Essay about Case 4.6 Phar-Mor, Inc.

LabCo must determine if their accounting policy for the revenue treatment of its construction contracts is reasonable, if it is appropriate for LabCo to change its method of accounting for the Halibut contract from the percentage-of-completion method to the completed-contract method and how the change should be treated on the basis of the guidance provided within ASC 250, and how LabCo’s accounting policy and accounting for the Halibut contract may change under IFRS if adopted in the coming year. This memorandum will provide support for how the overall conclusion, based on the issues above, was reached.

The collapse of small or large organizations in recent years; such as Enron Energy has renewed interest regarding the issue pertaining to fraudulent financial reports, henceforth the conscious publication of misleading financial information by management to stakeholders. This interest sparked debates that highlighted the importance of proper reporting and the role that must be fulfilled by auditors which is yet to be comprehensively determined and agreed upon by industry leaders, regulators and governments however according PCAOB Chairman « detecting fraud is the responsibility of external auditors and that with few exceptions they should find it »(CFO.com 2004).

There are procedures set in place for the purchasing of goods/services in an organization. The process involves any action or data handling associated with the buying and paying of goods or services. Departments work interdependently to produce information that can later be used in the preparation of financial records and reports; these documents are used by decision makers to evaluate how well a business is doing. Businesses are becoming more complex and it has become increasingly more important to keep up with the demand to provide quality accounting records. One way for stakeholders to measure how true and fair a company’s statements is by enlisting the expertise of auditors. Auditors are called upon to comment on the accounting methods used and truthfulness in the reporting of financial activities; internal auditors are especially interested in detecting mistakes and fraud that can be costly for the company if exposed. Businesses are becoming more complex and it has become increasingly more important to keep up with the demand to provide quality accounting records. For that reason firms install accounting information systems to assist in the management of business practices.

The purpose of the Sarbanes-Oxley Act is to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities law, and for other purposes. (Lander, 2004) The Act created new standards for public companies and accounting firms to abide by. After multiple business failures due to fraudulent activities and embezzlement at companies such as Enron Sarbanes and Oxley recognized a need for the revamping of our financial systems laws, rules and regulations. Thus, the Sarbanes-Oxley Act was born.

4) What factors in the auditor-client relationship create a power imbalance in favor of the client? Discuss measures that the profession could take to minimize the negative consequences of this power imbalance.

5. If the personnel at our client were unable to locate requested invoice records, as a member of the audit team, I would have contacted the external parties to see if they had any copies of the invoices or any records pertaining to the transactions being investigated. I could also inquire as to whether or not the invoices are linked/related in any way to other documents, and if so, request to see those. Being that they were unable to locate a significant number of requested documents, I would observe their procedures for a transaction from the start to finish in order to identify possible reasons and opportunities for crucial documents to get lost and information and records to be compromised. Additionally, this would be an indicator that some of the clients’ internal controls were compromised, insufficient, or non-existent, so I would look into that as well until the controls were fixed and proper controls were in place.

After major corporate and accounting scandals like those that affected Tyco, Worldcom and Enron the Federal government passed a law known as the Sarbanes-Oxley Act of 2002 also known as the Public Company Accounting Reform and Investor Protection Act. This law was passed in hopes of thwarting illegal and misleading acts by financial reporters and putting a stop to the decline of public trust in accounting and reporting practices. Two important topics covered in Sarbanes-Oxley are auditor independence and the reporting and assessment of internal controls under section 404.

Under the Security Act of 1933 and 1944, any individual that willfully filed untrue statements should be penalized. Auditors acting behalf of the public’s interest should make sure the company’s financial statements are not misleading. All the testing and auditing procedures are to verify that the number on the financial statements, and audit testing should be supported by substantial evidence. When auditors took their responsibility for and but did not show their competence for work, they should be heavily fined because their carelessness resulted the investors making a bad decision. Furthermore, if the auditors did not take their responsibility and showed no work to support their opinions should be charged as gross negligence with a heavy fine and license taken away. If it comes down to fraud, auditors should definitely face criminal charges along with their auditing company, and their license should be taken away

After several scandals that involved such major corporations as WorldCom, Enron and Arthur Anderson. President Bush signed the Sarbanes-Oxley Act of 2002 on July 30, 2002 which created after Senator Paul Sarbanes and Representative Michael Oxley. The act was created to regulate financial practices and corporate governance. It consists of 11 different sections or titles. It is aimed at protecting investors by providing accuracy and reliability of corporate disclosures and to help restore confidence within the investors. “ Sarbanes-Oxley developed the Public Company Accounting Oversight Board, a private, nonprofit corporation, to ensure that financial statements are audited according to independent standards”.(Fass 2003) The first main aspect of federal legislation was the Securities Act of 1933, which was derived from the Market crash of 1929.

