As an external auditor is required to be independent of the company when perform auditing services. If an auditor being to perform internal audit and management consulting services for the same company which they provided auditing services, there will have some issues arise. The issues included whether the auditor can be independent in mind and in appearance when providing such services.
In US, there is prohibited the public accounting firm to provide non-audit services to an audit client.
The arguments for the auditor should be allowed to perform these services for the same client is the auditor can work more efficiency by conduct both external and internal auditing services. They can reduce the time of work by eliminating overlapping work. Auditors will discover inefficiencies and other weaknesses while performing auditing service. When they discover such weaknesses, they can use the knowledge and expertise to provide the consulting services to management to improve such weaknesses. Besides that, by providing other services to same client, the company can save the time and money that would spend to obtain these services from another firm.
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The arguments for auditors should not be allowed to perform non-audit services for their audit client is they may not act independently in performing the external auditing services. The incentives of performing consulting and internal audit services will affect the judgment of the external audit. As we know internal audit services are best performed by the people who understand the culture and the operation of the company. Internal auditors are an important part of the corporate governance and should not be replaced by external auditor act as an internal auditor. A company will get more benefits from many different viewpoints. Therefore, company should obtain different entities to act as consultant and internal auditor to get multiple viewpoints.
Explain how “rules-based” accounting standards differ from “principles-based” standards. How might fundamentally changing accounting standards from bright-line rules to principle-based standards help prevent another Enron-like fiasco in the future? Some argue that the trend toward adoption of international accounting standards represents a move toward more “principles-based” standards. Are there dangers in removing “bright-line” rules? What difficulties might be associated with such a change?
Rules-based accounting standard are specific and detailed rules that must be followed when preparing company’s financial statements. Principles-based standard is the general accepted accounting principles (GAAP) which used as a conceptual basis for accountants. It is general guidelines that describe the way classes of transactions should be reflected in general term.
Principles-based may prevent another Enron issues by requiring accountants to make their professional judgments on the spirit of the law instead of just regarding technical compliance with the rules. In this case, for example, Enron’s SPE, the manager may have succeeded in pressuring auditors to accept the deceptive financial reporting by pointing to the bright-line standard. However, the principles-based standard would require auditors to evaluate the situation of the company as a whole in order to determine whether the company did not have significant exposure in relation to the unconsolidated SPE.
The dangers in removing the bright-line rule is in some situation will involve human judgment and discretion. Auditors may rationalize aggressive financial decisions. They will defend themselves when questioned by asseverate that the accounting standard did not prohibit their action.
Enron and Andersen suffered severe consequences because of their perceived lack of integrity and damaged reputations. In fact, some people believe the fall of Enron occurred because of a form of “run on the bank.” Some argue that Andersen experienced a similar “run on the bank” as many top clients quickly dropped the firm in the wake of Enron’s collapse. Is the “run on the bank” analogy valid for both firms? Why or why not?
The run on the bank analogy is valid for both firms. Both of the firms are loss of confidence and credibility of investors and clients. Enron can avoid the bankruptcy if its customers willing to continue to use its services. The debt and obligations of the company are large but it also had large profit. The customers were not willing to use its services when Enron loss its credibility. Besides that, Andersen also can survive if Enron issue had been isolated. Andersen was a large and multinational firm. If it just loss of one client, Enron, it would not go to the end of the firm. However, once the Enron issue occurred, the clients of Andersen were loss of confidence in the firm’s credibility. As the result, many clients of Andersen had fired the firm as an external auditor of their company.
Coopers & Lybrand was sued under both federal statutory and state common law. The judge ruled that under Pennsylvania law the plaintiffs were not primary beneficiaries. Pennsylvania follows the legal precedent inherent in the Ultramares Case. (a) In jurisdictions following the Ultramares doctrine, under what conditions can auditors be held liable under common law to third parties who are not primary beneficiaries? (b) How do jurisdictions that follow the legal precedent inherent in the Rusch Factors case differ from jurisdictions following Ultramares?
According to Ultramares cases, only the third parties who are primary beneficiaries can sue for ordinary negligence successfully. However, the third party who did not primary beneficiaries and did not have privity of contract also can successfully sue for gross negligence, recklessness and fraud. In this case, the creditors of Phar-Mor were not considered as primary beneficiaries. Therefore the creditors of Phar-Mor were needed to prove there had recklessness or fraud. Besides that, U.S. federal securities laws had required that recklessness needed be prove by a preponderance of the evidence, the Pennsylvania state common law had required prove by a clear and persuasive standard.
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According to Rusch Factors case, it had been broadened the Ultramares doctrine by allowed recovery by third party who are considered as foreseen users. A foreseen user is the limited class of users who the auditors were aware the user has the intention to rely on the financial statements. For example, the bank who lend loan to company will be a foreseen user.
Coopers was also sued under the Securities Exchange Act of 1934. The burden of proof is not the same under the Securities Acts of 1933 and 1934. Identify the important differences and discuss the primary objective behind the differences in the laws (1933 and 1934) as they relate to auditor liability?
For the case under the Securities Acts of 1933, the plaintiff have to prove that the audited financial statements were consisted material misstatement which caused the plaintiff suffered a loss. If the auditor faces an unusual burden of proof, auditor must demonstrate as a defense. The defenses are about the auditor had been conducted an adequate audit and the loss of plaintiff was caused by another reasons which other than the misleading financial statements.
Under Securities Acts of 1934, the plaintiff must prove the reliance on financial statements where the financial statement consist material misstatement which caused in a loss.
The Securities Acts 1933 had exposes the auditor to more litigation risk than the Securities Acts 1934. This change is to protect the buyers of new securities.
In this case, even though neither Phar-Mor’s management, the plaintiffs’ attorneys, nor anyone else who associated with the case ever alleged the auditors knowingly participated in the fraud, a jury had found that Cooper liable under fraud claim. The important key of this fraud charge is the plaintiffs had been alleged that Cooper made representations which recklessly without regard to whether they were true or false. This had enabled plaintiffs to sue the auditors in term of fraud.
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