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Financial reporting and earning manipulation fraud have been very attractive topic in the past two decades. We were witnesses of several cases by corporations, of what appeared to be financial statement fraud, and which were undetected by the auditors. According to Joseph T. Wells (2002), one of the most interesting cases in twentieth century occurred in the '70s when an enterprising insurance salesman, Stanley Goldblum, managed very easily to add over 65 thousand fake policyholders to his company - Equity Funding - rolls, along with over $800 million of fake assets - in front of its independent audit firm (Rezaee, 2002). From that time onward, financial fraud and manipulation were closely connected to the auditors, consequently resulting in a mutual failure of both audited companies and auditing ones. The cases started to become an increasing issue, including the case of Enron, as well as Xerox, Waste Management and AOL Time Warner Company.
The international auditing firm, Arthur Andersen, which was an external auditor for Enron corporation, seems to be a school example of a firm that resulted to be an major audit failure. Mostly since the company was one of the Big Five at that time, resulting in more people and authorities belief that professional accountants have to study how to more effectively detect the fraud in financial statements. Probably one of the best ways is to profit from the mistakes of others. Implementing actions against external auditors have been rare, but the consequences of individual cases can be great and the cases offer the profession an opportunity to learn and grow (Beasley, Carcello, Hermanson, 2001).
In order to fully understand the problems and challenges of modern financial auditing, this paper will give an overview on auditing history as well. Since auditing has always existed, in many forms, but not named the same way it is today. It can be said that auditing has existed as long as commercial life itself. Because auditing is a form of control, and there has always been a need by those who entrust their property (shareholders, actual owners) to others, to have some control over them. General perception is that modern financial auditing started to form its today's shape in the middle of the nineteenth century. The emergence of corporate entities, where ownership and control were completely separated, provided a need for rapid development of financial auditing services and increasingly disclosed requirements for financial statements.
When companies tend to collapse, for any reason, but mostly in cases of alleged or actual fraud, the reaction of mass media and public are always focused on auditors and that the primary possibility of fraud was their failure. As a result, it is very necessary for auditing professionals to take responsibility and always improve their practices overall. The best way to do so is to use their experience and talents to prevent problems before they occur (Hunt, 2001).
This paper has an aim to present Financial Audit to the wide range of potential readers. It will introduce purposes and scopes of auditing, as well as responsibilities of auditors, with the historical overview of auditing, as an independent controlling body for assessing financial statements of an audited firm.
In the past decade, international financial system has been hit several times by many different gigantic occurrences. The most recent was the subprime mortgage crisis, but the case this dissertation will be concentrating on is the failure of Enron Corporation. Mainly because this scandal has lead one of the largest auditing company in the world to fail, Arthur Andersen, which was one of the Big Five auditing companies, together with PwC, Deloitte, KPMG and E&Y. Moreover, this scandal has reached over $70 billion of losses to the shareholders and $2 billion to the employees who had their pension and health insurance plans incorporated in the company.
This scandal brought the attention of a potential loopholes and poor financial reporting regulations existing at that time. Having in mind that the fraud was detected in large energy services company, with naturally an auditor connected to the scandal, authorities have made an effort to increase the control and regulation levels in order to eliminate the chance of future fraudulent actions. From that time on, new regulations were rapidly created, while old ones were renewed in order to expand the accuracy of the financial statements and reporting, especially of the large public companies. Primary aim was to increase the transparency, since it has the biggest role in potential fraud situations elimination.
One of the first legislations that were brought up was the Sarbanes-Oxley Act, which is actually a legislation for reforming accounting rules for public companies, protecting shareholders and potential investors. The same act has also increased the accountability of auditing firms to remain unbiased and independent of their clients.
More in detail, this dissertation will have a role to closely connect auditors work with the fraud determination. Basically, auditing is meant to be a job for transparently assessing financial statements of companies and as a fraud prevention mechanism. On the contrary, based on the abovementioned example, opposite conclusions could be drawn. And those conclusions could be that auditing as a profession has failed to asses fraudulent actions in this particular example, that unfortunately lead two high corporations to fail, employees lose their jobs and shareholders lose their share value. Furthermore, Enron scandal is a drastic example of a company going bankrupt due to actions made by fraudulent management, therefore this dissertation will be mostly focused on that case study.
Additionally, this paper will also research the work done by the Association of Certified Fraud Examiners. It is a very important fraud examining association that deals on day to day basis in numerous projects. Basically, what they are trying to achieve is determination of the source of fraud. The role of this organization is to find a way how to spot and prevent the fraudulent activities.
Finally, the purpose of the following dissertation is to fully present auditing in the modern financial environment. It will present why auditing is important in financial system and assessing performance of public companies. Moreover, this dissertation will explore future accounting and reporting standards that are being prepared in order to decrease the chance of potential fraudulent activities in corporations.
History of auditing