Sarbanes-Oxley Act contains 11 titles, which provide the specific guidelines and regulations for financial reporting. The titles are: Public Company Accounting Oversight Board (PCAOB), Auditor Independence, Corporate Responsibility, Enhanced Financial Disclosures, Analyst Conflict of Interest, Commission Resources and Authority, Studies and Reports, Corporate and Criminal Fraud Accountability, White Collar Crime Penalty Enhancement, Corporate Tax Returns and Corporate Fraud Accountability. The introduction of the act states that it is an act “to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes”. (Sarbanes-Oxley Act, 2002)

SOX prohibited services to try and make auditing more independent. Prior to the Sarbanes-Oxley Act one, of the biggest questions was whether the accounting firms should be allowed to provide nonaudit services to their audit clients. Members of Congress were convinced that the SEC were forced to back off from giving strict limitations because of the intense lobbying of the accounting firms. The consulting departments had been called by many as a conflict of interest. SOX bans the large scale, big fee financial information system design and implementation or information technology work. However, the SEC never intended to ban all nonaudit services. Many have been around since before audits became required in 1933 by congress. Many of them are closely related to the audit like statutory audits or reporting on internal controls. Another reason to keep some of the nonaudit services is because over time it would diminish the accounting firms overall technical expertise and cause the audits to become less effective. The companies are allowed to retain their auditor to perform non-audit services

We have the responsibility that if a material weakness and or a significant deficiency are discovered in the performance of the audit, it should be communicated to the audit committee in writing (PCAOB, 2014). The management is also responsible to adjust the financial statements to correct material misstatements found during the audit; if the correction are not done because they are immaterial, it should be stated as part of the representation letter were management is confirming their responsibilities during the audit (PCAOB, 2014).

Statements prepared by company managers for their shareholders (Heang and Ali 2008). The general consensus achieved the primary objective of an audit function is to add credibility to the financial statement rather than on the detection of fraud and errors. This change in audit objective is evident in the successive edition of Montgomery’s Auditing text issued during this period which stated “An incidental, but nevertheless important, objective of an audit is detection of fraud.” (1934, p. 26). “Primary responsibility…for the control and discovery of irregularities necessarily lies with management.” (1940, p. 13). Hence, it can be witnessed that the shift of the focus of an audit function from preventing and detecting fraud and error towards assessing the truth and fairness of the companies’ financial statements began at this period (Heang and Ali 2008).

Auditing is all about assessing the financial statements of a company in order to obtain reasonable assurance that they are prepared in accordance with the appropriate conceptual frameworks. The financial statements must give a true and fair view therefore auditors are responsible in detecting if there are risks of material misstatements caused by intentionally misstating or omitting items. Auditors must follow all ethical principles and should adhere to auditing standards in order to have an objective audit opinion. It is essential that they remain independent and free of influence from their client. They must have control over the process, in case the client wants to hide something that affects their company adversely.

On an ongoing basis Auditors perform methodical and independent reviews of paperwork, financial records, documents and receipts. Due to the complexity and difficulty nature of assessing judgment on audit reports, the necessity to determine if misstatements are material enough to be mentioned in the audit report and if the existing accounting position of the business or industry can be warranted is essential (Sun, 2016). With this information auditors are able to document and determine if the information presented can be verified and if it represents a true and fair standing of the company’s financial statement at that given point in time. Internal control deficiencies occurs in situations where the manner in which financial information that is reported is hindered by restrictions placed upon management and employees. Additionally, these boundaries hinders them from efficiently and accurately identifying misstatements while performing their daily tasks (Graham & Bedard, 2015). Based on established internal controls auditors are able to perform different procedures that are required to follow while performing an audit and also at the conclusion of an audit to detect Internal control deficiencies.