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An auditor is a qualified professional accountant that examines information of a business and expresses an opinion as to whether or not it fairly reflects the economic events that occurred during the accounting period. Audited financial statements are used to determine if they are presented fairly and accurately in agreement with an appropriate disclosed basis of accounting. These audited financial statements would be required by investors and creditors before they decide whether or not to invest in the company or loan money to it.
Role of an Auditor
The work of auditors must be adequately planned and properly executed by using adequate knowledge and information of the business's entity as a basis. When assistant auditors are engaged with the audit they should be properly supervised by their manager to ensure full control on financial statements. A adequate understanding of internal controls should also be used to plan the operation of the audit. When the risk of control is deemed below recommended, a sufficient audit evidence should be obtained through the testing of control to confirm the assessment. An adequate amount of appropriate audit evidence must be used, in the means of inspection, observation, confirmation, enquiry, calculation and analysis, to confirm an overall honest and accurate audit. The auditor's report should not only identify the financial statements but also differentiate between both the responsibilities of the management and the duty of the team of auditors. The report of the audit should describe the scope and limitation of the auditor's examination on the financial documents. The report should also enclose either an expression of opinion that cannot be expressed. Information needed to show this should be included in the audit.
In the practice of auditing procedures there are times when information needed is missing or an auditor could not a significant area of the financial statements. In this case it is the auditor's responsibility to find or obtain the required missing information before concluding the opinion of the audit.
Auditors must avoid making false, unconfirmed and misleading statements to prevent any discredit to the audit organization's reputation. This way the organization can be trusted with future clients.
Ethics of an Auditor
During the operation of the audit, auditors often have access to proprietary information of the audited organization. Auditors must have a moral obligation not to reveal any of this information to anyone. Revealing proprietary information is a violation of this moral obligation and is not in the business's best or professional interest or of organization being audited. The exposition of inside information betrays the trust of the audited organization and in doing so tarnishes the reputation of the audit organization. Auditors must avoid the temptation, during external (second party) audits, to discuss or reveal another audited organization's performance with the people they are presently auditing.
Example of a Failed Audit
What is an Audit Failure?
An audit failure is when an audit is conducted by a respected auditing firm is conducted and does not find things which it should, meaning that there could be fraud or scandal.
Scandal by Duke Energy
Duke Energy engaged in many round trip trades which is illegal in the United States. Round trip trading is an action that attempts to inflate transaction volumes through the continuous and frequent purchase and sale of a particular security, commodity or asset. Duke Energy used round-trip trading to sell unused asset (mostly energy) to another company of a similar market while agreeing to buy this same asset for approximately the same price sold. This is a market manipulation practice was used by Duke Energy to cheat the number of flow transactions happening on any given day. By doing so, Duke Energy, artificially inflates volume and revenues, which deceives the public and potential investors about the performance of the company. Even though round trip trading adds no profit, to the public it would look like the company is doing well based on the increase volume and size of the company's revenue.
Duke Energy also engaged in market to market accounting, which is the valuing of assets on the balance sheets based on the latest market indicators of the price that those assets could be sold for. Not only were the valued price of the assets too high, Duke Energy also used market to market accounting to generate fake or potential profit.
Timeline of Events Leading to Failure:
Duke to Refund Over $40 Million - December 24, 2002
The Alberta Energy and Utilities Board (EUB) ordered by Engage Energy Canada, charges Duke Energy Corp. to refund $40.3 million to the province's Transmission Administrator by Jan. 15, 2003 due to overpriced and unfair energy costs.
Duke Market Manipulation Investigation - May 24, 2002
Duke Energy is accused of engaging in market to market manipulating trading described like the kind used for Enron Corp. Duke Energy denied all claims.
Duke Admits 'Round-Tripping' - April 17 2002
After an internal investigation with Duke Energy Corp. , it was proven that it engaged in a trading practice under inspection(market to market accounting) by federal securities regulators, but Duke Energy responded by saying their actions were legitimate and they did attempt to inflate financial results.
Duke Energy Ordered to Report on Prices - March 12, 2002
The Federal Energy Regulatory Commission has ordered Duke Energy to report by May 22 to confess if they used any techniques and strategies similar to those seem in Enron Corp. memos describing how to exploit the California's deregulated market.
Duke Energy Under Inspection - January 30, 2002
SEC was worried about "a lack of transparency and clarity" in the financial reporting Duke energy. SEC found out roughly 37 percent of Duke Energy's $1.9 billion profit in 2001 was of cause of mark-to-market variety, meaning the gain was not realize and only existing on paper.
Duke's Earnings Up; Benefits Down - October 18, 2001
Duke Energy's third-quarter earnings are up 50 percent but benefits promised and earned by employees were terminated.
Duke Energy Accused of Price Gouging - September 19, 2001
Residents accuse price gouging by Duke Energy in California's escalating energy crisis. Duke Energy acknowledges that it has sold power for more than twice the previous highest price.
Duke Energy Employees Demand their Money Back - July 17, 2001
Union workers demanded their money back from Duke Energy Tuesday at a rally outside the Chula Vista Plant. Workers protested that the company was decreasing their pay without any notification.
Whose Faulty Ethics are to Blame?
The board of directors were simply not educated enough about their own company. The management is to blame because of the use of illegal procedures such as round trip trading. The management also abused the use of market to market accounting to generate unrealized and imaginary profits. The auditors are also to blame for not reporting the abuse of market to market accounting and round trip trading by Duke Energy. The auditors acknowledged the manipulation and error in the books by Duke Energy and chose not to report it. The board of director should be blamed because they were not attentive to the nature of the off-books entities created by Enron, or to their own obligations to monitor those entities once they were approved. It is the board's responsibility to monitor how the company generate revenue and at what cost.
Recommended Changes to Audit Practices In Order to Minimize the Incidence of Future Audit Failure
The use of market to market accounting should be banned because of its contradiction to the revenue recognition principle, which states revenue recognized in the accounting period in which it is earned. This way companies cannot recognize revenue until it is learned and realized. Audits investigate a company's accounting procedures relating to the revenue recognition and to make sure a company is accurately recording information according to accounting standards. With this change companies can't record potential or possible income financial statements and can only record income that is actually received.
To prevent Round trip trading auditors should monitor the assets of the company. Auditors should check if the company isn't buying and selling their asset in a short amount of time. Also if the company purchases an asset that was previously owned, the company should be required to give a valid explanation to why the purchase was made. With this change companies will think twice and not be allowed to artificially inflate volume and revenues to attract investors.