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The Counselor - June, 2002

Financial Reporting comes of age

The meltdown of an accounting powerhouse, brings another, similar change to mind. In the late 1980s, after the S&L collapse, government and appraisers alike tried to fix the "appraisal problem." Inadequate appraisal standards, it seemed, were to blame for misleading, incompetent, or fraudulent opinions of value. Well-meaning committees met to write careful standards so that it couldn't happen again. The new reports would be authoritative, thorough, and clear. And expensive. For a while, it appeared that FIRREA meant "finally, I'm a rich real estate appraiser."

The outcome, of course, was much different. Appraisers were humbled to learn how little value lenders placed on the new reports. Fees fell. And new restrictions on client relationships meant that appraisers worked for lenders, not for developers.

To be sure, the program succeeded in removing many opportunities for appraisal abuse, by lenders, borrowers and practitioners. But at the same time, it destroyed the opportunity for a skilled appraiser to make other use of all that he learned. The combination of price pressure and client restrictions meant that appraisal became formulaic, repetitive, and specialized. The profession shifted toward large firms, capable of reliable, systematic production of repetitive, streamlined reports. Others focused on expert testimony and high-cost specialty work. For the ordinary property, appraisal is indeed cheaper, better, faster. But those with unusual properties or transactions find it increasingly difficult to obtain affordable, competent appraisal services in a standardized market. Many flexible generalists have left valuation, and appraisal is the lesser for it.

* * *

Fifteen years later, the strength of audited financial statements is routinely called into question. The Big Eight is now the Final Four. Once, each sported a consulting arm with a familiar name, meant to make use of a strong reputation. Today's names, Cap Gemini, Accenture and most recently, Monday, are as distant as possible from their stolid roots.

Where did these firms come from? Around the time that the S&Ls began their death march toward the RTC, the major accounting firms decided to make better use of all the knowledge gathered while mired in the clients' books. Their emphasis on consulting, outsourcing, and systems created new, lucrative careers, and drew better talent from the universities. The strongest minds stayed in the profession, rather than moving on.

Recent abuses have called the auditing field into question. And this time, the penalty falls not on those who perpetrated the crime, but on those who failed to notice. So the audit of the future will become the audit of the past, with an emphasis on noticing.

Auditors are reminded that the ultimate client is the investor, not the corporation. And already, diligent, well-meaning committees are cranking out detailed specifications for the new, improved audit. When they're done, much will be improved. But don't expect accounting to become more profitable, more innovative, or more reflective of the latest trends. Like appraisal, the definition of a solid audit will be clear, predictable and better enforced. But like appraisal, parts of it will disappoint.

Copyright 2002 - Noah Shlaes