ACCOUNTING AND AUDITING PRACTICES AND PROCEDURES THURSDAY, JUNE 9, 1977 U.S. SENATE, SUBCOMMITTEE ON REPORTS, ACCOUNTING AND MANAGEMENT OF THE COMMITTEE ON GOVERNMENTAL AFFAIRS, Washington, D.C. The subcommittee met at 10 a.m., pursuant to recess, in room 6202, Dirksen Senate Office Building, Hon. Lee Metcalf (chairman of the subcommittee) presiding. Present: Senators Metcalf and Percy. Staff present: Vic Reinemer, staff director; E. Winslow Turner, chief counsel; John B. Chesson III, counsel; Jeanne A. McNaughton, chief clerk, and Burleigh Leonard, minority counsel. Senator METCALF. The subcommittee will be in order. The Senate is going to vote at 10:30. We only have 15 minutes until we will have to recess. I think, in view of the time, we will call the meeting to order and then when the vote comes up, you will have to wait while we vote. Today, we are resuming our inquiry into the types of auditing practices which are promulgated or approved by the Federal Government. Senator Percy is taking an especially active interest in this particular inquiry, and his knowledge and experience has been a valuable contribution to our hearings. He has asked that I schedule this hearing so he can hear several witnesses' testimony which he believes will further the goals of this committee. All of us want to correct the problems which have been brought to our attention. With that in mind, I am pleased to welcome today's witnesses. The first witness today is Mr. Manuel Cohen, chairman of the AICPA's Commission on Auditors' Responsibilities. We have been talking about the Cohen report in every one of these hearings. So we are delighted to have you here this morning with the knowledge that we may have to suspend for a few minutes. Senator Percy, do you have any opening remarks? OPENING REMARKS OF SENATOR PERCY Senator PERCY. Very few. We have a conflict in hearings. I had to greet a few old friends, publishers and editors of the Los Angeles Times and Time magazine, and so forth, this morning. But these hearings. I explained to them, are among the most important that we have held in the Senate in a long time. Today does mark the final day of the testimony during what I consider to be a most constructive and thorough set of hearings that have ever been held in this profession. I have advocated repeatedly that meaningful reform in the area of audit and accounting standards must come from within the private sector itself. This subcommittee has the will, the desire, the commitment to see that the private sector is given every opportunity to follow upon the many excellent recommendations witnessed today. What is most encouraging thus far is that I sense that the private sector is developing a degree of will and commitment to see that the challenges are forcefully and effectively met in the near future. There has been expert testimony given, sometimes cynical, sometimes skeptical as to whether, as one witness said the profession will ever respond to its responsibilities. Certainly, you can't overlook Admiral Rickover's challenging and highly provocative testimony, but I simply am still convinced the industry will and can measure up to its responsibilities. That is the best way to go about it. I far prefer to give the profession every chance to prove it can measure up to the standards that so many of the leaders of the industry have said the industry must, the profession must adhere to if it is to continue to carry its burden of responsibility that we expect in the American industry and the free enterprise system expects them to carry. I think it is fitting that we conclude this portion of the hearing with testimony from the individuals whose work and philosophy indicate the type of attitude and values so vitally necessary if the private sector is to meet these challenges. I look forward to today's testimony, to participate in the continuing dialog in the months ahead to build a responsible and reflective consensus of the actions which meet the needs and concerns of growing public awareness of the credibility of the accounting profession and its clients. With all of the industry as witness, I would like to pay tribute to you, Mr. Chairman, for the way that you have conducted these hearings, the fairness and the sense of justice you have had, and the commonality of interest I think we have in wanting to see the profession is given every opportunity to measure up to its own self-imposed standards and see that they are implemented and carried out by every segment of the profession. Senator METCALF. Thank you very much, Senator Percy. We are very pleased to have you here, Mr. Cohen. You may go ahead with your prepared statement or in any way you want, and introduce your colleagues with you. TESTIMONY OF MANUEL F. COHEN, CHAIRMAN OF THE COMMISSION ON AUDITORS' RESPONSIBILITIES, ACCOMPANIED BY WILLIAM C. NORBY, LEE J. SEIDLER, KENNETH W. STRINGER, AND WALTER HOLMES, JR. Mr. COHEN. Thank you, Mr. Chairman. My name is Manuel F. Cohen. I am a lawyer and I appear here to 1563 With me, to my immediate nan of the commission, who wi Mr. Seidler is a nonpractising write He is a professor of accounting & New The Timer ness analyst and consultat The other members of the CommSTRAT on my far left, chairman of the boat and ther large finance-based diversifed magam. A On my far right is Mr. Wan analyst and senior vice president of lu Unfortunately, Mr. Lehry Lamu melt der firm of accountants and antislime the Accounting Principles Board pre- & Sells. The seventh member of day, and I should say he and Min. LIS firm of accountants and and Mrs At the outset. we wish to trade s and that certain members of the sys Copies have also been sear House Committee on Internet m mary is too brief to promie mendations or a basis for mater submitted to this subomines, $18 discussed in our report I took seriously your today. Accordings, for at of th tire report be include: Senator METCALF. Mr. Cohen. I have already printed and terr Senator PERCY. Mr. Cocen Senator PERCY. I wouldn't save. I suppose a so readily available T " Mr. COHEN. You are quite right, gentlemen. We are content with merely a suggestion, and as the chairman has already