34 Executive Counsel MAY/JUNE 2006 Auditors and Airport Screeners Have Similar Blind Spots

AUDITORS AND AIRPORT SCREENERSHAVE SIMILAR BLIND SPOTSBut Terrorists Don’t Pay the Screeners

By Gary D. Zeune

E ven though the items and information are right in front of them, air-

port screeners miss banned items, according to a December 30,

2005, article in The Wall Street Journal. Auditors miss fraud for the

same reasons screeners miss weapons. To test terrorism readiness, British

authorities digitally inserted images of guns, knives and other banned objects

into luggage. Initially the screeners’ performance was mediocre. But with prac-

tice it improved dramatically.

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Then the images were changed, and the screeners’performance dropped to no better than when the pro-gram started. There are several reasons why.

We “see” what we expect to see. We don’t see thebottle of beer on the shelf in our fridge because we’rehunting for a can of beer. For accountants, this meansthat if they haven’t received significant training inwhat the “red flags”of fraud look like, they aren’tlikely to detect fraudulent financial statements.

“Most auditors look for what they expect to see.After looking at the numbers, they look for supportfor those numbers, or look for what they are told isthere. A good auditor, with an instinct, just looks forthe facts. He listens to what he is told, but looks underthe rock to find what is there,” says Ralph Dickson, acertified financial examiner in Columbus, Ohio.

“Distractions” or “noise” render some thingsinvisible. The more items in the luggage, the morelikely the screeners failed to detect the weapon. Theability to pick out a single item declines when it’s partof a complex scene, loaded with similar items.

Likewise, auditors look at hundreds or eventhousands of transactions, journal entries, andevents. So finding a few fraudulent items is difficultat best.

Cognitive scientist J. David Smith at State Uni-versity of New York, Buffalo, used origami-likeitems to test recognition. The 88 participants even-tually spotted up to 76 percent of the targets. ThenSmith slightly changed the target and performancefell off a cliff.

Just as screeners have trouble applying theirknowledge to new situations, might auditors fail torecognize fraud or a misstatement because they haven’tpreviously seen it, or been trained to look for it?

Auditors are creatures of habit. They do thesame thing over and over. A good set of audit workpapers looks just like the prior year’s papers. Know-ing this, the client realizes if the fraudulent informa-tion can be made to look like what the auditor isused to seeing, the auditor will likely accept theinformation as true. So the client makes everythinglook “normal.”

“Auditors are taught to identify things that lookunusual – ratios, account relationships, trends, varia-tions,” says Patrick Turner, former Arthur Andersenpartner and now senior lecturer in accounting atOhio State University. “Sophisticated financial state-ment fraudsters also know what things would drawthe attention of the auditor, and hence conceal theirfrauds by manipulating data in a way that such rela-tionships don’t pop up. They can reconfigure the datato conform to an auditor’s expectation. It takesextensive training and a thorough understanding of

the business to create an appropriate framework forexpectations, and to always remain skeptical evenwhen things do conform with your expectations.”

David Dennis, Otterbein College, Westerville,Ohio, says: “For years I have been telling accountingstudents, and anyone else that will listen, that themost difficult error or fraud-related characteristic isan error, intentional or otherwise, of omission. Evenfor people who are well trained and fairly experi-enced, this can be a tough one.”

In other words, auditors are really good at audit-ing what’s there, but terrible at recognizing what’snot there but should be. They don’t recognize some-thing is missing. The oversight is compoundedbecause most auditors let clients prepare audit workpapers.

How can you tell? The schedules are marked,“PBC” (Prepared By Client), usually in the upperright corner of the first page of the schedule.

YOU’RE FIRED

Auditors have a strong disincentive to find fraud.Why? Because the client will likely fire the accountant.

“The types of frauds I see are managementfrauds, and I don’t believe that auditors fail to see thefrauds. I think, more often than not, they don’t wantto lose the client,” says Colorado attorney GordonYale. “Often the issues are clearly documented inwork papers, but the auditor comes to the wrongconclusion, chooses the wrong accounting, or simplyissues the improper report.”

Historically, audits have been viewed as a lossleader to get more lucrative work such as consulting.So the auditors are under tremendous pressure tocome in under budget and keep the client happy. Asa result, some auditors engage in “false sign-off.”False sign-off occurs when auditors don’t do thework, but sign off that they did it.

Finally, as a result of the corporate scandals,Congress enacted Sarbanes-Oxley, and the AmericanInstitute of CPAs adopted “Statement on AuditingStandards Number 99.”

SAS 99 says that the auditor “has a responsibili-ty to plan and perform the audit to obtain reasonable

36 Executive Counsel MAY/JUNE 2006 Auditors and Airport Screeners Have Similar Blind Spots

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Auditors have a strongdisincentive to findfraud. Why? Because the client will likely firethe accountant.

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assurance about whether the financial statements arefree of material misstatement, whether caused byerror or fraud.”

Thus, auditors have a positive affirmative duty todetect fraud. Given that auditors have a strong rea-son not to detect fraud, the question is whether audi-tors will detect methods of cooking the books if they

haven’t been trained on those methods. Of course,there are many ways to cook the books, but is thereany amount of training that will allow auditors tofulfill their obligation under SAS 99?

In the final analysis the question is, how do audi-tors train their brains to generalize their detectionskills to recognize fraud indicators that they haven’tbeen trained on? So far, I’m not aware of anyone whohas figured out how to do that.

SOLUTIONS ARE PAINFUL

There are several things that auditors can do to min-imize the problem. First, there’s more to hiring andretaining accounting staff than just debits and cred-its. Just as some people are better at math or music orart, some people are better at seeing patterns thanothers, including fraud patterns. So accounting firmscould screen employees for their detection ability.

Accounting firms now do a significant amount oftraining on ethics, which is a good thing. But fewfirms have any processes to hire ethical employees.Accountants aren’t ethical just because they’reaccountants. And no amount of ethics training willovercome an unethical employee.

It’s nearly impossible to be truly independent ifyou have a vested interest in the outcome. So all therules and regulations and lawsuits will not solve thefundamental systemic problem, which is auditors get-ting paid by the client.

There are a number of possible solutions. One isto form a “Federal Department of Auditing.” Anoth-er would be to have financial statement insurance,and have auditors work for the insurer. Another is forbanks to finance audits of their loan clients.

With Sarbanes-Oxley and SAS 99 legislatures, reg-ulators and the public may think they have solved theproblem, but corporate scandals are cyclical based onwhat’s happening in the economy. Every time there’s abooming economy those in oversight positions, likeauditors, let their guard down. It will happen again.Guaranteed.

Gary D. Zeune, CPA, is a nationally rec-ognized speaker and writer on fraud. Heis the founder of The Pros & The Cons,the only speakers bureau in the UnitedStates for white-collar criminals. He

teaches fraud classes for the FBI, bar and health careassociations, more than 30 state and national CPAsocieties, and numerous banks and accounting firms.

Indispensable

Auditors are really goodat auditing what’s there,but terrible at what’snot there but should be.

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