Paid Program: Beyond the Balance Sheet

Beyond the Balance Sheet

How auditors use professional skepticism and independence to uncover risks, ensure accuracy and protect trust.

Imagine millions of investors pouring money into companies based on financial statements that could be hiding systematic fraud. Independent auditors help prevent this reality every day, protecting retirement funds, pension plans, individual savings and keeping our capital markets stable. The following fictitious case study is inspired by real-world audit challenges to illustrate how rigorous professional skepticism and routine audit procedures can reveal improper accounting that threatens investor interests. We talked to real public company auditors for insights into how they approach their job of assuring information found in a company’s financial statements. When global pharmaceutical company Consolidated Health Sciences (CHS) completed its acquisition of Lunthera Therapeutics last year, the deal barely registered in financial headlines. For millions holding CHS shares through pension funds and retirement accounts, it appeared to be another growth opportunity. What these investors couldn’t have known was that their trust was about to be tested in ways that reveal why independent auditing exists in the first place. External auditors are legally required to examine public companies’ financial statements, serving as independent watchdogs who verify that reported numbers are accurate. “It’s simply not realistic for every investor to understand what’s going on within a company, even if they are financial experts,” explains Sara Lord, chief auditor for RSM US LLP. “As external auditors, we are independent of the company and serve as a proxy for every stakeholder.”

Part 1: When Routine Procedures Reveal Hidden Problems

During routine audit procedures that follow any major acquisition, auditors conduct walk-throughs—systematic examinations of how companies handle their financial processes—to understand where reporting might go wrong. At Lunthera Therapeutics, these standard procedures revealed troubling patterns. The CHS audit committee chair had already shared concerns about the acquired company’s culture, issues that surfaced only after the deal closed. Recognizing that cultural problems often manifest in financial reporting, the audit partner approached procedures with heightened professional skepticism. “Professional skepticism is a bedrock of what we do,” Lord notes. “It’s the intersection between not presuming everyone is fraudulent while also not accepting everything at face value.”

Initial walk-throughs confirmed suspicions. When documenting revenue controls—internal processes ensuring revenue is recorded accurately—auditors found no evidence that supervisors were reviewing staff work. The capital expenditure process revealed worse gaps: five-year-old flowcharts and key positions vacant for months.

Why It Matters

Control failures which affect one company could cascade across investment portfolios, affecting millions of retirement accounts and pension funds. The auditor scrutinizes and examines these controls to keep healthy companies functioning, which in turn could prevent company breakdowns.

Part 2: From Warning Signs to Hard Evidence

When auditors encounter potential risks, they recalibrate their strategy rather than simply note them and move on. “Based on our risk assessment, the auditor develops procedures and audit responses to the risks of fraud,” says Brian Croteau, U.S. chief auditor at PwC. “It’s an assessment we do throughout the audit, updating our views of risk and modifying our approach.” This dynamic response was exactly what happened at Lunthera Therapeutics. As the auditors identified more risks through their procedures, they expanded their testing, which is a standard response when initial procedures raise concerns. A sample of 25 revenue transactions revealed systematic manipulation: The company had been recognizing revenue before drugs were delivered to buyers. While internal reviews only spot-checked major contracts quarterly, the auditors’ systematic sampling across all transaction sizes revealed the pervasive pattern that internal processes had missed. Purchase orders, invoices and shipping documents showed consistent premature revenue booking. For investors, this practice is particularly dangerous because it makes companies appear more profitable than they actually are. Stock prices and investment decisions depend on accurate revenue figures. When revenue is manipulated, investors make decisions based on false information. “Whether a misstatement is intentional or not, we certainly want to understand the nature of it,” Croteau explains. “If we determine a misstatement was potentially intentional, we respond by considering the implications to our audit.” This approach proved essential at Lunthera Therapeutics. Expanding testing revealed improper capitalization of routine maintenance costs as long-term investments, understating expenses and overstating earnings. Internal approvals only covered expenditures above $10,000. Auditors’ comprehensive testing of all expense classifications caught systematic errors below internal review thresholds. Standard year-end fraud inquiries—direct questions auditors are required to ask of certain management and staff—can reveal important information about underlying fraud risks. At Lunthera Therapeutics, these inquiries uncovered a corporate culture exhibiting all elements of what auditors call “the fraud triangle”: opportunity (through weak controls), pressure (aggressive performance targets) and rationalization (justifying accounting manipulations). “The fraud triangle is brought into play throughout the whole lifecycle of the audit,” Lord says. “We’re looking at incentives for fraudulent financial reporting, pressures that might exist internally or externally, and opportunity—that’s where we really get into looking at the control environment.”

