The assignments of external auditors in reporting fraud

In Latin, the term audit means 'to listen to'. One person creates the Financial Statements, whilst the auditor 'hears' what they say, and moves his judgment to them. External auditing (EA) is "an examination of the annual financial statement of a business by someone 3rd party". The goal of an EA, to express an judgment on whether the information presented in the financial statements, reflect the financial position of the business at a given night out and reported to the clients or shareholders. For instance, are details of what the business owns and owes properly saved in the balance sheet? Are earnings or loss properly assessed?

There are two types of external auditors, statutory audits that happen to be compulsory by the law and Non-statutory audit which is not compulsory by the law. The EA survey must includes different areas to show a genuine and fair value such as, going concern, consistency, prudence, matching theory and aggregation theory. Also, the International Federation of Accountants lays down important principles the following, freedom, integrity, objectivity, confidentiality, specialized standard, etc. External Auditors have duties and protection under the law related to the business Act 1985 which was described by ISA, CMA and Statutory law which allow them to perform a good job.

This paper is about the jobs of exterior auditor to record financial statements fraudulence. Number of commercial scandals on the planet has increased 12 months by year like Enron, Tyco, and Parmalat. Researchers will discuss the situation of WordCom Company to focus on the key issues.

Key words: Scam, Exterior Audit and WordCom

The role of external Audit

There are certain functions that the exterior auditors do in auditing F. S of the business. These are the following:

The major role of external auditors is to express an view on whether an entity's financial claims are free from material misstatements.

Auditors just want to be sure that company's financial assertions are true and good representation of its real position.

Normally, exterior auditors review the entity's information technology control strategies when assessing its overall inner controls.

They must also investigate any materials issues raised by questions from professional or regulatory government bodies, like the local taxing authority.

The self-reliance of external auditors is essential to a correct and in depth appraisal of an entity's financial adjustments and assertions.

Literature Review

Many scholars had discussed in their empirical studies the external auditor responsibilities in accounting scandals which bring about filling section 11 of personal bankruptcy safety by those cooperate firms.

Recognition of income and the auditor's responsibility for detecting financial record fraud were most issues been mentioned in the study by Intal & Thuy (2002) titled "FINANCIAL RECORD Fraud". One of the most objectives of the research is to identify the reason why of why auditors never have detected financial claims fraud. Researchers want to proposing alternatives for enhancing the audit process in these issues. Analysts address a descriptive and explanatory research which is a case-based study. They make interviews with audit specialized plank in 10 audits companies in Sweden and one Swedish professional accounting organization. The discovered that the reasons which makes auditors never have discovered the fraud are: software of analytical review strategies as "sufficient audit evidence;" weaknesses in audit risk model and risk analysis concerning interior control; and audit failing in revenue popularity and related get together transfer disclosure.

Others like NEUMEISTER (2009) found that external auditor was responsible for fraudulence in 'Bernard L. Madoff Investment Securities LLC'. He added that Friehling & Horowitz pleaded guilty for this alleged fraudulence as it was auditing its consumer financial claims for 15 years. It didn't verify the disgraced money manager's financial data. The company reported to AICPA that it didn't performed audit since 1993. Thus, the organization license was not renewed for everyone that period. In addition Christodoulou (2010) brought up that KPMG was also the auditor of Madoff. However the court performed that KPMG found not liable in the event which it acquired sued by Madoff feeder account, the firm failed to put more work in being able to access information essential to ensure investors were not cheated.

OJO (2006) agreed the view of NEUMEISTER (2009) and Christodoulou (2010) in their research of 'The Role of the Exterior Auditor in Financial Rules and Supervision' in which the statutory auditor played role to avoid further commercial scandals such as Enron. One of major problem that happen in Enron was the total amount sheet debts which resulted from following guidelines because the accounting expectations did not authorize. The audit organization experienced shredded documents related to Enron, thus it terminated the data that could lead to deducted fraud which resulted to Enron scandal. This was also considered as an offence against Andersen in the judge of law.

