The Elusive Audit Cure

As someone who is following the current travails of JP Morgan Chase thinking about the audit challenges, I’ve been looking at ideas for improving an auditor’s ability to detect defects in internal controls.  This is an area getting much thoughtful attention, but it’s also a tough nut to crack.   

A piece written in March of this year by Keith L. Johnson suggests that auditors should try to take a more diagnostic approach to their tasks.  He suggests that current audit procedures focused on financial and operational metrics are doomed to miss things because they don’t consider how organizations and humans actually behave.  He recommends a medical exam paradigm that would think of the current audit testing as similar to lab test results.  Then he would add the financial equivalent of behavioral and genetic risk factors.  He also wants some forward-looking evaluations of ongoing health and sustainability. 

Frankly it sounds more like what a stock analyst is tasked with doing than what an auditor does.  I don’t think the track record of stock analysts is such that anyone thinks they would increase the reliability of audits.  What audits already have in common with medicine is a requirement that you design testing so that it can be replicated.  The outcomes of sampling and testing can be manipulated either on purpose or in error.  However, with proper documentation, one can determine where the potential for bias and error was introduced.  That seems an area where the model already works.

Audit reports are based on a sum of the investigatory results, which are then used to form an opinion. Simply adding more opinions to the mix isn’t going to help build clarity.  Auditors are tasked with using professional judgment, which could be another way of articulating some of the considerations raised by this “medical model”.   

Joshua Ronen proposes the use of an insurance product associated with the financial statements.  His theory is to provide a market based incentive to get at the truth of the matter.  As an alumni employee of a bond insurance company I’m concerned that execution of this approach would also be very difficult to do effectively. 

One of my favorite nuggets of time management is that you need to prioritize between what is urgent and important.  Unfortunately, finding a more consistently effective method for auditing financial statements appears to meet both criteria. So I’ll keep reading….