The Times Union reports that an audit of an international electricity and gas company has uncovered major problems with the utility’s internal finance systems. The bulk of the audit focused on how the company handled integration of a Brooklyn-based utility after acquiring it in 2007. The two utilities ran on different financial reporting systems, but the parent company did not execute plans to merge the systems. The report also found disparities in how expense and other costs were accounted for at the parent company. The company’s president stated that although he asked the auditors to be deliberately critical, he did not want the report to give the impression that the company’s accounting departments are in disarray, because good practices were deliberately left out of the report.

Lessons Learned

Mergers and acquisitions can result in different levels and types of controls being applied across the organization. This is of particular concern when the financial systems are incompatible, and the automated controls to prevent and detect fraud are severely hampered. Furthermore, if the parent company assumes that the acquired company has been “switched over,” there may be an extended period of time where controls originally in place in the newly acquired company are no longer working, and the controls in the parent organization have not yet been put into effect. This “control vacuum” is a serious fraud risk.

The president of the parent company stated that the misallocation of costs may be “errors.” While this may be the case, the ability of employees to “obscure the origin and tracing” of transactions provides ample opportunity for fraud to occur. This opportunity could easily be coupled with employees feeling insecure over the future given the merger, and it can lead to both pressure and rationalization that could transform “errors” into deliberate acts of fraud.

The president also expressed concerns about the tone of the audit report. I would agree that all audit reports should be balanced — reporting the areas that are working well in addition to those that are not. Tone is a key component of balanced reporting — how are the control weaknesses reported? Is it a “scathing” report where the auditors “uncovered major problems involving lavish expenses,” or did the audit “identify expenses that were not compliant with corporate polices?” Internal auditing needs to consider the interpretation others will have when they read terms like uncovered, discovered, lavish, and obscure in the report. Audit findings should be put into appropriate context and focus on the facts (e.g., observed, identified, noncompliant) when reporting. Confrontation is not always conducive to effecting the desired change.

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