Business | Auditors aren’t so bad

Box ticked

The rich world is not suffering an outbreak of accounting fraud

|NEW YORK

IF YOU peer into the world of accounting in any given month, it is easy to get the impression that an epidemic of skulduggery and incompetence has broken out. Consider the month of August. A whistleblower at Monsanto, an American seeds firm, received a reward from the Securities and Exchange Commission, after spotting that the firm was misreporting its earnings for Roundup, a weedkiller. T. Rowe Price, an asset manager, launched a lawsuit against Valeant, a drugs firm which it accuses of fraud and misleading accounting.

The list goes on. PricewaterhouseCoopers, one of the Big Four accounting firms, settled a case involving Colonial BancGroup, a lender it audited which went bust after suffering fraud. The boss of Monte dei Paschi di Siena, an Italian bank, said that he was under investigation as part of a probe into false accounting. Shares in Orbital ATK, an American defence firm, tanked after it said it had made accounting mistakes, and an internet firm called ComScore replaced its top brass amid problems with its numbers.

The obvious conclusion is that the accounting industry has failed to clean itself up since 2001-03, when Enron and WorldCom, among others, blew up in spectacular style because of book-cooking. Those two American firms were worth a combined $250 billion at their peak, and their collapse also brought down their auditing firm, Arthur Andersen.

In fact the opposite is true: accounting scandals have become less of a problem. With over 10,000 listed firms in Europe, America and Canada, bad apples are inevitable. But the impact of recent blow-ups has been far lighter than at the turn of the century. WorldCom overstated its profits by a colossal $7 billion. Enron puffed up its shareholders’ equity by $1 billion. Parmalat, an Italian food firm that folded in 2003, had a $15 billion hole in its accounts.

Today’s scandals are smaller. When companies admit to fraud or mistakes, their books are restated, making comparisons straightforward. Valeant’s restatement, announced in February, was a modest $58m, while Monsanto’s was $48m. Tesco, a British supermarket that confessed in 2014 to an accounting scandal, exaggerated its profits by about $350m. One important measure, which is the scale of the single largest restatement by an individual firm in America in any given year, has shown a marked decline in the size of the corrections, points out Don Whalen of Audit Analytics, a data provider and research firm (see chart).

In the dark days of 2000-01, investors worried that no firm in America could be entirely trusted. If you look at the sum of losses across the economy due to accounting fraud now, the number is low. The figure in 2015 was $2.7 billion, or 0.3% of total corporate profits, suggesting there is no systemic problem.

There are plausible reasons why auditing and book-keeping might have improved so much. Sarbanes-Oxley, a corporate-governance law passed in America in 2002, has bite: it requires chief executives and chief financial officers personally to certify accounts. The spread of a common international accounting rule book in Europe has raised standards. The grisly collapse of Arthur Andersen may have led the other big accounting firms to behave better. During the financial crisis, auditors, along with regulators, pushed big banks to write down the value of subprime securities to realistic prices, often to squeals of protest from bosses and politicians.

There is still no room for complacency. It is quite possible that huge undiscovered frauds are taking place. The incentive structure of the accounting industry remains suspect: accounting firms are paid fees to audit their customers, but they often earn more by selling various advisory services to them. The rise of opaque private markets for trading the shares of private firms—including Silicon Valley “unicorns”—seems ripe for fraud.

And in many big emerging economies, including China and India, the state of accounting rules and of the auditing business is still murky. In Japan an accounting scandal at Toshiba, a conglomerate, which led to a restatement worth $1.9 billion last year, dented faith in accounting and in the local affiliate of EY, another Big Four audit firm. Yet to argue that there is a crisis in the quality of financial information that investors get about Western firms is to be guilty of a misleading overstatement.

This article appeared in the Business section of the print edition under the headline "Box ticked"

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