*REPLY TO THE FOLLOWING POST WITH A WELL THROUGH ANSWER
One of the key audit consideration and procedures related to planning and supervising an audit under generally accepted auditing standards (GAAS) is having an understanding of the entity’s business and industry (AU 311 prior to 2010 and later PCAOB 2010-004). The Lincoln audit failure, especially by Arthur Young centers around this apparent lack of industry understanding due to the large gains recognized on undeveloped raw land acquired just 18 months prior. The argument that the auditors did not understand the real estate market Lincoln operated in is suspect in my opinion. The auditors not only identified the questionable transactions, including the Hidden Valley transaction, but they also identified the parties as well as the loan Lincoln’s made to a related party of the end purchaser, Wescon. In addition, the auditors were aware the property sold for almost twice the value of an independent appraisal a week earlier and almost 5 times the acquisition price 18 months earlier. The fact the auditors never realized Wescon lacked the financial means to support the property nor did it have the ability to develop the property may highlight the auditor’s lack of knowledge of the real estate market. The auditors may also not have realized the Arizona residential market was already in decline and that Wescon did not have a business purpose for the acquisition. My difficulty believing this knowledge would have made a difference stems from the auditor’s constant justification of the transactions relying on the form instead of the substance of the transaction even in the face of several red flags they themselves identified.
Considering it is a requirement for auditors to understand the entity being audited as well as its environment, the only time I can see an audit partner not having to have industry experience is if the rest of the audit team has extensive experience in that area, especially the audit managers.
Mandatory audit partner rotation only exemplifies the need for audit partners to be experienced in the entity’s industry. The study in the link below claims financial reporting quality declines during audit partner rotation and takes several years for the new partner to truly understand the entity being audited. This weakness is offset with the benefit of auditor independence and the assurance auditors remain the watchdog they were intended to be instead of the enabler they often were prior to Sarbanes-Oxley.
https://pcaobus.org/Standards/Archived/Pages/AU311.aspx (Links to an external site.)
org/doi/abs/10.2308/ajpt-50753?journalCode=ajpt” class=”external” target=”_blank” rel=”noreferrer noopener”>https://aaapubs.org/doi/abs/10.2308/ajpt-50753?journalCode=ajpt
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