Normally, I prefer facts over opinions and prefer the fact-giver to be qualified. However, when it comes to auditors, I do want opinions, but–oh boy–I want mine Unqualified.
The raging debate over audit opinions is one of the juiciest parts of accounting. Aside from the myriad types of Fraud (See letters “F” and “K”) that can happen, companies with good intentions still stretch their accounting practices a bit. Even when they’re large and public, with their financials in plain sight. Especially when they’re large and public, it seems. Just ask GM and Toshiba.
But let’s step back a minute. What does an auditor do and where does a Qualified Opinion come into the picture?
Opinions Vary, Depending on Your Sense of Smell
Auditors are hired to inspect a company’s financial statements and financial processes. They are supposed to look, not just at the end result, but at the raw accounting data which create the statements. They’re trying to make sure the debits match the credits and that all the transactions are accounted for. For a public company, they’re trying to assure all existing and potential shareholders that the financial information which everyone uses to evaluate the company is truthful.
At the end of their inspection, they issue an opinion:
- Unqualified opinion, aka a clean report. Clean as a whistle!
- Qualified opinion. The auditors think the financials are generally acceptable except for a crucial piece. The auditors smell something fishy.
- Disclaimer opinion. Worse than a Qualification, the auditors are distancing themselves. Perhaps the company didn’t provide information requested or allow them to see critical procedures. The auditors couldn’t see what was behind the locked door in the basement, but it smells like a rotting whale carcass.
- Adverse opinion. The auditor thinks there is potential for fraud or that the financials are misstated. There’s a bag of dog doo in plain sight that’s been set on fire.
- No opinion. The auditors quit. This happens more than you might expect. Rather than issue something that isn’t a clean opinion, auditors may resign, since they have liability if they issue a positive report and something is later found. Just ask Arthur Andersen.
Auditing: The Ultimate Thankless Job
Think about what happens whenever you hire someone to inspect something, like your roof or basement. It’s a curious relationship. Since you’re paying them, you want them to find anything wrong, but you really don’t want them to find anything wrong, do you? You’re also annoyed having to pay them for bad news. There’s something primal about being inspected that makes you feel like mom is going to find cookie crumbs under your bed. Hence, no one likes auditors, and they know it.
The resistance to auditors is significant, and the pressure on auditors–paid by the company–to issue clean audit statements is very strong. How strong?
A study by Weiss ratings (2001) found that 42% of companies which went bankrupt had been given an unqualified opinion.Cited in the Philadelphia Inquirer
Goodbye Mr. Goodwrench
In the late 2000s, a financial scandal brewed for General Motors. Sales had lagged, as they had missed the rising competition from hybrids. They had covered their drop in income by accelerating how quickly they booked credits and rebates from suppliers in a non-GAAP way. A $300 million lawsuit from large investors cost both GM and their audit firm, Deloitte, who had failed to make GM disclose the discrepancies.
GM by 2008 teetered on the verge of bankruptcy. As a result, Deloitte issued a Qualified Opinion, saying they believed GM might not be a “going concern.” Such a Qualified Opinion is rare, but it was clearly warranted.
GM ended up taking emergency loans through the federal TARP program, restructuring itself during bankruptcy, renegotiating union contracts, closing factories, closing brands (like Mr. Goodwrench), and reducing management pay. They were able to repay the TARP loan, and as of October 2018, they were considered the “best-run car company in the U.S.”
Still a Company, Which Makes…Whatever
Toshiba, after a knock-down drag-out battle with its auditors, PwC, ended up with both a Qualified and an Adverse opinion in 2017. I hadn’t followed all the ins and outs at the time, but auditors Ernst & Young were fined and fired by Toshiba for allowing the company to misstate profits over several years.
When PwC took E&Ys place, in 2015, they immediately zeroed in on financial problems with Toshiba’s Westinghouse nuclear power plants. (How did Westinghouse end up primarily running nuclear power plants? That’s another blog, as is the “2017 South Carolina nuclear power political scandal.” The financial scandal rabbit hole!)
Anyway, Toshiba claimed Westinghouse had overstated its value when it was acquired in 2006, and PwC wanted Toshiba to disclose massive cost overruns in plants Westinghouse was building as of 2015. After a long argument, PwC issued an audit opinion that Qualified the financials–they were stinky, but viable–and Adverse on management governance–flaming pile of you-know-what. Since the CEO of Toshiba had already resigned because of the financial scandal, PwC did seem to have a point.
Frankly, some of these financial opinions, especially the notes at the very end of the statements make for fascinating reading. Heated arguments take place over the use of the adjective “material.” (See letter “M”). And, they’re pertinent. As a result of all this, Toshiba is literally today considering an acquisition offer by a large Japanese firm, CVC Partners.
And you thought Toshiba made laptops? Oh, honey, they stopped doing that ages ago…