In February 2024, the USMC became the first military branch to receive a clean financial audit opinion in the history of the Defense Department. While this accomplishment comes decades after such audits were required by law, it is a well-deserved cause for celebration for the Marine Corps whose commitment and perseverance prevailed. For auditors, it’s also an opportunity to revisit one of the best/worst audit quality management case studies in US public auditing history.
It’s no mere bookkeeping exercise to independently audit a $50 billion war-fighting organization that relies in part upon multiple disparate legacy IT systems and manual processes. It’s no small feat accounting for buildings and bullets scattered around the world. To reach its opinion, the audit team visited more than 70 U.S. and overseas sites. They checked more than 7,800 real property assets such as land and buildings; 5,900 pieces of military equipment; 1.9 million pieces of non-ammunition supplies, such as spare parts; and 24 million items of ammunition, some of which are stored at Army and Navy facilities.
In the beautiful prose of auditing standards, the auditors concluded:
“In our opinion, the accompanying financial statements present fairly, in all material respects, the financial position of the USMC at September 30, 2023, and the results of its net cost of operations, its changes in net position and its budgetary resources for the year then ended in accordance with accounting principles generally accepted in the United States of America.”
Ten Years Ago – Audit Quality Management Case Study
The Marine Corps and its auditors thought they had reached the mountaintop in 2014, when auditors initially issued the first clean audit opinion.
That announcement was so noteworthy that Defense Secretary Chuck Hagel shared the news from the Pentagon’s Hall of Heroes. “I know that it might seem a bit unusual to be in the Hall of Heroes to honor a bookkeeping accomplishment,” Hagel said, “but, damn, this is an accomplishment.”
Less than a year later that audit opinion would be withdrawn by the inspector general based on audit quality deficiencies, and at least one audit executive lost their position over the audit quality failures at multiple levels. Withdrawals of audit opinions are few and far between.
Here’s what happened.
Competency
For the 2014 Marine Corps financial statement audit, an outside accounting firm (called an independent public accounting firm, or IPA) was awarded the contract, to be monitored by the Defense Department Office of Inspector General (OIG). The selection of this IPA firm raised some eyebrows as the inspector general had found this firm’s prior work on smaller, unrelated, audits to be substandard. A prior quality control review found that the firm’s work was “not adequately planned, executed, and documented.” OIGs are required to consider the prior performance of an IPA firm in determining its collective competency to conduct an audit.
But, hey, the IPA firm won the competitive contract so whaddaya gonna do? (Perhaps heightened professional skepticism and closer scrutiny and monitoring of the IPA’s work as the project proceeded might have been in order.)
Independence
Oh, and the firm’s audit partner and the Defense OIG’s head of audit were former colleagues from their U.S. Government Accountability Office (GAO) days. Close colleagues. There was nothing untoward about the relationship, but they had known each other well and were regularly co-panelists together at professional conferences.
Under government auditing standards, auditors must maintain independence in fact and appearance. One threat to independence is “familiarity threat” or the risk that a close or personal relationship will lead the auditor to take a position that is not objective. When faced with threats, the auditor should apply safeguards to reduce the threat to an acceptable level. None were applied in this audit.
In fact, as the audit progressed, this potential impairment to independence blossomed into an actual one, as described below.
Sufficiency of Evidence
Soon after the audit began, the OIG auditor-in-charge of monitoring and her fellow team members identified flaws in the IPA firm’s work papers. Specifically, the firm did not document some its audit conclusions and in some instances took the Marine Corps’ word for it regarding some data, without seeking supporting corroborating evidence as required. These concerns were raised to the DOD inspector general’s head of audit.
Differences of Opinion
The DOD inspector general’s head of audit was at odds with his audit team. He earlier had approved a contract extension for the IPA firm over the objection of audit team members who cited prior flawed audit work.
Beyond this, the bottom-line dispute during the audit was that the IPA auditors believed that the Marine Corps deserved an unqualified, or clean, audit opinion. The DOD OIG auditors who were monitoring the IPA’s work believed that this opinion was not warranted based on audit flaws and lack of evidence.
Professional auditing standards require that differences of opinion among auditors be appropriately raised, resolved, and documented.
The head of audit ultimately ordered his team to “reach the same conclusion” as the IPA firm.
In one email the head of audit sent to the auditor-in-charge and her supervisor, he said, “I have said repeatedly that the team needed a solid rationale for why a disclaimer was the correct option . . . “The level of documentation in [the IPA firm’s] work papers could be better. Some may even interpret this as a violation of audit standards.” But, he added, “the amount of documentation needed isn’t fixed, but a matter of professional judgment.”
The auditor-in-charge’s supervisor emailed back: “The bottom line is [the IPA firm] did not adequately document or support their conclusion about” the reliability of the Marine Corps’ record-keeping. In another email the DOD OIG audit team faulted the IPA firm’s methodology in determining “materiality.” That is a key concept in financial audits. Bookkeeping errors happen. Financial auditors concern themselves with material errors, or those big enough to potentially affect the financial statements.
Conflict of Interest
The DOD OIG auditor-in-charge refused to go along with the order to issue a clean audit opinion.
“I cannot do that,” she told the head of audit. “Our audit evidence does not support an unqualified [clean] opinion. We are at a disclaimer.” She wanted justification for the decision to overturn the team’s opinion. She asked: “show me where my work is substandard and where my conclusions are incorrect.” And she demanded to know what “standards” the head of audit used to reach his conclusions. The auditor-in-charge subsequently asked for and received a transfer of assignment.
According to a later OIG independent quality control review, the head of audit’s demonstrated a lack of objectivity, and his independence had become impaired by the personal relationship with his former GAO colleague and IPA partner.
Senator Charles Grassley conducted an independent oversight review of the OIG and its issuance and then withdrawal of the clean audit opinion. In an August 2015 floor speech, Grassley outlined his findings. The head of audit, according to Grassley, repeatedly met privately with the IPA firm partner regarding the audit opinion dispute, outside the presence of his own auditors and the DOD contracting officer representative (not cool). The head of audit further issued what Grassley called a “stunning set of instructions” to his auditors: do what it takes to reach the same conclusion as the IPA firm (not cool). Finally, according to Grassley, the head of audit further inappropriately shared DOD OIG audit work papers with the IPA firm (again, not cool).
According to a subsequent independent review by the Government Accountability Office, the OIG’s decision to “overturn” the disclaimer was “undocumented, unexplained, and unjustified by evidence in the work papers as required by professional standards.”
The DOD OIG head of audit was removed from his position.
Key Takeaways
In one respect, the former head of audit was absolutely correct. Determining whether auditors have enough (“sufficient”) relevant (“appropriate”) evidence to support an audit conclusion is a matter of professional judgment. There is no specific formula delineated in professional auditing standards. Here are some general guidelines though: the more significant the audit risks, the more evidence that is needed; the lower the quality of audit evidence, the more evidence that in needed. And this much is clear: if you’re going to substitute your professional judgment for the collective judgment of your auditors who are closer to the work, it better be a well-reasoned, well-documented, and compelling decision.
Perhaps just as important, an audit executive has to be above reproach. What started as an inconsequent social connection became a fatal independence matter. I wasn’t there so I can’t say whether it was arrogance or ignorance, but holding private meetings without witnesses and your audit team and sharing work papers were unsurvivable self-inflicted wounds. Safeguards.
Ten years later and following tons of audit readiness work by the USMC, it’s great to see the Marines finally getting the recognition it has earned: a clean financial audit opinion. The American taxpayer deserve nothing less.