Welcome to annual report season! This is the yearly tradition dictated by the Securities and Exchange Commission that requires publicly held companies to file their annual 10-K forms anywhere between 60 and 90 days after the calendar year ends. Many banks, investors and other institutions place similar requirements on their clients. These reports include a company’s financial statements, which are audited by an outside accounting firm.
My advice? Be very skeptical of that auditor’s report.
As a CPA, a proud member of this great profession and a former manager at a big accounting firm, I’m not confident in an auditor’s report. Why? Have you read one lately? Like most investors you probably haven’t. But you should.
The industry-standard template provided by American Institute of Certified Public Accountants says that "management is responsible" for the company’s financial information and that the auditor is only giving "reasonable assurance about whether the financial statements are free from material misstatement." What’s material? What’s significant? This is information not shared.
Those same executives are required to sign a “representation letter” that lays all the burden on them and makes it almost impossible to blame an outside accountant for any problem that may occur. This letter alone, with its heavy reliance on what management says and does, raises questions as to how ineffective today’s audit procedures are.
What about fraud? It’s no better. An audit report “expresses no opinion" on the effectiveness of a company’s internal controls. Translation: we’re not responsible for fraudulent activity.
As investor, these are not exactly comforting words. Basically, the accountant is saying to the world that all the information in the financial statements comes from management and that they've........