Examining the role of auditor and management in financial fraud

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This chapter analyses and interprets the data collected for the purpose of this study. This data analysis chapter is divided into two parts. Part A explains and interprets the answers and information given by the managers and auditors. This analysis will help us to find the answer to the title of this project that is 'Examining the role of auditor and management in financial fraud'. Part B will contain those data and analysis that would support the discussion in part A and will be in form of figures and charts.

The answer to this question will be answered using certain graphs and charts that will support the result and conclusion derived from the information and data collected for the purpose of this study.

Part A;

Its section describes and analysis the reasons behind the occurrence of big accounting fraud. The methods used in this study to collect needful data and information are the interview. A structured interview through e-mail with a manager of taxation in Bayer Crop Science Ltd (India) and an auditor of Pricewaterhouse Cooper an auditing firm was conducted and following are the results derived from their explanation.

Question 1: According to you, how does accounting fraud occur?

When the Taxation Manager of Bayer Crop Science Ltd, was asked about his view on accounting fraud, he answered that accounting fraud occurs when the person responsible for handling and maintaining account of the company intentionally or unintentionally forgets to record a transaction, falsifies the numbers or record the entries in other sub heads where it should not appear as per the accounting rules. This is called as 'Window Dressing'. Window dressing is the process in which the financial statements of the company are falsified and modified in order to present better position of the company in front of the stakeholders and the market. According to him most of them uses this common techniques in order to present better picture of the financial statement: understating of assets, overstating of liabilities and over booking of expenses etc.

While answering the same question, auditor of PWC added there are many ways in which an accounting fraud occurs. There are two types of people who are likely to make fraud; Management and employees. Employees generally get involved in cheating the company when there is a huge difference in the pay rates of those at the top with those at the bottom of the organizations. So, many employees rationalise these fraud by saying that their organization is not playing fair as their bosses are overpaid. Other people who are mostly responsible for fraud are top management who have various reasons for committing fraud. They sometimes force their accountants to make false entries in the books of accounts and form a statement which will show a brighter picture of the company.

Question 2: Who all are responsible for such frauds?

For this the taxation manager and the auditor shared the same view and they replied that mainly such big accounting frauds are committed by internal employees of the company. Mostly, these people are managers, top level executives and they are supported by the auditors of the company. Top level executives include Chief Executive Officers (CEO), Chief Financial Officer (CFO), and Managers of the company. Top Executives are in position to order the accountant to manipulate the accounting data, and then finally auditors had to confirm the audit report as in order to support their most valuable clients. Thus according to them financial frauds in big companies are combine efforts of many people which are generally at a reputed position in the company.

Answer to this question given by the auditor of PWC was, to identify fraud some special and extra check should be conducted on those people who held big position in the company. Job rotation and annual leave should be given to the employees so that, during that period fraud made by them are unleashed. Taxation manager explained the same procedure but added some more methods to it like system checks and surprise audit. Surprise audit should be given more important as the employee's handling accounts are unaware of the check and this may help to detect fraud.

Question 4: Are there any limitation faced by the auditor while conducting audit? If yes, what are they?

Both Auditor of PWC and taxation manager agreed that there are certain limitations faced by the auditor while conducting audit of the firm. The main factors that limit the audit procedure is voluminous transaction that is they have numerous transaction to record and thus sometimes it become impossible for the auditor to check whether each and every transaction is recorded or not. Second important factor is time; they have many compliances procedures to be met due to which time available for auditor is much less. Taxation manager also added a point that when an auditor smells fraud he immediately starts to work on it to collect evidence but some time it's the management behind the fraud so, they don't cooperate with the auditors.

Question 5: which are the areas investigated by the auditors before signing an audit report?

This question was answered differently by both the persons. The auditor is of the view that the mandatory requirement of the area of investigation in audit process is different in different countries. Auditor should investigate areas such as about going concern in near future, chances of company going bankrupt, financial stability etc.

Whereas, in the view of taxation manager, before signing an audit report it is the duty of the auditor to check the expenses, assets, liabilities, provision etc of the company. He can check expenses by verifying the amount with the bills and receipts. He may physically go for checking assets of the company to check that there is no fake entry about any sale or purchase of asset.

Question 6: Under what conditions auditors can deny to sign the audit report?

