Should audits be graded?

Chief Executive, The, April, 2004

NOT ONLY are accounting firms doing more fraud detection in the wake of Enron and other scandals, there is also a movement afoot to replace the current pass/fail audit with a more detailed grading system.

The idea was first suggested by Samuel DiPiazza, CEO of PricewaterhouseCoopers. Its proponents say accounting firms should adopt a grading system similar to the one used by credit-rating companies such as Moody's and Standard and Poor's.

DiPiazza has proposed that auditors grade their clients on what he calls the "six C's" of financial reporting: completeness, compliance, consistency, commentary, clarity and communication.

In the case of Enron, the argument goes, there was no way that the company's auditor, Arthur Andersen, would have dared give the energy giant a failing grade under the present pass/fail system. But Andersen might have given, say, a grade of "B" or worse to Enron's financial statement transparency. That could have sent a signal to the financial markets, prompting analysts to more carefully scrutinize the company.

It's unlikely, though, that if the nature of the audit ever undergoes such a radical change it will happen anytime soon. The profession has already been buffeted a great deal over the past three years, and the new standard-setter, the Public Company Accounting Oversight Board, is expected to let things settle for a while.

--M.B.