Why It Matters

Revenue recognition fraud is one of the most common forms of financial statement fraud because it directly impacts the metrics investors use to value companies—affecting stock prices, analyst recommendations and investment decisions that influence retirement accounts and pension funds.

“Based on our risk assessment, the auditor develops procedures and audit responses to the risks of fraud. It’s an assessment we do throughout the audit, updating our views of risk and modifying our approach.”

— Brian Croteau, U.S. Chief Auditor, PwC

Part 3: The Value of Independence

The external auditor’s “superpower,” as Croteau explains, is their “independence and objectivity. It’s a hallmark of our profession—being objective and engaged with management from this unique vantage point,” which is critical when collaborating across stakeholders to identify and flag complex financial reporting issues. This independence is irreplaceable. Unlike internal auditors who report to management or analysts who depend on company relationships, external auditors have unrestricted access without any financial conflicts, a combination no other market participant can provide.

“There are a lot of stakeholders in any entity,” Lord notes. “Investors and lenders want a return on their investments. Employees want job security. Vendors want to get paid. We provide confidence to everybody who cares about the organization.” When auditors uncover such issues, companies typically respond with immediate corrective action: enhanced internal controls, updated policies and hiring qualified personnel for vacant positions. CHS was no exception.

“Without independent assurance, stakeholders would lose that next level of confidence that management is doing what they say they’re doing.”

— Sara Lord, Chief Auditor, RSM US LLP

Why It Matters

Independent auditing gives investors and workers trust that the information coming from companies is reliable. It protects the capital markets while promoting growth and innovation.

Part 4: Protecting Capital Markets

The case illustrates how audit procedures protect not just individual investors but also the broader financial system driving economic growth. When investors lose confidence in financial reporting, they withdraw capital, making it harder for businesses to fund expansion and job creation. “Without independent assurance, stakeholders would lose that next level of confidence that management is doing what they say they’re doing,” Lord explains. “People might not feel as confident investing in or lending money to an entity.” This confidence is essential for capital market function. Pension funds, mutual funds and institutional investors all depend on accurate information. For millions holding CHS shares, auditor intervention protected them from misleading information that could have affected retirement savings and financial goals. “If there’s significant concern about reliability or integrity, it becomes challenging ultimately to issue an audit report,” Croteau says. “That creates, by itself, a natural deterrent to unethical behavior.” The very presence of external auditors encourages companies to prioritize honesty and transparency, reinforcing trust in the financial system. In today’s complex global economy, this deterrent effect is particularly important. “The rapidly changing environment can regularly cause challenges to reliable financial reporting,” Croteau adds. “The key is constantly looking around the corner, thinking about risks.” Only auditors combine deep company access with legal independence, making them uniquely positioned as guardians of financial integrity, serving as early warning systems that can strengthen investor confidence in financial reporting, which ultimately supports economic growth.

Why It Matters

Assurance helps companies maintain market access and investor confidence during challenging periods. It is the foundation of trust in the American economy, allowing workers, retirees and investors to be confident in the reliability of financial information that powers the economy.

The Lunthera Therapeutics case may be fictional, but the challenges are real and ongoing. Every day, auditors perform similar procedures to get investors reliable, decision-useful information. Their work, though often invisible, forms a crucial foundation of trust enabling our financial system to function effectively and drives growth in our economy.