In the view of taxation manager, an auditor can deny signing an audit report when he/she finds that the amounts shown in the financial statement does not reflect the true and fair view of the transactions. Whereas auditor emphasizes on this issue by adding some more arguments to it. According to her two more factors exist based on which the auditor can deny to sign the audit report they are; if there is disagreement between management and auditors regarding certain points, then an auditor should not sign the audit report before clearing his/her doubt. And secondly, if the auditor asked for certain data or proof regarding ant transaction and if the management is not able to provide it then the auditor can deny signing the audit report.

Question 7: Talking about recent scam, what according to you were the problems with Satyam?

Majority of people answered that the problems with satyam would have been wrong management in the company, lack of proper internal control, lack of communication between the management and the directors, more reliance on management etc. the auditor of PWC also mentioned a point saying that the independent directors of the company should have given more responsibilities to take part in the decision as that would help in reducing fraud.

Question 8: what do you think actually happened in Satyam and how it could have been prevented?

This was very satisfactorily answered by all the people but the auditor of PWC explained deeply, some of the things that went wrong in Satyam along with the steps that would have prevented the occurrence of the fraud.

They recorded the sales of the subsequent year in the current year by pre-dating the invoice. Now they have to continue with this policy in order to maintain the profit trend. What auditor should have done is to check the dates of invoices, shipment advices, debtor's confirmation, physically verify the stock, check the gate passes etc.

They recorded fake sales transaction in the current period in order to inflate the profit of the company and in the subsequent year they showed it as sales returned. For this the auditor should have checked the invoice, subsequent years sales return, debtor's confirmation, stock tally etc.

They also recorded fake transaction to show inflow of money. The auditors could have checked the actual documents supporting other income and should have compared it with the expertise in the company who provides such services.

The company even tried to inflate their profits by not booking the purchases and overhead this could be detected by the auditor by comparing the purchase with physical stocks, quantitative tally of stocks, obtaining creditor's overheads, bank reconciliation statement etc.

Question 9: What are the lessons learnt by you from such increasing accounting fraud?

According to the auditor, she believed that this increase in the number fraud had made the auditor and the auditing firm more cautious about the accounting procedure followed by them. She placed importance on some basic things like before taking any audit assignment procedure, it is important for the auditor to properly understand the clients business, the accounting methods used by then, their internal auditing process etc. auditor should also have knowledge of the history and background of the company like whether or not the company had and are important case of fraud in the past. All these things can help preventing fraud in future. Whereas the taxation manager had a different argument according to him the lesson learnt by all the auditing firms and auditor is, they should be self reliance rather than believing more on the management of the company. If the person from top management is also the one who looks after the accounting of the transaction, then all the details should be thoroughly checked by them along with the evidence for the existence of that transaction.

Question 10: Are there any changes required in audit procedure to prevent such scams in future? If yes, what are they?

The taxation manager suggested some changes which should be brought about in the audit procedures are; in-depth knowledge of the clients business before taking any audit assignment. He believes that if the auditors are allow making a study about the business of the client before actually accepting the responsibility of performing audit will help preventing scams. He also states that auditors should be given proper training prior to assignment. He should be clear about the areas where he need to de in-depth research.

Even the auditor has the same view that changes are required to be made while performing audit procedure so that the possibility of committing fraud decreases in future. According to her strong internal control system should be implemented in the company. External auditors should make periodical and surprise visit n the company in order to check whether or not all accounting procedure is conducted as per Accounting and Auditing Standards (AAS). One step is to be taken from the side of government that is to be strict with the imposition of penalty if the company does not follow proper procedure and guidelines given in AAS.

Part B

10 Highest accounting scandals across the world:in monetary terms

The above chart shows 10 major accounting frauds in the history of the world which had drastic effect on the economy of their respective countries. The chart shows the name of the company and the amount of fraud they committed. People are mainly influenced by "Big Brand Name" they invest in the company which is the top gainers in the stock market. But our study reveals that mostly companies with are more successful have greater chances of committing fraud. The bigger the company, the greater is the mismanagement of the accounts leading to financial scams. According to my research there are three main and common reasons for such mismanagement of accounts in big companies are as follows:

When the management did not want to disclose the real picture of the company in front of investors and the world, they try to manipulate the accounts of the company. This may be overstating or understating the results.

The major problem with the top management is their personal status and ego. Because of this problem they find it difficult to accept the failure of strategy made by them. So, when the business of the company faces any losses due to them they try to manipulate the accounts in order to hide their failure.

