Auditors Need to Listen

Here is an article I wrote in 2003. It seems to me it is still applicable today.

The Wall Street Journal has been reporting on the fraud at HealthSouth. What occurred at HealthSouth is instructive to auditors because it shows how senior management can have a pervasive influence over transactions, how easy it is to alter invoices with the technology available to us and how difficult it is for staff to be heard when they have concerns within an organization.

The Securities and Exchange Commission has charged, "Since 1999, HealthSouth Corp. ("HRC"), one of the nation's largest healthcare providers, has overstated its earnings by at least $1.4 billion. This massive overstatement occurred because HRC's founder, Chief Executive Officer and Chairman of the Board, Richard M. Scrushy ("Scrushy"), insisted that HRC meet or exceed earnings expectations established by Wall Street analysts. When HRC's earnings fell short of such estimates, Scrushy directed HRC's accounting personnel to "fix it" by artificially inflating the company's earnings to match Wall Street expectations. To balance HRC's books, the false increases in earnings were matched by false increases in HRC's assets. By the third quarter of 2002, HRC's assets were overstated by at least $800 million, or approximately 10 percent of total assets. HRC's most recent reports filed with the Commission continue to reflect the fraudulent numbers."

As reported in the Wall Street Journal, Mr. Michael Vines, a bookkeeper in HealthSouth's accounting department, tried to alert outside auditors and others to the questionable practices in his accounting department, but his concerns fell on deaf ears.

According to the Wall Street Journal, "…Mr. Vines identified about $1 million in entries he believed were fraudulent. Mr. Vines told his immediate superior, Cathy C. Edwards, a vice president in the accounting department, that he wouldn't make such entries unless she first initialed them. "I wanted her signature on it," Mr. Vines testified.

"Ms. Edwards, according to Mr. Vines's testimony, signed off on the entries, and he logged them. Mr. Vines also testified that he saw Ms. Edwards falsifying an invoice, which according to his testimony was a way to cover up the larger fraud involving the accounts. In December 2001, Mr. Vines said on the stand, Ernst was conducting a routine review of how HealthSouth depreciated its assets. As part of the review, Ernst asked about an asset on the company's balance sheet.

"The problem: There was no invoice showing that the asset, for a facility in Kansas, had been purchased. (The court papers don't specify what the asset actually was.) So, Mr. Vines testified, Ms. Edwards ordered Mr. Vines to pull an invoice for a different purchase, for a facility in Braintree, Mass., that roughly matched the asset's price. She then scanned the invoice into her computer and altered the shipping cost and other information to make it fit the asset that Ernst was asking about, according to Mr. Vines's testimony."

Our ability to rely on the traditional documentation supporting transactions is diminishing in today's environment. Our ability to detect fraudulent documentation is limited. Instead, there are two primary forms of evidence that auditors need to focus on: analytical evidence and physical observation of the actual items purchased.

We are developing our analytical skills with our data analysis software. Now we need to put more emphasis on getting out from behind our desk and visiting agencies to examine what we are paying for. And this can be a challenge because we may not always know what we are looking at. Most of us would be hard pressed to assure that a network computer has all of the features the agency requested when it was purchased - but I'm sure there are technical staff available who can assist in making that determination. Trying to verify that consumable products were actually used by the agency is also a challenge. Here we need to rely on some analytical review to give us a clue as to reasonable usage and interviews with staff to assure they can vouch for the items used.

We can go on with all of the challenges to verifying the existence of a purchase, but these are the real issues we need to confront as we seek to meet our audit responsibilities and the expectations others have in relying on our work.