Monday, July 23, 2012

The Dreaded Auditor Change

When companies change auditors, it spooks investors. Shareholders wonder if an accounting disagreement between managers and auditors is the cause, which can indicate that shareholders are being mislead. Look no further than shares of Alco Stores (ALCS) last week, which fell as much as 14% during the day following its announcement that it has chosen a new auditor. Should shareholders be concerned?

There are certainly reasons to worry. As previously discussed, Alco made changes to its inventory methods over the last couple of years, which has positively contributed to the company's "earnings". Was Alco trying to push for more changes, perhaps going a little too far for the comfort level of its auditors?

This change is also surprising considering that Alco only recently asked shareholders to approve the renewal of KPMG. It gave KPMG a strong vote of confidence: "The Audit Committee extensively analyzed the performance of KPMG...After taking into consideration KPMG LLP’s performance as discussed above, the Audit Committee determined that KPMG LLP should be [re-]appointed..." I guess the analysis wasn't as "extensive" as first thought?

In its latest proxy filing, Alco writes that "[t]he Audit Committee selected KPMG LLP to serve as the Company’s independent accountants, after considering KPMG LLP’s independence and effectiveness." Furthermore, "[t]he Board of Directors recommends that you vote for ratification and approval of the selection of KPMG." What a waste of paper!

At the same time, there are reasons to believe the move is a prudent one in order to reduce costs. The company paid KPMG over $600 thousand last year, whereas Alco only earned net income of $1.8 million.

ALCO noted that this change was made following a "competitive process". Alco is still going with an auditor of good repute (Grant Thornton), but will likely save costs by not going with one of the Big 4 oligopolies and their expensive rates.

It's probably unlikely that the quality of the auditing is any different, on average, between these two firms. (After all, it used to be the Big 5 before one of them went bankrupt due to fraud.) But what may concern shareholders is whether this change is being made because the company couldn't convince its former auditors to go along with an accounting policy that crosses the line. Though both Alco and KPMG disclaimed any disagreement in their release, as shareholders we're often in the dark about such issues. All we can hope is that the board is representing us as well as they should.

Disclosure: Author has a long position in shares of ALCS

1 comment:

Anonymous said...

If they were hiring Mr. Grant Thornton at P.O. Box 666 I might be concerned. But if they competitively shopped with an equal auditor they are probably doing it solely to save money possibly after being handed a large price increase.

With margins so thin at ALCO it seems like a prudent move to me to reduce SGA.

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