I have this natural tendency to want to trust everybody. I know that’s not good, so I have to fight that tendency, especially in the business world. Fortunately, I started my career as a CPA and auditor, and I learned about this thing called “Professional Skepticism“.
If you look that up in the accounting standards book, it will tell you that “(auditors) need to overcome some natural tendencies—such as overreliance on client representations—and biases and approach the audit with a skeptical attitude and questioning mind. Also essential: The auditor must set aside past relationships and not assume that all clients are honest.” (my emphasis)
Quite a lot to swallow for a naive kid coming right out of college who thought truth ran rampant in the corporate halls.
But swallow it I did, and I rushed into my career with my skepticism meter cranked up to 10, expecting to ferret out any fraud that came my way. I searched under every rock, and doubted just about everything my clients said. Needless to say I wasn’t getting the jobs done very fast this way, and I very quickly had to alter my approach, or go insane (and lose my job too).
I eventually figured out that this “BS Meter” had to be more carefully calibrated – for example, there were some things that just weren’t “material” enough to make a difference – i.e., I didn’t have to spend a day tracking down that one or two dollar difference in my bank reconciliation. Plus, I developed some quicker ways to do fraud checks on the key balance sheet accounts.
There was one place, however, where I got a close-up view of how a “past relationship” can put trust to the ultimate test, and really learned the value of correctly calibrated Professional Skepticism. It was at a Savings & Loan, where everything hinges on the collectible value of its loan portfolio. If an institution like this had too many bad loans, it could easily be forced to go under. So the battleground for auditors was this thing called “the reserve for bad loans“. Since it also was the most subjective line item, THAT was the place we needed to crank up the skepticism meter.
We would go in and assess this reserve by looking at a lot of loans, particularly ones that were not current, and ask a lot of questions about them. What we got in return was was a lot of “hey, don’t worry, I know this guy – he’s going to pay“, or “this strip mall will get rented out any day now“, or “the value of this real estate is not properly reflected in this appraisal” – answers all designed to convince us not to recommend raising this all-important reserve.
Then, we made our judgments, and put them on the workpapers. Since I had never met these loan officers before, it was easier to figure out that these people were stretching the truth to the breaking point, so in in this case, we made the reserve much higher than what had been in the Savings & Loan’s books- high enough to put them in dangerous territory. Then we left it up to the “higher-ups’ in my firm to present it the S&L executives. Next thing I knew, the “final” reserve in our audit report was the same as the client’s original number.
What happened? Too much reliance on the “past relationship”. These folks had worked together for a long time. They had lunches & dinners together. They probably played golf at the same country club. And, on top of that, there was the fear of losing the client, by telling them something they didn’t want to hear, and really sticking with it. Professional skepticism was put on the backburner.
That turned out to be a big mistake. The S&L went under not long after the audit was completed.
I walked away from that experience 25 years ago with a great lesson that has served me very, very well. Despite our desire to trust, sometimes there are situations where there is too much at stake – where money, livelihoods, and reputations are involved. So you just have to be skeptical, and ask those questions, and dig a little deeper. Even with people you’ve known professionally for many years. Even with friends.
Because at the end of the day, the only person that can really protect you from being taken advantage of is….. YOU.
That’s just the way of the world.