Assignment 2: Litigation, Censures, and Fines
Research the Internet for recent litigation, censures, and fines involving national public accounting firms. Examples of litigation cases against national public accounting firms include fines by regulatory authorities and censures by professional societies.
Write a three to four (3-4) page paper in which you:
- Analyze the primary accounting issues which form the crux of the litigation or fine for the firm, and indicate the impact to the firm as a result of litigation or fine. Provide support for your rationale.
- Examine the key inferences of corporate ethics related to internal controls and accounting principles which lead to the litigation or fine for the accounting firm.
- Evaluate the primary ethical standards of the accounting organization’s leadership and values which contributed to approval of the accounting issues and thus created the litigation or fines in question.
- Identify specific conduct violations committed by the organization and accounting firm in question. Next, create an argument supporting the actions against the organization and accounting firm, based on the current professional code of conduct for independent auditors and management accountants.
- Make a recommendation as to how regulators and professional societies may prevent this type of behavior in question for the future. Provide support for your rationale.
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Assignment 2: Litigation, Censures, and Fines – Sample Answer
Disciplinary Order for Audit Failures against Ernst & Young and Four of its Partners
The Ernst & Young LLP was censured by the Public Company Accounting Oversight Board in 2012 and imposed a $2 million civil money penalty for violation of PCAOB rules and standards in relation to the audits of Medicis Pharmaceutical Corporation, and a consultation stemming from an internal E&Y audit quality review of one of the audits (Public Company Accounting Oversight Board, 2012). The litigation regarded the failure by Ernst & Young LLP and four of its partner’s to properly provide an evaluation of material component of the financial statements of the company regarding the sales return reserves.
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The Primary Accounting Issues
First, Ernst & Young LLP and four of its partners accepted the company’s basis for reserving at replacement cost, though it was not supported by audit evidence. It was also found that E&Y personnel, though not associated with the audit, identified a rationale as conflicting with both GAAP and E&Y’s internal accounting guidance that specifically addressed revenue recognition for sales with rights of return. Thirdly, the audit firm and partners violated the PCAOB standards when they audited the methodology of the company’s product returns reserve estimates for years 2006 and 2007. Finally, it was found that the audit firm failed to conform to the PCAOB standards when they evaluated Medicis’s practice of reserving for most of its estimated product returns at the cost of replacing the product, instead of at gross sales price (Public Company Accounting Oversight Board, 2012).
The Impact to the Firm As A Result Of Litigation
The litigation caused financial implications and reduced the public trust on the operations of Ernst & Young LLP. The audit firm was fined was considered a record $2 million in civil money penalty. The firm was also censured and the partners who included Ronald Butler, Jr. and Robert H. Thibault were barred by the board from associated themselves with PCAOB-registered accounting firms and fined $25,000 civil money penalty each.
Inferences of Corporate Ethics Related To Internal Controls and Accounting Principles
It is the duty of every employee to manage the internal control system of their company. The organization employees, heads of departments and the executive teams must ensure that appropriate and effective controls are in place. However, with regard to the Ernst & Young LLP, then it can be seen that the company have weak internal control system in place. This was evident from the fact that the company was able to make false assumptions and present the same for public consumption. The presence of weak internal control system within the audit firm did little to prevent the audit team from evaluating and highlighting material misstatement in Medicis’ financial statements.
Evaluation of the Primary Ethical Standards of the Accounting Organization’s Leadership
It is the fiduciary duty of any audit firm to provide accurate and relevant information that gives the true reflection of the financial position, to the company shareholders, stakeholders and interest groups. According to (Securities and Exchange Commission, 2016) PCAOB demands independent auditors to exercise professional scepticism while evaluating accounting statements and making company audits. However, Ernst & Young LLP violated their professional duty and ethical standards related to internal controls and accounting principles.
The audit company knew and failed to evaluate and reveal the material components of the financial statements of Medicis. This was against the principle of corporate ethics and it resulted in fine of the audit company and its partners. In addition, the audit company accepted the company’s basis for reserving at replacement cost, though it was not supported by audit evidence. This is unethical as it provided false information to potential investors, the company stakeholders and shareholders.
Conduct Violations Committed by the Organization and Accounting Firm in Question
There are various specific conduct violations committed by the audit firm and Medicis. First, Medicis reserving for sales returns did not comply with the United States generally accepted accounting principles (GAAP). The audit firm violated the PCAOB standards when it accepted the Medicis’s basis for reserving though it did not conform to GAAP guidelines. The other violation is the audit firm’s to accept the reserving rationale though their internal control found it as conflicting with GAAP and PCAOB standards. Also, Ernst & Young LLP failed to audit key assumptions, placing undue reliance on the company’s management representations as being reasonable.
The fines and censures were justified under the FAS No. 48: Revenue Recognition When a Right of Return Exists. Based on FAS No. 48, should make estimates of product returns based on the prior periods (Needles, Powers & Crosson, 2011). According to PCAOB standards, Medicis should have estimated the product returns based on product gross sales price. However, the company failed to follow the guidelines and used the replacement cost approach, which the audit company knew but allowed in their audit process. The result was a misstatement of the company revenues and overstatement of reserve returns. This was against the code of professional ethics that requires accountants to act with honest, integrity and independence.
Recommendations
The paper recommends that Ernst & Young LLP develops and implements a strong internal control system. Although the initial audit failed to provide a good evaluation of the accounting procedures for the sales returns reserve, the audit company’s internal control identified but failed to make appropriate actions. In putting in place a strong internal control system, Ernst & Young LLP can identify and correct anomalies done by the company audit team before making final recommendations to its clients.
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