Sheely (2000) also recognized in 'A Simple Formula for Baking the Books' audit inability in deduction scam as in case there is WorldCom although there have been alert about the company's budget. When invoices were paid, these were properly coded for an operating expense accounts. The audit firm Arthur Andersen's staffs were implemented an invoice through the accounts payable system and could not find any fraud. This fraud happened by reclassified the line-cost as capital expenses. For example, $500 million in undocumented computer expenses were logged as a capital expenses. However, the inner auditors discovered that $2 billion of the business's expenses have been allocated to capital expenditures through the first three quarters of 2001 had never been authorized for capital spending.

Moreover, Sheldon and Reena (2007) stated that the federal government also takes on in minimizing or reducing frauds. However the propose of exterior audit is to certify that the financial record reflect the real and fair view. First, they reviewed the role of exterior auditor in deduction fraudulence from an accounting scandal case in Turkey. The Imar bank or investment company circumstance was collapsed although this bank or investment company was in list of administrative ability for about a decade. The collapse of the bank was mainly due to IT- related scams which happened in two ways. The details of the bank had been deleted and then, it got dual record-keeping system where the original records placed at the bank and the fake one delivered to the Banking Regulation and Supervision Specialist. The auditor didn't test the machine which leads to deceptive activity. Second, they talked about the role of authorities in deciding the correct standards to be used and that the external auditor should be certified by BRSA before auditing the lenders.

On other side, Agrawal and Chadha (2005) targeted in their research about "Corporate Governance and Accounting Scandals" directed to examine whether certain commercial governance mechanisms are related to the likelihood of a firm restating its earnings. The authors choose a sample size of 318 US open public companies including those that restated their profits, such as Adelphia, Gateway and Xerox and non-restating businesses. The research workers empirically check out the relation between your probability of restatement and self-reliance of planks and audit committees. Also, they discuss about financial expertise of boards and audit committees. In the last section research workers discuss other governance mechanisms. They discovered that several key governance characteristics are essentially unrelated to the likelihood of a corporation restating earnings like the independence of planks and audit committees and the magnitude to which exterior auditors provide non audit services to a firm. Also they found the use of Arthur Andersen or another big 5 (previously) audit firm is also unrelated to the probability. Experts also discovered that the likelihood of restatement is significantly lower in companies whose planks or audit committees include an unbiased financial expert.

Finally, Stirbu et al (2009) in "Fraud and problem: Auditors' responsibility levels" directed to identify the perceptions of users about financial record on the magnitude of fraud in Romania and to identify shareholders belief of the duties in reporting fraud and the performance of auditor steps. The question of the study was "Are auditors responsible for detecting fraud in the companies they examine?" The sample of the research was 451 auditors. On-line questionnaires were delivered by email in support of 378 auditors were responded. Analysts found an expectation distance between respondents and present statutory requirements regarding fraud reporting and recognition.

The management team is the one who should uncover the fraud at first place. However, External auditors play one of the most important role in cooperate scandal for their failure to consider some requirement steps, such as following ethical code of carry out. But they shouldn't be blamed only as government has also responsibilities in prevention these frauds. If it not has suitable procedures for appointing auditors as well as for punishments, the amount of accounting scandals could be more.

WorldCom Scandal

Background

WorldCom (WCom) was the second greatest long distance telecommunication company in USA. It also was the major internet network on the globe with around 60, 000 employees over 65 countries worldwide. The business grew through merger and acquisition. It first merge was with MCI Inc which cost $37 billion making the greatest merger in US. It purchased over 60 companies within 15 years.

On July 2002, it submitted chapter 11 to get bankruptcy safety. The estimation of corporate fraud scandal was $11 billion.

Staffs involved with scandal

The pursuing is a set of WorldCom executives and other employees who implicated in the accounting fraud:

Bernard Ebbers - previous CEO found guilty of most charges and convicted of fraud, conspiracy and submitting false documents with regulators.

