and by their nature, financial reports are about the past. So, while financial reports are extremely helpful, they cannot guarantee future outcomes. I would argue that financial reports provide a critical part, if not the majority, of information supporting investment decisions. When people are willing to buy stock in a company with giant losses, those people are taking the risk that the company will turn around and make profits in the future. In effect, the future projected value of net income is driving the company’s market value. Sometimes a company turns things around and sometimes it doesn’t. While financial reports are still very relevant in predicting future prospects of most companies, in the final analysis, only God knows the future with absolute certainty.

In conclusion, I have the highest regard for Rick Kravitz and Baruch Lev but I respectfully disagree with their negative assessment of the value of financial statements.

That, in turn, drew a rebuttal to the rebuttal from Rick! He noted:

I would ask the good professor how he can conclude this when Uber, Tesla, Lyft, and dozens of other cash burning companies now have losses in the trillions of dollars and yet possess positive share value. Bad reporting by accountants caused 55 billion dollars of shareholder losses last year, the highest since the Great Recession. And according to Baruch Lev, the information content of the financial statements only constitutes 3% to 4% of information that supports investment decision. What a lack of relevance!

The debate clearly rages on. It clearly will not be resolved in the near future. Nevertheless, our Public Interest Section is delighted to host a professional forum for this lively conversation.

Using the PLUS Ethical Decision Making Model to Teach Ethics to Accounting Students

Editorial Note: It’s time to go “back to school” as we begin the traditional academic year! In the spirit of the season, we’re pleased to feature the following piece by Contributing Columnist Steve Mintz on accounting education.

Steve is one of three regular columnists who have agreed to author a blog post every quarter. All posts are distributed via email, and are published online at AAAPublicInterest.org.

We welcome contributions by all members of the academic and business communities who maintain an interest in Accounting and the Public Interest. Please direct your queries to Michael Kraten at mkraten@hbu.edu.

As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.

It’s time now for accounting educators to rethink the scope of decision-making models used to teach accounting ethics. If ethical issues that arise in the context of organizational culture are not dealt with properly then it is less likely ethical conflicts can be resolved. Consideration of the internal systems within organizations is what’s missing from traditional decision-making models and should be given a more prominent role.

Ethical Decision Making

Accounting educators typically use an ethical decision-making model to teach ethics to accounting students. Ethical decision models provide a systematic way to think through ethical issues, identify alternative courses of action, evaluate the ethics of each alternative and decide what to do.

Traditionally, the decision-making models used to teach ethics to accounting students have focused on applying philosophical reasoning methods to the analysis of what should be done. These models tend to downplay or ignore the importance of organizational culture in the decision-making process including internal policies and practices, the code of ethics and individuals in the organization who might serve as supporters to help resolve conflicts.

Given the added focus on organizational ethics since passage of the Sarbanes-Oxley Act and the profession’s recognition of the importance of the control environment, accounting educators should look for new ways to incorporate organizational factors to make the ethics curriculum more relevant. Moreover, the AICPA Code of Professional Conduct now addresses ethical conflicts and describes the process to resolve them including internal steps.

The PLUS Ethical Decision Making Model

The PLUS Ethical Decision Making Model was developed through The Ethics Resource Center, the research arm of the Ethics & Compliance Initiative (ECI). The ECI is a community of organizations that are committed to creating and sustaining high quality ethics and compliance programs to assist organizations in building strong cultures. The mission of ECI is to assist its members across the globe to operate their businesses at the highest levels of integrity.

The PLUS Model is based on a seven-step process described below. The word PLUS refers to ethics filters that facilitate the analysis of ethics considerations and implications of the decision at hand. The filters ensure that ethical issues rise to the forefront in ethical decision making. The mnemonic PLUS refers to four considerations that apply to the analysis in steps 1, 4 and 7 of the decision-making model as follows.

P = Policies
L = Legal
U = Universal
S = Self

A description of each filter and its role in decision-making follows (Ethics Resource Center of the Ethics & Compliance Initiative, The PLUS Decision Making Model, https://www.ethics.org/resources/free-toolkit/decision-making-model/).

Policies. Is it consistent with organizational policies, procedures and guidelines?
Legal. Is it acceptable under applicable laws and regulations?
Universal. Does it conform to universal principles and the values of the organization?
Self. Does it satisfy my personal definition of right, good and fair?

The advantage of the PLUS model is it relies heavily on organizational ethics. This is important because no matter how good one’s ethical judgment may be, ethical decision-making is not likely to occur unless support for the position exists in the organization. A summary of the seven-step model follows.

Step 1: Define the problem. Determine why a decision is necessary and identify the desired outcome(s). This helps to clearly state the problem and where to look for alternatives to resolve it. Consider the PLUS factors to ensure the existing situation does not violate any of them.

Step 2: Seek out relevant assistance, guidance and support. Identify the available resources within the organization to help resolve the problem. This helps to define the guidelines and individuals within the organization that may help to resolve the problem.

