Building a Better Auditor: What Are You Incentivizing?

When I was taking intermediate accounting in college, cash flow statements were the bane of my existence. They were like a colossal puzzle I could never solve; one small mistake would nullify the rest of my calculations until I ended up with a completely wrong result.

Our weekly class assignments, which usually involved preparing financial statements based on a case study, had me frazzled until I learned a hack — creative bonus points. I'm not sure if it was because it was 3 a.m. or because I was bored with the detailed work I was doing, but I decided to turn the assignment into a story. I took the limited statistics from the case study and wrote an elaborate and exciting tale about the fabricated organization, including some poorly done art in Microsoft Paint. To my surprise, not only did my professor love the story, but I was awarded two bonus points for creativity on a ten-point assignment — a 20% score increase. Ironically, as a single component of the financial statements, the cash flow statement was only worth about two points, so my hack resulted in the same score I would have earned if I had turned in a perfect cash flow statement.

As the assignments continued, so did my quest for creative bonus points. The stories became more elaborate — as did my use of Microsoft Paint, and I weaved in my accounting professors and classmates as characters. (On a side note, please contact me if you are interested in releasing a children's book series for future accountants.) If I was short on time, I'd skip the cash flow statement entirely and focus on writing the story since I knew it had the most potential to elevate my score on the assignment.

Without realizing it, my professor was incentivizing me to develop my creative writing skills rather than my accounting skills. While the assignment was clearly to prepare financial statements, I dedicated my efforts to the behavior that brought me the greatest reward.

Soft controls, such as employee motivation and incentive structures, are increasingly being recognized within internal audit. According to a position paper by The IIA Netherlands, "soft controls are about culture and the behavior of management and employees and their impact on achieving organizational objectives." Soft controls can be difficult to evaluate, but their importance is undeniable.

My CEO has been known to say, "People do what you pay them to do." In other words, employee behavior will most closely align with what employees are rewarded for doing. At QuikTrip, a privately held corporation that specializes in gas station convenience stores, customer service is paramount. There are multiple incentive programs in place to recognize excellent customer service, including awarding outstanding employees with trips to Hawaii, bonuses, and other forms of recognition.

Organizations can write elaborate policies and procedures, but if they aren't rewarding the behavior they desire — or are inadvertently rewarding the wrong behavior — the soft controls will fail. For example, I once audited a call center and the manager told me his goal was customer satisfaction. However, when I asked about the metrics used to evaluate employees, I learned they were largely based on the number of calls completed. Quickly completing calls and satisfying customers may not be directly correlated — and can even have a negative correlation if employees are rushing to get customers off the phone without solving their issues. After my review, the call center created a feedback process in order to better reward the behavior they truly desired.

As auditors, we can add value by identifying misalignment in our organizations' incentive structures. As we perform our reviews, we should ask three questions:

1. What are this business unit's key objectives?
2. What behaviors do their processes — intentionally or unintentionally — reward or incentivize?
3. Is there alignment?

If the answer to the third question is no, auditors can add value by making recommendations to better align employee motivation with the organization's objectives. These types of observations demonstrate that the auditors understand and care about what matters most to the business.

Additionally, control breakdowns often have a root in motivation — or lack thereof. When employees aren't performing their assigned control procedures, it is likely because they are being more highly rewarded for behaviors like operational efficiency or others. Employees are unlikely to comply with policies and procedures if they are not incentivized to do so.

You may be wondering if I ever did end up learning how to prepare a cash flow statement. I did. I learned years later in public accounting when I prepared the financials for non-profit clients — in other words, when my compensation depended on it. Just as my college-aged self would have benefitted from being more motivated to learn how to prepare a cash flow statement before entering the workforce, our organizations will benefit as they learn to incentivize the behaviors that matter most.