Sometime in order to meet or exceed the revenue growth expectation by stock market analysts the management makes changes in their financial accounts in such a way that these analyst finds it more impressive.

The source of above data http://bizcovering.com/history/10-major-accounting-scandals/

Explaining top 5 financial frauds in India:

The table shown below gives the detail of top 5 accounting frauds that occurred in India along with the people who were involved in the fraud and the total amount included in the scam.

Name of the company

Year in which fraud occurred

Person responsible for the fraud

Amount

CRB Capital Market Limited.

1996

Chairman of the company.

12000 crore.

ITC, Chitalia

1996

Director of the company.

364 crore.

Home Trade

2002

Chairman and Director of the company.

6000 crore.

DSQ Software

2003

Chief Executive officer of the company

595 crore.

Nagarjuna finance

2003

Executives and promoters.

98.37 crore.

Satyam Computers Services.

2007

Chairman of the company.

14000 crore.

The above table shows the top six financial frauds in the history of India. It can be concluded from the above table that majority of people involved it the financial frauds are from the top management. They are generally chairman, director and CEO of the company. This can also be shown in the following bar chart:

Amount in Crore

It can be seen that Satyam tops the chart with the fraud of Rs14000 crore. This is the most recent scam in India in the year 2007. The person behind this scam was B. Ramalinga Raju the Chairman as well as the founder of the company. He was supported by the auditors of the company in order to cook the books of accounts. Price Waterhouse Cooper was the auditing firm of Satyam, two auditors S. Gopalakrishnan and his deputy Srinivas Taluri, were arrested in this fraud case as they were held liable for cooking the books of accounts and for not revealing the truth of the fraud in the company.

The source of the above data is http://economictimes.indiatimes.com/quickiearticleshow/3959731.cms

Satyam fraud:

Let us now have the breakup of total amount of the fraud in the Satyam. The chart shows the actual figure as well as the inflated figures which were shown in the balance sheet of the firm.

Amount in Crore.

The above graph shows all the areas in which the fraud was committed by the chairman of Satyam. He inflated the figures in the balance sheet in order to hide its actual position. We can see from the graph that the amount of cash available with the company forms the major part of the inflated balances. The actual cash available with the company was Rs 139 crore where as it was shown as Rs 5160 crore in the balance sheet of the company.

The source of the above data is http://www.scribd.com/doc/46641804/Sat-Yam

Recently a survey was conducted to find the extent of auditors' responsibility to detect fraud. Individual selected for answering this survey were randomly selected from the following sources: Small Firm CPA's, Large Firms audit partners, corporate financial managers, Bankers & Financial Analysts.

Table A: Pre SAS.

Very High

High

Neutral

Low

Very Low

Total

Small-firm CPA's

66

31

3

0

0

100

Large-firm audit partners

61

21

8

3

7

100

Corporate financial managers

74

20

3

1

2

100

Bankers

82

12

2

0

4

100

Financial

analysts

86

4

2

2

6

100

Over all total

369

88

18

6

19

500

Over all percentage

73.8

17.5

3.5

1.2

3.8

100

This was the result before implementation of SAS 16 and SAS 17. It states that all the groups majorly rated that auditor has a very high responsibility to detect fraud. According to the data collected from these 5 groups, result can be analyzed as:

Small-firm CPA's:- 66% of them rated that auditors have 'very high' responsibility, 31% of them rated it to be 'high' and 3 % were 'neutral'.

Large-firm audit partners:- 61% of them rated it to be 'very high', 21% said that it is 'high', 8% rated it 'neutral', 3% believed that their responsibility is 'low', and lastly 7% rated it as 'very low'.

Corporate financial managers:- Around 74% of them believed it to be 'high', 20% of them are of view that the responsibility of auditor to detect fraud is 'high'. 3% were 'neutral' about it, nearly 1% says it to be 'low' and 2% said it to be 'very low'.

Bankers:- 82% from the bankers said that its 'very high', 12% voted it as 'high', 2% of them were neutral and 4% of them said that auditors responsibility for detection of fraud is 'very low'.

Financial analysts: Amongst the financial highest number of people voted the responsibility of auditor to detect the fraud to be 'very high'. 4% said it to be 'high', where as 2% of them rated it to be 'neutral' and 'low', and finally remaining 6% voted it 'very low'.

