Auditing and $9 million in phony receivables. An

Auditing is the conduction of an examination of several events to verify that those events are being managed and documented in agreement with established guidelines, policies and procedures.

The auditing profession initially existed for governmental accounting purposes. It was mainly involved with reporting instead of accounting procedures. It wasn’t until the Industrial Revolution, that the auditing profession began progressing into an area of fraud discovery and financial liability. As businesses expanded immensely during this extent of time, company owners could not directly manage all of their operations and had to hire managers.

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The above-mentioned owners acknowledged an increasing need to oversee managers’ financial tasks, both for accuracy and for fraud avoidance. In the years between the McKesson & Robbins scandal and the Enron and Worldcom scandals, administrators made many alterations to accounting and auditing policy in the United States. One of these many alterations was that of the Sarbanes-Oxley Act of 2002 (“SOX”). The Auditing Profession Pre-Sarbanes-Oxley Implementation The auditing profession in the United States was prone to self-regulation before SOX was made known. Self-regulation is the fact of something such as a company regulating itself without interference from external bodies. According to the International Federation of Accountants, “Self-regulation with public oversight and accountability would typically involve some form of oversight being carried out by an independent agency (IFAC, 2011, p.

4).” Independent agencies are important because audit requires bringing attention to the audit profession challenges, weaknesses, and risks and that is what an independent agency does. Without awareness of these challenges, weaknesses, and risks, it is safe to assume the auditing profession would experience major downfalls. This proved to be true in the years to come. The Sarbanes-Oxley Era Many accounting scandals helped shape the auditing profession to what it is today. From McKesson & Robbins to Enron and WorldCom, they each played a major part in developing SOX.

These companies used “creative accounting” to make themselves appear more profitable than they really were. In 1937, McKesson & Robbins recorded total assets of $87 million. It was later detected that this $87 million was comprised of $10 million in nonexistent inventory and $9 million in phony receivables. An overstatement of assets will also lead to an overstatement of owner’s equity.

As a result, the net worth of a company will increase, and that is exactly what happened in the McKesson & Robbins scandal. The fraud was executed by the c-suite executives of McKesson & Robbins and involved fabricated purchases from and sales to counterfeit Canadian companies, which were indeed just vacant offices staffed by secretaries who forwarded mail. The widely known McKesson & Robbins fraud triggered the auditing profession to endorse two auditing standards that are adhered to today.

Cengage (1999) described the two standards as follows: 1. The physical existence of inventory must be confirmed through direct observation. This simple procedure applied in the McKesson & Robbins case would have revealed that the reported purchases from the Canadian suppliers were phony. 2.

The existence and accuracy of reported receivables must be independently confirmed by contacting a sample of the parties who allegedly owe the money. Sixty-two years after the original McKesson & Robbins scandal, this simple procedure, applied by a staff auditor at Deloitte & Touche, uncovered the modern-day McKesson HBOC fraud. The accounting scandal of McKesson & Robbins was only the beginning of many issues to be uncovered within the auditing profession. The cases that altered the auditing profession, for the better, took place some thirty years later.

 In 2000, Enron utilized special-purpose entities (“SPEs”) to engage in “off-balance-sheet” activities. The purpose of a SPE is to allow an increase in leverage and return on assets without having to record debt on its balance sheet through the creation of a subsidiary company. Many companies use SPEs, it is how you use them that makes them legal or not. Louwers stated that special-purpose entities are “off-the-book arrangements.” More specifically, Enron used SPEs to “create joint ventures for new businesses.

” These SPEs were not used for their original purpose. Instead, they were used to hide more than $1 billion worth of liabilities from external users of financial data. The case of Enron played a valuable part in illustrating what the auditor-client relationship should not be. It is the main accounting scandal that gave way to the implementation of SOX.

Arthur Andersen LLP (“Andersen”) was Enron’s auditor during the time the scandal took place. They audited Enron’s publicly filed financial statements and provided internal audit and consulting services to it. Andersen’s audit team had allowed Enron to “aggregate” the SPEs for accounting purposes so that they showed a positive return, an infraction of generally accepted accounting principles. The case of WorldCom, a telecommunications company, turned out to be one of the largest accounting scandals in United States history. An internal audit of the company found that improper accounting practices were employed.