Step 3: Identify available alternative solutions to the problem. Consider all relevant solutions to avoid the dichotomy of one choice versus another (i.e., either this or that).

Step 4: Evaluate the identified alternatives. This step in the model uses a decidedly consequence-based criteria. Positive and negative consequences are evaluated with fact-based consequences weighed more heavily because the expected outcome is more likely to occur. The PLUS factors are an integral part of the evaluation to supplement outcomes-oriented considerations, which are teleologically based, with universal principles (deontology) and virtue ethics as represented by organizational values.

Step 5. Make the decision. After evaluating all the alternatives, it’s time to decide on a course of action. The reasons for choosing one alternative over the others should be explained especially if the decision is by a work team that recommends a solution to higher-ups.

Step 6. Implement the decision. Putting the decision into effect is essential to change the situation and resolve the problem identified.

Step 7. Evaluate the decision. A determination has to be made whether the decision fixes the problem identified. Questions to ask are: Did it go away? Did it change appreciably? Is it better now, or worse, or the same? What new problems did the solution create? In making these determinations it’s important to incorporate the PLUS factors to ensure the solution conforms to organizational policies, laws and regulations, universal principles and values adopted by the organization.

Advantages of the PLUS Model

The “S” component of the PLUS factor is a feature of the decision-making process that requires explanation because it’s not recognized explicitly in traditional decision-making models although virtue considerations come close. To implement the “self” factor, the decision maker should consider whether the solution satisfies one’s personal definition of right, good and fair. It means that individuals should understand how their values influence decision making to ensure the decision reflects those values. For ethical decision-making to occur in an accounting situation those values should include independence, integrity, objectivity and due care, which are the principles of professional behavior.

Ethical decision making is a complicated process that relies on organizational variables to ensure the ultimate decision is supported by those who have to carry it out. The PLUS model incorporates those factors and should be used in accounting ethics education to make it more relevant given the increased focus on organizational ethics in the post Sarbanes-Oxley era.

The advantage of using the PLUS model to teach ethics to accounting students is it increases student awareness of organizational factors that influence ethical decision making. In reality, regardless of the ethical justification for one’s position it’s unlikely to be implemented unless individuals within the organization support resolution of the ethical problem. Knowing how the internal systems work can help to make that determination early on and influence ethical decision making in a positive way.

Sustainability Reports and the Limitations of ‘Limited’ Assurance

Editorial Note: We are delighted to publish the following article by Professor Michael Kraten of Houston Baptist University. It was originally published in this month’s issue of The CPA Journal; we thank Journal Editor-In-Chief Rick Kravitz (who is himself a frequent contributor to our blog) for permitting us to transmit the article to our Section members. We encourage our members to peruse the contents of this month’s issue at CPAJournal.com.

How many standards can a sustainability accountant possibly follow? Three dozen comprehensive standards are published by the Global Reporting Initiative (GRI), and 77 industry-specific standards are issued by the Sustainability Accounting Standards Board (SASB). In addition, 17 sets of metrics are promulgated within the Sustainability Development Goals (SDG) of the United Nations, 15 components of integrated reporting are defined by the International Integrated Reporting Council (IIRC), and the AICPA, not to be outdone, chimed in earlier this year with its new guide, Attestation Engagements on Sustainability Information.

Sustainability standards are growing in length and complexity; as a result, the length and complexity of corporate sustainability reports are growing as well. The 2018 sustainability report of Volkswagen (VW), for instance, runs at 108 pages. The report of its European rival Fiat Chrysler Automobiles (FCA) is much lengthier, at 148 pages.

Some analysts complain that such reports are filled with “green-washed” public relations content. Others disagree, claiming that the European Union’s Directive on nonfinancial reporting ensures that the sustainability content is meaningful on an individual report basis and comparable across multiple reports.

To be fair, the latter group of analysts can cite examples of meaningful and comparable data. VW’s report, for instance, includes a section entitled “GRI Content Index”; it cross-references its published data to the standards of the Global Reporting Initiative. FCA’s equivalent section, the “GRI Standards Content Index,” serves the same purpose.

But are readers of sustainability reports missing out if they only pay attention to the sustainability report data and the underlying standards? Should they also pay attention to the assurance letters issued by public accounting firms and printed in the reports? After all, if the assurance letters are not sufficient, then all of the information in the reports, greenwashed or substantive, is of dubious value.

Consider, in comparison, the annual financial statements of business entities. They would obviously be less useful if public accounting firms were to use extremely limited assurance procedures during their annual audits. Their assurance procedures would be even less useful if auditing firms could offer different levels of assurance to different clients.

Indeed, spending a little less time worrying about the data in the sustainability reports and a bit more time considering the limited assurance letters may lead to the conclusion that confidence in the validity of any of the report data may not be warranted.


