Assignment 1: Auditors and Regulatory Oversight
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.
- Use at least two (2) quality academic resources in this assignment. Note: Wikipedia and other Websites do not qualify as academic resources.
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Recent Accounting Scandal Where SEC Accused Public Companies of Accounting Irregularities – Olympus Corporation and CPA Firm KPMG Scandal
Many public companies listed in Securities Exchange Commission tend to inflate their financial records in order to make the company to look financially health. The falsification and manipulation of financial statement by the independent auditors leads to inaccurate decision making and it contrary to the Generally Accepted Auditing Standards (GAAS). This act is unethical and criminal under federal law and common law since it leads to deception to the creditors and investors while making important financial decision (Arens, et al., 2014). This paper evaluated the accounting scandal involving Olympus Corporation and the CPA firm KPMG. It analyzed the audit report released by Olympus Corporations’ internal auditors and signed by KPMG as well as determined the legal liability the third party can bring against the Olympus Corporation based on the federal law and common under relevant SEC Acts. In addition, the paper attempted to look into available sanction based on SOX and make recommendation about key action that Public Company Accounting Oversight Board (PCAOB) should instigate against Olympus Corporation and KPMG to make them accountable.
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Olympus Corporation was founded in 1919 and it specializes in the manufacturing of cameras and medical supplies worldwide. It is headquarters is situated in Japan and it is known for its accomplishments stemming from the endoscopes. However, the financial statement of previous years was inflated to show that the company was profitable after the sale of scanners, cameras, microscopes, surgical and medical equipment (Inside Olympus, 2016). The Japanese authority discovered about the fraudulent acts and prosecuted three Olympus’ top executives and other four consultants. The accounting scandal was discovered by whistleblower Michael Woodford and the ousted CEO. In an attempt to protect the image of the corporation, Olympus executive made an effort to make financial statement accurate. Investigation by New York Time indicated that KPMG AZSA which is CPA affiliated to Japan failed to noticed these misstatements in financial statement (New York Times, 2011). As a result, KPMG auditors based in Tokyo attracted major scrutiny for signing off the audit report issued by Olympus Corporation.
Another audit review by the KPMG showed that the audit report issued by Olympus had several accounting irregularities. The new KPMG auditors were specifically concern with more than $600 million payments on acquisition and takeover advisory fees. Despite the audit queries raised by the CPA firm, the outside consultant approved the audit report and decision to sign off was made. The Olympus Corporations’ financial statement contravened the GAAS due to misstatement of the financial statement, lack of enough evidence submitted by the company and negligence in the part of internal control.
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Although Securities Exchange Commission was informed about this accounting scandal, they decided not to take any action against the Olympus Corporation and KPMG because of strong corporation accorded to them during investigation. However, the fact remains that Olympus Corporation internal auditors and KPMG auditors violated GAAS by bridging integrity principles and ethical procedures. It is the responsibility of auditor to ensure that integrity principles are maintained throughout the audit process hence enhancing professional responsibility and competence.
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Any third part or investor who relied in the audit report to make crucial financial decision can sue KPMG under Ultramares doctrines and common law. Securities Act of 1933 states that third parties or investors who are the consumers of the financial statement only need to prove that the audited financial statements contained materials misrepresentations or omissions. In addition, Securities Exchange Act of 1934 Rule 10b-b hold accountants responsible for recklessly or intentionally misrepresenting information used by the third party. Since Olympus Corporation and KPMG recklessly or intentionally misrepresented the financial statement to deceive potential investors, they are both liable. KPMG violated GAAS AU150 Section 01 & 02 which mandate the CPA firms and independent auditors to plan, conduct and report the results of an audit in accordance with generally accepted auditing principles (PCAOB, 2016). It further requires them to “maintain independence in mental attitude in all matters relating to the audit and exercise due professional care in the performance of the audit and the preparation of the audit report”.
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The management of Olympus Corporation have the responsibility of ensuring that internal auditors adopted sound accounting policies, make fair representation and maintain adequate internal control while reporting financial statement. Studies have shown that management are in better position to understand companies’ equity, liabilities, assets and transaction since they actively take part in day to day administrative activities of the company (Arens, et al., 2014). Contrary, auditors’ knowledge of the company is limited to materials that they need to conduct an audit. Under Sarbanes-Oxley Act, the CEO and CFO of public companies are required to certify the quarterly and annually financial statements before submitted to SEC.
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According to SEC Rule of practice and the PCAOB Rules, CPA firm that is found to have violated accounting federal and common law based on GAAS can be suspended temporarily or permanently from conducting audit to the financial statement of any public company. Based on the offence, PCAOB can recommend to the CPA firm to improve education and training level of its staff. If the offence is extreme and a lot of third party’s money has been lost, it is recommended for PCAOB and SEC to notify law enforcement agencies in order to commence appropriate disciplinary action. Sometime, PCAOB can publish the name of the CPA firm responsible in business press as a warning.
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