As a follow-up to my first post on Too Big to Disclose, I want to look at the issue of why accountants are not the market participants to rely on for exposing our failing firms in advance.

Accountants don’t want the role of exposing failing firms.  The role accountants want is to be an independent umpire who says a company’s financial statements were constructed in compliance with the current accounting rules.

The role of independent umpire insulates accountants from lawsuits or any negative repercussions from an audit client failing.  If the company commits fraud the auditors don’t find, it is the fault of senior management and the Board of Directors.  If a company fails because it has a bad business model, it is the fault of the investors for not doing sufficient due diligence.

However, the role of exposing failing firms presents all sorts of problems for accountants.

Consider the rule all material information must be disclosed.  What is considered material?  Accountants have developed a simple rule of thumb saying an item is material if it affects earnings or assets by more than 5%.

So should accountants base their assessment that a firm is failing only on publicly disclosed data or should they use the much more granular data they are privy to?  If only publicly disclosed data, why are the accountants needed to expose failing firms?  Isn’t this the investors’ responsibility?  If the identification of a failing firm is based off of more granular data, why isn’t this data being disclosed (after all, it is clearly material to the accountants reaching a conclusion a firm is failing)?