Interpretation of overall result: when the collective result of the overall survey is taken it concluded that in all the five section majority of people which is 74% said that auditors have a very high responsibility towards detecting material misstatement. Whereas 18% found it to 'high', 4% voted for 'very low', 3% were of opinion that its 'neutral' and rest 1% said its low. So, from the above survey we can come to a final conclusion that everybody finds auditor as highly responsible for the detection of misstatements which leads to financial fraud.

The same results of the above survey can be described in the pie chart shown below:

Same survey was conducted after the implementation of SAS 16 & 17 in the year 1977, the data collected showed a different result as the introduction of new accounting standard by AICPA gave auditors more responsibilities towards detecting fraud. Following was the data collected from the survey.

Table B: post SAS

Very High

High

Neutral

Low

Very Low

Total

Small-firm CPA's

49

31

14

6

0

100

Large-firm audit partners

36

33

12

5

14

100

Corporate financial managers

68

22

6

3

1

100

Bankers

77

17

5

0

1

100

Financial

analysts

81

13

2

0

4

100

Over all total

311

116

39

14

20

500

Over all Percentage

62.2

23.2

7.8

2.8

4

100

The above result stating the responsibility of an auditor in detecting fraud can be analyzed as under:

Small-firms CPA's: 49% of people from this section believed it to be 'very high', 31% said that its 'high', 14% were neutral, and 6% said its 'low'.

Large-firms audit partners: this section has a balanced view about the responsibility of the auditor as 36% says its 'very high', 33% said it to be 'high', 12% viewed it to be 'neutral', 3% thought it to be 'low' and just 1% of them said that its 'very low'.

Corporate financial managers: people from this group voted 68% to 'very high' 22% of them said its 'high', 6% were 'neutral', people who voted for 'low' and 'very low' were 3% and 1% respectively.

Bankers: amongst them highest rating that is 77% was for 'vey high', next comes 'high' with 17% followed by 'neutral' which is 5% and rest of them said it to be 'very low'.

Financial Analysts: a very slight difference in the view of this group of people can be seen as compared to pre SAS survey. 81% voted it to be 'very high' followed by 13% who viewed it to be 'high' and the rest 4% and 2% said it to be 'neutral' and 'very low' simultaneously.

Interpretation of overall result: Even after implementation of SAS no 16 and SAS no 17 it can be concluded from the overall result that highest number of people were of the opinion that auditors have 'very high' responsibility of detecting fraud, nearly 62% of the overall people have this opinion, whereas 23% believed it to be 'high'. 8% people were neutral about it. 4% voted it to be very low 3% said it to be low.

From both the survey that is Pre and Post SAS, the results derived can be concluded as, high number of people believed that auditors are highly responsible to detect the material misstatement of the financial accounts which leads to financial fraud in the company. If the fraud occurs, the auditors are always blamed for mismanaging the accounts of the company. Very few of them believe that auditors responsibility for detecting fraud is low as auditors are mainly appointed to check whether or not all the transactions are recorded correctly as per accounting rules or not and whether or not the financial statement shows true and fair view of the company they are not responsible to find frauds in the company.

According to an article issued by Deloitte, an auditing firm majorly top management is behind the big accounting frauds which have occurred till date. They made a research on it based on the roles of the individual subjects of SEC alleged financial statement fraud enforcement released in 2008. The pie chart shown below provides us with the result of their study.

This study revealed that 44% from the total number of people responsible for the financial fraud accounts for Chief Financial Officer (CFO), Chief Accounting Officer (CAO), and controller. Next is followed by Chief Executive Officer (CEO) with 24%. Other members of the management which are alleged by the SEC to be generally involved in the accounting fraud are the people from sales, operating and planning department and collectively they represent 24% of individuals identified in the SEC's enforcement releases in the year 2008. The directors and the general Counsel each forms 4% of their participation in accounting fraud. Thus it can be learnt that it is the people who are inside the company commits fraud. And the most common amongst those are CEO's, CFO's and accounting officers of the company. So, the auditors and the management play a very important role in the financial fraud. They are the people who are responsible for it as they are in a position to manipulate the accounts of the company. So, on the basis of the position they hold in the company they manipulate the accounts of the company as per their own needs so that they can present better picture of their company in front of the stakeholders.

(Source of the data explained below is, http://www.deloitte.com/assets/Dcom-UnitedStates/Local%20Assets/Documents/FAS_ForensicCenter_us_fas-us_dfc/us_dfc_ten_things_about_financial_statement_fraud_241109.pdf)

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