More than $3.8 billion in expenses were reported as capital investments over five quarters. Tran (2002) stated, “WorldCom’s chief executive, John Sidgmore, blamed the company’s former chief financial officer, Scott Sullivan, and the former controller, David Myers. The two were fired for claiming $3.

8bn in regular expenses as capital investment in 2001.” Also, as another client of Anderson, they began to feel the pressure. Anderson audited the company’s 2001 financial statements and reviewed their books in the first quarter of 2002. Andersen accused Mr. Sullivan of withholding material information from them. According to Tran, “The deputy US attorney general, Larry Thompson (“Thompson”), said: We have to ask where the professionals were, the accountants and the lawyers.

” Two major accounting scandals have happened before WorldCom. The question posed by Thompson was a valid one to ask. Why were there no accountants who caught the fraud from the beginning?  From these three cases, one should understand the importance of auditing and the responsibilities that go along with it. Auditors are held accountable for having relevant competence and capabilities to execute the audit, complying with relevant ethical requirements, and maintaining professional skepticism and exercising professional judgment throughout the preparation and performance of the audit. The Public Company Accounting Oversight Board (“PCAOB”) SAS No.

1, section 110 (1972), detailed the responsibilities and functions of the independent auditor. They are described as follows: “The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud… The auditor has no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements..

. The auditor’s responsibility is to express an opinion on the financial statements.” Each auditor is held accountable to his profession, the responsibility to adhere to the standards accepted by his fellow auditors. Knowing this, each auditor should know the importance of their role. SOX was created with the intent to address the confusion and animosity in the country over the bankruptcies of WorldCom and other accounting scandals. The goals of SOX are to complement the clarity of financial information, redeclare auditor independence, and detail aspects of corporate governance. SOX assigned specific SEC oversight and altered the self-regulatory, peer review environment in which accounting firms had conducted business. It decreed that the SEC set up the PCAOB which would “establish auditing and related attestation, quality control, ethics, and independence standards and rules to be used by registered public accounting firms in the preparation and issuance of audit reports.

” SOX held c-suite executives to a greater standard of accountability, required the use of independent audit committees, and enhanced auditor independence. Post Sarbanes-Oxley Era Today, the auditing profession is in a continual state of growth. Auditors are held to a higher standard so that accounting scandals are not as prevalent.

There are four things that stand out amongst the auditing profession today. These four things are explained by Daniel Goelzer, a board member of the PCAOB. The first is the refocus on auditing.  “The profession is beginning to again view auditing as its core business — not merely an adjunct to consulting. Many non-audit services have been prohibited. For those that remain legal, audit committee pre-approval is required, and audit committees are more reluctant to let their auditors perform significant non-audit services” (Goelzer, 2005).

 Secondly, the impact of inspections.  “…

While there is a place for enforcement proceedings and a place for liability to private parties who are injured by bad auditing, in my view, a well-thought-out inspection is more likely to improve the day-to-day quality of auditing than are those other, blunter tools” (Goelzer, 2005).  Next, auditor risk aversion and client selectivity.  “Our inspections and published figures show that the major firms have “fired” some clients, particular those that are riskier. Firms also have developed more sophisticated tools for assessing client risk and using those assessments to tailor how they audit” (Goelzer, 2005).  Last, but not least, Section 404 internal control audits.  “The audits of internal control have added an important new dimension to the auditor’s work.

The auditor is required to have a more complete understanding of the strengths and weaknesses of the client’s financial reporting systems. Audit committees are also being forced to learn more about those systems in order to assess significant deficiencies that the auditor reports to them” (Goelzer, 2005). The auditing profession will continue to develop to become adaptive to the new pressures placed on the profession. Constant training and development must be required for auditors to adapt to the changing culture of auditing. The auditing profession has experienced many setbacks, but it is much stronger than it was years ago. McKesson & Robbins, Enron, and WorldCom were included amongst the many accounting scandals that led towards the implementation of SOX.

The implementation was a stride in the right direction for the auditing profession. SOX helps to support audit quality and investor assurance. It also enhances the audit effectiveness and efficiency, while also increasing the reliability of financial reporting. Because the profession will continue to grow, the auditing profession must continue to set regulations to push auditing in the right direction. In the years to come, regulations will make it easier for auditors to do their jobs.


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