your letter that many large accounting sted about these issues, but am not completely e subcommittee members will have the full S: any further suggestions you may have to stee in achieving proper reforms in the The subcommittee members and staff bretect the interests of small and cunting firms while addressing the problems Mr. J.B. Dresselhaus 20 May 1977 Page Two If any legislation is proposed, we will seek your views. I assure you that you will not need a Washington law firm to have the same input into this subcommittee as a "Big Eight" firm. Very truly yours, ORIGINAL SIGNED LEE METCALF My statement on the use of internal control to replace audit steps stems from the Statement on Auditing Standards Number 1, Paragraph 320.01: The second standard of field work is: There is to be a proper study and evaluation of the existing internal control as a basis for reliance thereon and for the determination of the resultant extent of the tests to which auditing procedures are to be restricted. My comment related to the fact that in many large companies, which give the appearance of having good internal control, the auditors give more credence to its value than perhaps should be. The extent of tests of the underlying items of the financial statements is thus reduced. I would refer wo to the announcement subsequent to my letter, that the S.E.C. Quality Control investigation of Peat, Marwick, Mitchell & Co. had shown too much reliance on internal auditors by the firm. As to the matter of materiality. With a company as large as General Meters, and using a 5% materiality factor, it is possible that a small subsidiary of a value or income under this percentage of the total would not be subjected to any audit testing on the theory that if it were to disappear entirely, it would not be material. I hope that these explanations help you. I realize they are short, but will be happy to respond again if you want amplification. Yours very truly, ACCOUNTING AND AUDITING PRACTICES AND PROCEDURES THURSDAY, MAY 12, 1977 U.S. SENATE, SUBCOMMITTEE ON REPORTS, ACCOUNTING, AND MANAGEMENT OF THE COMMITTEE ON GOVERNMENTAL AFFAIRS, Washington, D.C. The subcommittee met at 8:30 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 members present: Vic Reinemer, staff director; E. Winslow Turner, chief counsel; John B. Chesson, counsel; Gerald Sturges, professional staff member; Lyle Ryter, minority counsel; Jeanne A. McNaughton, chief clerk; and Anne Boni, legislative assistant. Senator METCALF. The subcommittee will be in order. Today, we resume our hearings regarding the improvement of auditing and accounting practices established or recognized by the Federal Government. One of the impacts of the new budget procedure has been that we have a logjam in legislation on or before May 15, hence the early hearings here today and my time commitments over in another committee upon which I am serving. At 9:30 a.m., we are marking up the Outer Continental Shelf bill and an energy bill in that committee. It will be necessary for me to impose some time limitations on witnesses in order to complete the hearings within the limited time available. Witnesses testifying alone should summarize their prepared statements within 10 minutes. Those testifying as part of a panel should summarize their statements within 5 minutes. The prepared statements of witnesses will be entered into the record as if read in full. This procedure should allow us ample time to ask questions. I hope the witnesses and members of the subcommittee will honor our time restraints, because we do have to end this hearing rather early today. The first witness today is Mr. Walter Hanson, senior partner of Peat, Marwick, Mitchell & Co. We are delighted to have you with us. Please introduce your colleague and go right ahead. TESTIMONY OF WALTER E. HANSON, SENIOR PARTNER, PEAT, MARWICK, MITCHELL & CO., ACCOMPANIED BY VICTOR EARLE, GENERAL COUNSEL Mr. HANSON. Thank you, Mr. Chairman. With me this morning s Votre M. Earle, the general counsel for PMM. nator. I really welcome the opportunity to appear at these hearmes and to participate in what I believe is the most thorough and metal alg ever undertaken between Congress and the acprofession. These bearings have certainly intensified the profession's ongoing Ln. sis of its role and responsibility and how we are meeting public perations. This undoubtedly will lead to many changes that will zened: the public. Your stad study has raised valid concerns about past accounting and ating performance, but in our opinion it failed to give adequate gton to changes that have taken place. We also believe it was e pessimistic about the capacity of the profession to respond further the public interest. Our extensive printed statement, which I have submitted for the eerd, deals with some of the charges in the staff study that we beeve to be unsupported. Rather than summarizing the evidence preserted there, I would prefer to use our brief time together to emphae ways of enhancing the profession's ability to meet its present and fre public responsibilities. I would like to stress three basic points. First, accounting and auditing in the United States today are the best in the world, not only in the comprehensiveness and soundness of standards, but more importantly in the integrity of their application in practice. This has been accomplished through vigilance and responsiveness by the private sector, with limited intervention but effective oversight by the SEC and other governmental bodies. To be sure, there are areas which currently need improvement; indeed, in a dynamic business environment there always will be continuing needs for improvement. However, the public accounting profession has been and continues to be highly responsive to such needs. In our detailed submission we itemized various problems which arose over the past decade togther with the responses the profession has made to each. Some of the additional issues which were given prominence in the staff report have not yet been resolved. However, even those were already being addressed by the profession. The Cohen Commission Report on Auditors' Responsibilities, the Financial Accounting Foundation Structure Committee Report, and the AICPA peer review program are all good examples. I repeat, without equivocation, that the private sector in the United States has done a commendable job in establishing accountability standards, has demonstrated its responsiveness to deficiencies or new problem areas, and continues to offer the best approach for dealing with these matters in the future. Second, I believe cost effectiveness has received inadequate consideration in all of the discussions concerning present deficiencies and |