accounting information systems 9th edition

10-1

Fraudulent

Financial

Reporting

10-2

A little Insight into CEOS….

A survey by Starwood Hotels & Resorts showed that 82% of CEOs admit to cheating at golf.

The same percentage hate others who do the same.

10-3

2002 Top 100 Accounting Firms Public Accounting Report (Firm: Reported Revenues)

1. PriceWaterhouseCoopers: $8,056.5M

2. Deloitte & Touche: $6,130M

3. Ernst & Young: $4,485M

4. KPMG: $3,171M

5. Grant Thorton: $432.5

6. BDO Seidman: $353M

7. BKD: $210.9M

8. Crowe, Chizek & Co.: $204.7M

9. McGladrey & Pullen: $203M

10. Moss Adams: $163M

Dropping Out:

Andersen #5

in 2001

10-4

Fun Facts

Economic Theory predicts there will be how many Big Accounting firms?

Three

10-5

Fraudulent Financial Reporting

Keep 2 things in mind: Most costly fraud Restatements associated with fraud

have cost investors over $100B in the last sixish years (Hilzenroth, 2001)

Perpetrated by management

10-6

Number of Securities Class Action Lawsuits

050

100150200250300350400450500

1996 1997 1998 1999 2000 2001

Lawsuits

2001 :308 IPO

PWC 2001 (Annual) Securities Litigation Study

10-7

% Lawsuits with Accounting Allegations

0

10

20

30

40

50

60

1996 1997 1998 1999 2000 2001

Acctg


10-8

Accounting Issues

0

10

20

30

40

50

60

70

2000 2001

Understatementof LB

RevenueRecognition

Purchase Acctg

Overstatement ofAssets

Other

Estimates


10-9

Securities Class Action Lawsuits -2001

53% involved FS restatement 10% dismissed On average, settled in 4 years biggest industries –

computer services (32%) followed by telecommunications (11%)

Most filed in NY (IP0) or CA (hitech) 2/3 firms listed on NASDAQ


10-10

Securities Class Action Lawsuits $$$$

Year

Settled

Cases

Avg/Median

Settlement

1996-2000 NON ACCTG 104 $7.8M/3.6M

ACCTG 157 $18.3M/7M

2001 NON ACCTG 40 $6.2M/3.9M

ACCTG 69 $23.7M/7.5M


10-11

Securities Class Action Settlements

2000 study by Bajaj, Mazumdar, Sarin Table 4: Settlement amount and time

Longer = more $$$ Table 12: Settlement statistics by co-defendant type

Accounting/Underwriting mean/ median much higher To settle or not settle? Why? E&Y: Cendant settlement= HUGE

Table 13: Settlement statistics by allegation type Table 16: Want to sue? Milberg, Weiss, Berhad,

Hynes & Lerach 31% of all filings

10-12

Types of Audits & Lawsuits

Compilation: prepares FS without any testing, no assurance AT ALL

Review: few substantive tests (inquiry, analysis, discussion), limited assuranceCan you believe the FS?

Audit: in accordance with GAAS, positive assurance

Most Lawsuits

SEC 2ed – Rules of Practice 2(e)

What went wrong? Corporate culture and reporting model

Simple greed or arrogance Market pressure on short-term

earnings Lack of transparency or timely

disclosures in the reporting model Lack of mandated disclosures on

management’s accounting policies Too many rules leading to connect the dots

accounting and auditing – rules vs principle

Chuck Landes – State of Audit Profession

What went wrong? The work of auditors

Some not stepping up to their responsibilities Some assumed good intent on part of mgmt Inherent weaknesses in our disciplinary and

monitoring processes Unqualified/inexperienced auditors Close relationship with client (leave for

companies they audit) Materiality judgments????

Waste Mgmt- Andersen decided 12% misstatements immaterial


10-15

What went wrong? The work of auditors

Movement to “business advisory role”

Make Audits Pay: Leveraging the Audit into Consulting Services (AICPA, 1999)

Auditor dependency on fees from major clients – especially non-audit feesKPMG: Motorola $3.9M/$62.3ME&Y: Sprint $2.5M/$63.8MPWC: AT&T $7.9M/$48.4M

EQUALS

CAVE IN

TO CLIENTS

What saying NO means

Auditors need to just say NO

Rejecting unsound corporate accounting practices Reducing the risk of deceit and fraud through

diligent inquiry Ensuring that audited statements are not just

accurate, but illuminating Questioning management, challenging

management When justified – rejecting management’s

accounting decisions

ZERO TOLERANCE POLICY!!!!


