Discussant's response to unique audit problems of small businesses that operate under managerial dominance;

              Discussant's Response to
Unique Audit Problems of Small Businesses
that Operate under Managerial Dominance
Albert A. Armstrong, Jr.
Baird, Kurtz, & Dobson
Let me say at the outset that this is a comprehensive and useful piece of research on a subject that is most significant to firms such as my own. I was dis­appointed
that Dan offers no specific solutions to the problems precipitated by Sections 320.35 and 320.34 of SAS No. 1 and apparently endorses the recom­mendations
of the Cohen Commission calling for "additional guidance specifically applicable to audits of smaller entities . . ." by the AICPA. Since I have no quar­rel
with the basic facts presented in the paper, I shall attempt to address these two areas to which I have referred. Let it be understood that the following opinions are my own and do not necessarily reflect the position of my firm on these matters.
Unique Problem
In my opinion, the problem of management override or dominance is not "unique" to the small business. Any objective review of major audit failures will reveal that they are primarily the result of management fraud or misrepresenta­tion.
Thus the single greatest audit risk, regardless of the size of the entity under review, may well be the integrity of management or, as I prefer to call it, "Management Bias.''
The unique aspect of management override in the small business sector, as defined in the paper, is the relative ease with which management can manipulate the accounting records. It is seldom necessary to resort to "policy writing par­ties,"
peer group pressure or other elaborate ruses commonly found to be the causative factors in major audit failures. Due to his "limited financial and ac­counting
experience and capability," the manager of the small enterprise is nor­mally
limited to simple misstatement of assets and liabilities.
Since the normal bias of the financially healthy small business is toward minimization of income taxes, the most frequent result is understatement of assets and income. Although the auditor should be as concerned with understatement as overstatement, I think it is fair to state that fewer auditors come to grief for the former than the latter.
Don Ziegler, in his paper presented earlier in this symposium, has offered a succinct and highly perceptive description of the audit attitudes necessary to deal with the risk of management override or fraud:
1. Watch out for overstated assets and understated liabilities.
2. Be wary of related party transactions.
3. Pay particular attention to large, complex transactions.
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