noted, nearly 50,000 copies of the report have been distributed to CPA firm offices and to a large number of individuals and organizations concerned with financial reporting and the role of the auditor. I might interpolate at this point that I wish we owned the copyright on the report and could collect royalties. It has gotten to be a best seller. Senator METCALF. I will ask that the staff consider this matter. It may be that excerpts should be incorporated in the record for understanding of both your testimony and the previous testimony that was given here and, if necessary, we will print the entire report. I am not going to make an order on that right now. Mr. COHEN. Thank you, sir. At the request of interested organizations, members of the Commission have been attending numerous seminars and other meetings. The report is or will be a topic of discussion at annual and regional meetings of the Financial Executives Institute. the American Accounting Association, the American Institute of CPAs, the National Accounting Association, and other groups. I should also note that we have arranged a public meeting in Washington beginning on June 21 to receive oral presentations with respect to our report. We have also asked for more detailed comment, criticism or suggestions in the form of written submissions. Upon the completion of the meeting and review of the written submissions and so much of the record of these hearings as may be available to us, we will review our tentative conclusions and develop a final report, hopefully by the end of this year. Before I describe the more significant conclusions of our report. a few words concerning the background of the study and our methodology may be useful. Senator METCALF. Haven't you available to you transcripts of all the hearings that have been held here? Mr. COHEN. I have not had available a transcript of all the hearings. I have tried to collect all of the written submissions and I am sure that your staff will be most helpful in providing additional materials to us. Senator METCALF. I know that the staff will work with you in providing you the material necessary for this June 21st meeting, and any further material that you need in developing your final report. Mr. COHEN. The reason I mention that, Mr. Chairman, is because I would like to join, add to the comments made by Senator Percy. I think these hearings are very useful, very timely and it is important to all of us to have the benefit of as much that has been presented to you in our further consideration of our own tentative conclusions. Senator METCALF. We want you to have every bit of information that we have been able to develop. Mr. COHEN. Thank you, sir. Just a bit about the background of the Commission's study. The Commissionn was created as an independent body by the American Institute of CPA's in the fall of 1974 in response to growing criticism of the accounting profession. The Commission was asked to study the role and responsibilities of independent auditors and to make recommendations designed to nar financial statements and the performance of auditors. A study of such broad scope had never been undertaken before that time. All members of the Commission serve without remuneration. The financial arrangements whereby our direct expenses are reimbursed by the AICPA are disclosed in our report. We have had no directions or restrictions as to the scope of our study or recommendations. We viewed the scope of our study broadly. Originally, we intended to deal with the full range of problems surrounding auditing. We decided later that some limitations were necessary to enable us to concentrate on audits of publicly owned corporations since the public interest is most widely affected by this activity. We believe we have addressed the principal issues that relate to the concerns of our society over the state of the auditing profession. We found it necessary to undertake a great deal of research first to identify correctly the major issues within the framework of our charge and then to determine the courses of action necessary to gather the data and other evidence relevant to an understanding of perceived problems and recommendations to deal with them. In the appendix to our report we have a listing and a description of certain of that research. Subject to modifications appropriate in the light of comment on our tentative conclusions, we believe our recommendations when implemented will deal effectively with these problems. We also believe that additional costs which may result from the adoption of our recommendations will not be excessive when compared with the benefits. Our research was extensive and diverse. We reviewed previously published materials and sponsored numerous research projects, surveys, and case studies. We sought information from many knowledgeable individuals including accountants in other countries, the chief accountants of many government agencies and the staffs of the SEC and the General Accounting Office, through discussions, interviews and participation in seminars. We also sought and obtained the views of users and preparers of financial information: Security analysts, investment advisers, officials of banks and other financial institutions, professional and amateur investors, academicians and officers of industrial and commercial enterprises. We reviewed the vast amount of material available to us and drew on the diverse experience of the members of the Commission to arrive at what we believe are the most appropriate conclusions. Implementation of some of our recommendations will require action by the AICPA, the FASB, the SEC and other agencies and institutions. Many are directed at individual auditors, boards of directors, management, other elements of the corporate community and can be adopted without formal or institutional regulation. For example, our recommendation that audit committees take an active role in the process by which the independent auditor is selected, the scope of his engagement developed, his fee determined and his work monitored can be adopted quickly by any board. We urge individual auditors and their clients to implement our |