Scott Sullivan - ex - CFO was indicted on charges of securities fraud, conspiracy, and phony claims to the SEC.

David Myers - ex - controller was costed with securities fraud, conspiracy, and phony claims to the SEC.

Buford Yates Jr. - past accounting director pleaded guilty to charges of securities fraud and conspiracy.

Betty Vinson & Troy Normand - past accounting managers pleaded guilty to charges of conspiracy to commit securities fraud.

Causes of scandal

There was several reasons business lead to commercial scandal as illustrated below:

Excessive projection. The WorldCom purchased many other companies at high price in anticipation that the progress rate will be persisted.

Expecting popular. The firm was anticipating that the demand for internet services will be leaped to sky high.

Over built the capacity. Only 10% of its fiber content optic-cable happens to be used.

Excessive leverage. The business's planks of directors weren't paying attention to the way the company was run.

Analysis of Scandal

There were two major ways WCom experienced dedicated fraud which it occurred between 1999 and 2002. Nevertheless the figures here are related to 1st quarter 2001 till 1st quarter 2002. Among these was underreporting the bills by capitalized them in balance sheet as an investment. The stand below explains how the improperly reported series cost affected on income before interest and tax. It could be noticed that after restatement these costs into proper category, instead of getting profit around $ 2. 6 billion the company suffer losses of $ 1. 2 billion between the amount of 1st quarter 2001 and 1st quarter 2002.

The other form of fraud was overstating company's income. WCom was recording revenue from service provided to its subsidiaries as earnings. In addition, management charge which was provided to the subsidiaries documented as income.

Auditor Responsibility

Arthur Andersen (the auditor) did not modified its audit types of procedures regardless of knowing that the line cost was one of the things where WCom could commit fraud. In addition, Anderson rated WCom as a high risk company because it was regarding about its talk about price. Nonetheless it did nothing to improve this example.

Anderson also disregarded the alert about WCom's budget. It ignored percentage signals, such as profit margin, debt/equity rations and so forth which most of them were offering end result below the bench draw.

The firm was trying to get a good impression from its client in desire to have more business from the client. Therefore, Anderson didn't try to do something when it was averted to access the client's ledger. Thus, it didn't take safe safeguard steps for such discord.

Lessons learned from the scandal

There are certain lessons can be learned from the above circumstance for different things of view.

The investors shouldn't rely only on company's financial statements in deciding of whether it's worthy for their investments. They should also look for second professional view.

The shareholders should diversify their purchases widely and not to keep them in a single basket.

The company should appoint more 3rd party directors to take care of public interest, thus avoiding employees interest.

The government must selected appropriate criteria also to follow excruciating consequence against those who breach the guidelines.

Conclusions and Recommendations

Arthur Andersen auditing firm which audited WorldCom Company failed to find the fraud. It is clear now the Audit organization ignored some issues to find out financial fraud. We believe the main reason of why audit have not diagnosed fraud were "application of analytical review methods, risk assessment concerning inside control". Intal & Thuy (2002) possessed analyzed this reason in their thesis.

In WCom, five factors of fraud had been passed gradually that are cooks, formulas, incentives, monitoring and final results or called as offense which because of inability of external audit even as we mentioned above. In such a paper we stated some analytical review of WCom scandal assisting our view with statistics. We discovered that the reasons of why auditor hadn't discontinued the fraud in early time including Ignore percentage indicators, such as profit margin, debts/equity rations. Relating to your review, we suggested some recommendations to both shareholders and audit company to avoid fraud as pursuing:

Shareholders should appoint different audit firms for different services, for instances auditing of financial claims and consultations.

Shareholders should appoint experienced audit committee with higher level of experience and honesty.

Company should change its auditor regularly (every five years) to prevent the discord of interest between your audit firm and its client.

Audit firms should develop the strategies of audit to discover staff members who suspected their intent to do fraud.

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