Auditors and Regulatory Oversight – ACC 403
The Securities and Exchange Commission (SEC) regulates public companies. The SEC has found that some of these companies have violated GAAP by using creative accounting practices to mislead investors and creditors regarding the health of their company. Research a recent accounting scandal within the last five (5) years where the SEC accused public companies of accounting irregularities.
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Write a three to four (3-4) page paper in which you:
- Analyze the audit report that the CPA firm issued. Ascertain the legal liability to third parties who relied on financial statements under both common and federal securities laws. Justify your response.
- Speculate on which statement of generally acceptable auditing standards (GAAS) that the company violated in performing the audit.
- Compare the responsibility of both management and the auditor for financial reporting, and give your opinion as to which party should have the greater burden. Defend your position.
- Analyze the sanctions available under SOX, and recommend the key action(s) that the PCAOB should take in order to hold management or the audit firm accountable for the accounting irregularities. Provide a rationale for your response.
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Celadon Accounting Fraud – ACC 403
In a perfect business world, investors, creditors, executives, and board members should have full confidence in their companies’ financial statements. They should rely on financial reporting to make informed estimates to judge whether the resulting their return on investment is fairly represented in their current stock price. The financial statements should also help potential investors make intelligent investment decisions. Unfortunately, in the real world, this is not always the case as some public companies violate the generally accepted accounting principles (GAAP) by using creative accounting practices to mislead creditors and investors. A recent example of such malpractice is the Celadon Group Inc. scandal involving fraudulent accounting practices. The corporation purposely overstated its financial situation to avoid disclosing substantial losses. Through using unacceptable accounting tactics, managers, firm auditors, and executives deliberately mislead investors and creditors about the health of their companies leading to inefficient capital allocation and bad loans.
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Analysis of Audit Report Issued by the Securities and Exchange Commission (CPA)
On April 2019, the SEC charged Celadon with accounting fraud. The audit report exhibited that between mid-2016 and April 2017, the organization deliberately injected error into its financial statements. Celadon entered into sham agreements with third parties to buy and sell used trucks at inflated prices. Consequently, the company concealed incurred losses, totaling approximately $20 million. Notably, the figure represents almost two-thirds of the company’s 2016 pre-tax income. The corporation overstated its income and earnings per share in its annual report for the respective financial year. The fraud also allowed Celadon to misrepresent its subsequent public filings for the first half of 2017 (SEC Charges Truckload Freight Company With Accounting Fraud). The accounting fraud by Celadon Group breached legal liability to investors and creditors. Investors have a legal right to know the financial position of their companies (Tutino & Merlo, 17). By overstating its health in the financial statements and reports, Celadon Group infringed this right. Similarly, creditors have a legal right to be provided with accurate financial reports when assessing the loan viability of companies (19). Presenting deliberately exaggerated financial statements is a violation of the said legal liability.
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GAAS Statements that Celadon Violated
Considering that Celadon Group admitted to knowingly engaging in a multi-faceted scheme to mislead its investors, it violated the generally accepted auditing standards (GAAS). Specifically, the company violated the statement regarding maintaining an independent mental attitude during the audit process. Evidently, Celadon Group approached the auditing process with the sole aim of overstating its health to mislead investors. If the company maintained an independent mental state, it would have accurately stated its financial condition as required by GAAS.
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Celadon Group also violated the GAAS statement stipulating that firms should exercise professional care in the performance of their audits and preparation of reports. Professional care entails adhering to the set GAAP aimed towards improving consistency, clarity, sincerity, and comparability of financial information (Lessambo, 29). The corporation deliberately manipulated its audit reports so that they provided an inaccurate and partial depiction of its financial situation. The by deceptive practices Celadon Group contradict the definition of professional care as per GAAS.
Management versus Auditor Responsibility
In financial reporting, a key fundamental aspect is the division of responsibility between management and auditors. The primary distinction is that the preparation of financial statements and their contents is the responsibility of management. On the hand, auditors are responsible for evaluating management’s financial statements and expression their informed opinion regarding their fairness (Tutino & Merlo, 22-23). Thus, management is culpable for all decisions regarding the form and content of financial statements. In contrast, the auditors’ responsibility is limited to the performance of the audit and reporting findings per the GAAS. According to Lessambo, auditors may assist management in the preparation of financial statements and propose adjustments where they deem necessary (28). However, acceptance or disregard of the given advise does not alter the fundamental separation of responsibilities.
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If management insists on carrying out financial practices that auditors find unacceptable, auditors are obligated to issue a qualified opinion and/or withdraw their involvement. Management, therefore, bears the more significant burden in ensuring adherence to the GAAP for financial reporting (Lessambo, 30). In the context of Celadon Group scandal, the SEC determined that the company lied to its auditors to conceal the scheme; thus, the auditors had no information regarding the company’s fraudulent accounting practices (SEC Charges Truckload Freight Company With Accounting Fraud). Nonetheless, auditors need to carry out due diligence to ensure that the information presented in financial reports is entirely accurate. They have a mandate to evaluate an entity’s undertakings through gathering all the information required to identify risks of fraudulent practices (Lessambo, 33). As such, they must maintain professional scepticism to overcome overreliance on managements representations.
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Recommended Key Action(s) that PCAOB Should Take
The Sarbanes-Oxley (SOX) Act of 2002 protects investors from fraudulent financial reporting by companies. Under the SOX Act, there exists various sanctions that can inform best action to address Celadon’s fraud scandal. Title VIII of the Act (Corporate and Criminal Fraud Accountability) stipulates actions that should be taken against entities found guilty of accounting fraud. According to the Act, penalties for accounting fraud include fines, imprisonment, or both. Section 802 of the Act state that whoever knowingly alters or falsifies any financial statement of report shall be fined, imprisoned for not more than 20 years or both. Additionally, section 807 of the Act declares that whoever knowingly attempts or executes a scheme to defraud shareholders of a publicly-traded company shall be fined, imprisoned for not more than 25 years, or both (Jaijairam, 9-11). Given actions available, the Public Company Accounting Oversight Board (PCAOB) should impose a hefty fine on Celadon Group Inc. per the SOX Act guidelines for its fraudulent accounting practices. Moreover, executives involved in the scheme should be fined accordingly and imprisoned for violating Security and Exchange laws.
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In conclusion, Celadon Group Inc. scandal demonstrates how public companies use creative accounting practices to mislead investors. In this case, the executives overstated the financial health of the company to conceal the losses incurred during the period. The GAAP and GAAS have made accounting frauds relatively less egregious by providing strict guidelines regarding accounting principles and auditing standards, respectively. However, managers and auditors still find ways to circumvent the set guidelines and regulations, as demonstrated by Celadon’s case study. It is, therefore, imperative that the Public Company Accounting Oversight Board take a stern stand against such companies and individuals involved by punishing them to the fullest extent of the law as provided by the sanctions under the Sarbanes-Oxley Act of 2002. This includes imposing hefty fines on the firms and imprisoning the individuals involved in the accounting fraud schemes. Consequently, this will discourage other companies and individuals from engaging in fraudulent accounting practices.
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