Audit Committee Does Not Stop Management Committing Fraud Accounting Essay


The world of audit committees is changing significantly. When most developed economies were booming in the 1990's, key issues emanating from sound corporate governance, such as accountability, transparency, effective independent boards, and strong audit committees were not judged as important. Following recent events in the last 10 years, the collapse of Enron Corporation and WorldCom, there has been a reasonable change to drive companies allying ethics, international codes and regulations. Though, there are fair questions arising from the audit committee role, specifically after the case of ENRON and WorldCom. Have audit committees identified major tools to use in conducting their business and define their effectiveness, through these years? Do we have a broader view of how audit committees undertake their tasks or there is the need for much more research to open the audit committee "black box"? This paper engages in a discussion and a critical evaluation of the crucial role that the audit committee plays to the company's welfare. In the post-Enron and WorldCom environment, there are governance lessons on how boards can be supervised and improved. Audit committee duty entails significant effort and time and requires accountability when things go wrong.

Enron and WorldCom cases: what did audit committees do?

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In a research report, (Fabbri Weiss and Priebe, 2005, p5) it was highlighted that in some respects, the Enron and WorldCom frauds were very different. At Enron, according to the Senate Report and the class action statements, the company transacted in a derangement of highly complex transactions - involving off balance sheet expenses, features as special purpose entities, and sales without economic substance - a well known but "hidden" secret within the company and by its auditors and its Board of Directors. However, these complex transactions were at a minimum not fully appreciated by the directors and not adequately disclosed to investors. In the Enron case, the rules were in place, but were skillfully and willfully ignored. Hence, an important issue raised by this, is why these conditions either escaped notice or were not acted upon by any link in the audit chain.

Barrier (2002) cited by Verschoor (2002, p29) discusses that the Board in the case of Enron assigned the Audit and Compliance Committee the duty to review the transactions, but the committee carried out the reviews in a hotheaded way. In addition, the board of directors didn't take any action because of missing important information. Consequently, internal controls, ethical as well as financial, failed as the delusions accumulated. In this case, the audit committee of the board of directors but also Enron's accountants at Andersen, who performed both external and internal audits and provided consulting services, were the main culprits. Nevertheless, both internal and external audit should report ultimately to the audit committee, and not to the management. Adequately, the audit committee should be only self-possessed of independent, equity-holding members. The Enron episode has broadened the responsibility of audit committees beyond looking at financial results, or financial controls, to managing risk. Increasingly, a crucial aspect of managing risk is managing the culture of the organisation. Managing the culture of a firm presents a quandary. If the people at the top - the tone at the top - "are committed to ethical behaviour through actions even more than words, that is the strongest auditing control, the strongest accounting control, any company can have" (Horton, 2005 cited in Verschoor, 2005, p30).

At WorldCom, fraud was mostly accomplished by a single accounting error. The result was the product of a simple error - capitalizing rather than expensing the costs of building transmission lines. Although the two cases seem to have a different "accounting nature", they do have a common risk factor; their observed transactions or reported numbers were just too good to be true; and their creative accounting was far less than the "true and fair view" of accounting. There are many questions arising from this case, such as where the board was at that time, or why they did not challenge / identify the practices in WorldCom. In this case, the audit committee should avoid the culture of fear and instead encourage the culture of openness inside the company.

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Breeden (2003, p6), argued that WorldCom satisfied the form of governance and not its substance. He clearly mentions that in several areas WorldCom exceeded the accepted norms of "best practice" in corporate governance, even though there was little if anything "good" of it in reality, because of the attitudes and actions or inactions of the people involved. Additionally, the company had a few excellent and experienced directors who would not let alone fraud, if they were fully informed. Furthermore, the audit committee did very little work relating to the complexity of the company, with weak internal controls and an ineffective outside audit team.

In the aftermath of Enron and WorldCom, there are vast expectations of the audit committee role in supporting auditor independence. A key element of audit committee activity and of the role of the non-executive director - as the only member - appears to be the asking of questions, if audit committee effectiveness is to be assessed (Spira, 2003).

Evaluation on the audit committee role:

In the UK, the Cadbury recommendations (1992) were based on the assumptions that audit committees composed of independent NED's will contribute auditor independence and consequently improve corporate reporting and the standards of corporate governance. Moreover, regularly publish guidance based on reputed "best practice" by professional bodies and accountancy firms, can give us a broader view and understanding of how audit committees work in practice. Spira (2003, p181) states that the Cadbury recommendations depend critically on independence - the independence of non-executive directors that will boost auditor independence, through the operation of the audit committee. She brilliantly adduces in the same research report that the concept of the audit committee role has been "black boxed"; and "asking questions about the detail of audit committee is one way of levering open the "black box" (Spira, 2003, p182).

The audit committee (or the audit & risk committee in some organisations) is a sub-committee of the main board of directors with an advisory and largely reactive role. It is related with issues covering annual accounts, internal audit, risk management, and management information systems, while its' main and strictly focus should be based on people and in overseeing the governance processes involving ethics systems. Additionally, it has no decision-making powers and does not report directly to company shareholders. It can be in brief described by words such as "monitor", "review" and "consider". Although, how this work is carried out remains problematic, given the lack of evidences and access into the activities of boards of directors.

According to the ICAEW report, essentials for an audit committee member - indeed, the non-executive director - are common sense, wide experience, independence, good judgement and an understanding of the role of the audit committee. Nevertheless, all members of the committee cannot be expected to have a detailed knowledge of financial reporting standards. The asking of questions is a major and critical tool used by audit committee members in carrying out their business but it is interwoven with the boardroom culture and logistics. Hence, it may remain a symbolic performance rather than a substantive contribution to the audit committee effectiveness (Spira, 2003).

In the post Enron & WorldCom environment, there is an increasingly demand of a scrupulous audit committee. There is the importance of open lines of communication between the audit committee and the internal audit department; and increased on time spending in audit committee meetings that are hold four times a year, the day before the full board meeting. Successively key components have also to do with the managing of the culture and the integrity of the organisation.

Undoubtedly, the Enron scandal has raised questions and issues such as compliance, divided loyalties, and conflicts of interest. Issues like these arise from the company's culture and position and should be embodied in a formal code of ethics. Even though, this is not enough; it is essential that the company has an ethical culture drilled into it, from the top down and the bottom up. Therefore, audit committee members can significantly contribute