Consider, for instance, Volkswagen’s 2018 report. The table of contents lists a two-page “Independent Assurance Report” on pages 104 and 105. That assurance letter, issued by PricewaterhouseCoopers, is called “Independent Practitioner’s Report On A Limited Assurance Engagement On Non-Financial Reporting.” How much assurance does it actually convey?

The letter notes that PricewaterhouseCoopers is required to “plan and perform the assurance engagement to allow us [i.e., the CPA] to conclude with limited assurance that nothing has come to our attention that causes us to believe that the Company’s Non-financial Report … has not been prepared, in all material aspects, in accordance with” the relevant standards.”

This double-negative structure raises some flags. In essence, the CPA is only required to conclude that nothing came to his attention to cause a belief that something is not right. Metaphorically speaking, an ostrich that buries its head in the sand during a desert storm could satisfy that level of assurance about the weather.

The letter continues by listing eight assurance procedures that were performed by the CPA. It notes that PricewaterhouseCoopers obtained an understanding of the structure of the organization, conducted inquiries regarding the preparation process, analytically evaluated selected disclosures, compared selected disclosures, and so on. There are, however, almost no detailed disclosures of the nature of the inquiries that were made, the disclosures that were selected for analytical evaluation or comparison, or anything else. Interestingly, PricewaterhouseCoopers does list a single specific procedure in its letter; it notes that it performed an “assessment of the aggregation of Scope-3-GHG-emissions (categories 1 and 11) on group level.” That procedure may have been necessitated by Volkswagen’s recent global emissions scandal. (For more on the Volkswagen case, see “The Volkswagen Diesel Emissions Scandal and Accountability” by Daniel Jacobs and Lawrence P. Kalbers, on p. 16 of this issue.). Nevertheless, no other detailed procedure is disclosed in the report.

Finally, the letter concludes with a disclaimer that it “is not intended for any third parties to base any (financial) decision thereon. Our responsibility lies only with the Company. We do not assume any responsibility towards third parties.” Thus, PricewaterhouseCoopers’s letter is not designed to serve the needs of the readers of Volkswagen’s sustainability report, despite being the sole assurance letter that is included in that very report.

Incidentally, although Volkswagen’s 2017 sustainability report is comparable to its 2018 report, one cannot compare these two documents to its 2016 report. Although a synopsis of the 2016 report is posted online, the full 2016 report has been deleted from the Internet. It is left to readers to wonder what was in the full report and why it is no longer available.

Fiat Chrysler Automobiles (FCA)

Fiat Chrysler Automobiles’ table of contents likewise lists a two-page “Independent Auditor’s Report” on pages 139 and 140. That letter, issued by Deloitte, is called “Independent Auditor’s Report on the Sustainability Report.” Deloitte does not explain why it refers to itself as an auditor and not as a practitioner (as PricewaterhouseCoopers does).

Furthermore, Deloitte’s letter contains the same double negative language as PwC’s, concluding that “nothing has come to our attention that causes us to believe that the Sustainability Report … is not prepared, in all material aspects, in accordance with” the relevant standards.

The Deloitte letter lists seven bullet points of assurance procedures. Certain details are excluded from the Deloitte report but are included in the PricewaterhouseCoopers report, and vice versa. For example, PwC’s explicit statement about its GHG emissions assessment procedure is missing from Deloitte’s letter. Conversely, Deloitte’s letter explicitly refers to analyses performed on “minutes of the meetings,” and the receipt of a “representation letter signed by the legal representative” of Fiat Chrysler. Such language is missing from the PricewaterhouseCoopers letter.

Finally, Deloitte’s letter does not contain a warning that it “is not intended for any third parties to base any decision thereon,” or that Deloitte does “not assume any responsibility towards third parties.” PricewaterhouseCoopers’s letter, as noted above, includes these disclaimers.

The Limitations of Limited Assurance

Should stakeholders worry about these facts? On the one hand, it is important to keep in mind that the sustainability movement has succeeded in compelling global corporations to issue more than 100 pages of data each year. Even if significant portions of the reports are filled with green-washed information, the remaining (and perhaps some significant) portions of the reports may contain useful data.

On the other hand, it is also important to keep in mind that the limited assurance of these public accountant’s sustainability letters provides, in certain respects, even less assurance than detailed agreed-upon procedure letters. After all, an agreed-upon procedure letter contains detailed descriptions of the procedures that are performed and the findings that are produced by the procedures. In contrast, the limited assurance letters in these sustainability reports contain very little detailed information and only reach vague, double-negative conclusions regarding the findings.

Furthermore, the descriptions of the procedures in the letters are inconsistent from company to company, and the disclaimers regarding the use of the letters by third parties vary remarkably from firm to firm. Such inconsistencies and variations greatly reduce the value of the assurance reports, and thus of the sustainability data that are included in them.

Clearly, there are significant limitations to the limited assurance letters in the sustainability reports. Perhaps, in addition to lobbying for improvements in sustainability reporting standards, public interest advocates should consider lobbying for the development of more stringent sustainability assurance standards.