10-17

Fraudulent Financial Reporting

(Internal) Auditors need to predict & uncover financial statement fraud using the three Cs.

Conditions: pressure to meet analysts’ earnings forecasts

Corporate Structure: aggressiveness, arrogancecohesiveness, loyalty, gamesmanshipcontrol ineffectiveness, blind trust

Internal Auditor (Oct 2002) – “The Three Cs of Fraudulent Financial Reporting” by Z. Rezaee

10-18

Fraudulent Financial Reporting Choice: managers should use ethical strategies

RED FLAGS for management• Personal wealth closely associated with

company’s performance• Willing to take (illegal) personal risk for co. $$$• HIGH pressure to maximize shareholder value• Probability of fraud detection low

1 = possibility, 2+ = high probability fraud occurredInternal Auditor (Oct 2002) – “The Three Cs of Fraudulent Financial Reporting” by Z. Rezaee

What was the response of Congress?

The Sarbanes - Oxley Act:Oversight Board

New Public Company Accounting Oversight Board (PCAOB)

5 members – only 2 CPAs (& only 2) Power to set auditing rules, inspect firms and

discipline wrongdoers Funding from accounting firms and

registrants

The Sarbanes - Oxley Act:Standard Setting PCAOB has authority to “adopt, amend, modify, repeal or reject”

standards Includes provisions for SEC oversight, governance and funding

of FASB

Independence/Scope of Services Proscribes eight specific services to public company audit clients Gives PCAOB authority to prohibit others Other nonaudit services not banned must be pre-approved by

audit committee

The Sarbanes - Oxley Act: Banned Services

Bookkeeping Information

systems design and implementation

Appraisals or valuation services

Actuarial services Internal audits

Broker/dealer and investment banking services

Legal or expert services related to audit services

Management and human resources services

Other services as determined by the board

HARSH PENALTIES

The Sarbanes - Oxley Act:

Liability Concerns Statute of limitations extended to 5 years from

occurrence or 2 from discovery No specific language on non-preclusive effect

Reporting on Internal Controls Requires auditor to report on internal controls

assertions Must be part of audit - not separate engagement

The Sarbanes - Oxley Act:

Corporate Governance Mandates audit committee oversight of audits Requires CEO/CFO certification of reports Prison terms of up to 10 years for senior executives

Workpaper Retention Auditors to retain documents in support of report for 7 years. 5 yr retention requirement under “criminal fraud accountability”

Overview of the Potential Impact New rules could require mandatory rotation of

all partners on audit engagements. New auditor responsibility for “testing” issuers’

compliance with laws and reporting on “potential” violations.

The new Board could have the authority to enforce securities laws, duplicating SEC’s powers.

State legislative/regulatory proposals could “pile on” and/or conflict with Federal laws.

10-26

The mess continues…..

Public Company Accounting Oversight Board (PCAOB) – William Webster resigns after it is revealed he headed an audit committee of U.S. Technologies that is being sued by investors for fraud.

SEC Chairman – Harvey Pitt resigns because of Webster

What was the response of the accounting profession?

10-28

Recently Issued Standards

SAS No. 95, Generally Accepted Auditing Standards

SAS No. 96, Audit Documentation SSAE No. 11, Attest Documentation SAS 97, Reports on the Application of

Accounting Principles SAS 98, Omnibus 2002

10-29

Auditors role in Fraud Previous standard: SAS 82

required specific assessment of the risk of material misstatement of FS attributable to fraudulent financial reporting

Consideration of 40 specific fraud factors New standard: SAS 99 (Oct 2002)

Part of anti-fraud movement Auditor is responsible for providing reasonable

assurance that the FS are free of material misstatement whether caused by error or fraud

Also responsibility place on board of directors and audit committee

10-30

Auditors Role in Fraud

Forensic accountant = fraud auditor

Work for FBI, public accounting firms, IRS, insurance organizations

Certified Fraud Examiner: requires passage of Uniform CFE Examination

10-31

AICPA Initiatives Institute for Fraud Studies with the University of

Texas and Association of Certified Fraud Examiners

calling for revision of auditing standards to provide public notice of internal control weaknesses

Will create enhanced attestation standards for CPAs to report on corporate anti-fraud programs

Will work with FASB for better reporting and disclosure standards

10-32

Impact on AIS

Large ERP vendors: equipped to handle reporting requirements as long as controls in place. Software vendors respond to regulatory changes with updates.

Disparate/fragmented/legacy systems: more interfaces/reconciliation procedures increasing risk of material errors (as well as the time required to close books)

accounting information systems 9th edition

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