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You are a newly hired associate auditor for Praxo & Hanks,CPAs, a professional services firm that provides financial audits,integrated audits, and tax work for a variety of private and publiccompany clients in the mid-Atlantic region of the U.S. Your firstweek with the firm was spent in a training program for audit staff,which was led by two of the firm’s audit managers. The first day ofthe training program focused on understanding the responsibilitiesof auditors and the nature and objectives of the services providedto audit clients. Answer the following based on what you shouldhave learned in the first day of training.

Required:

(a) Distinguish between the assertions made bymanagement in presenting financial statements and reporting onICFR, and the statements made within an auditor’s report.

(b) How do management’s assertions relate toaudit evidence?

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Collen Von
Collen VonLv2
6 Jan 2018

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Case Study - answer the questions on the bottom, 300 or 400 words recieve thumbs up ^^

Once the largest professional services firm in the world, and arguably the most respected, Arthur Andersen LLP (AA) has disappeared. The Big 5 accounting firms are now the Big 4. Why did this happen? How did it happen? What are the lessons to be learned?

Arthur Andersen, a twenty-eight-year-old Northwestern University accounting professor, co-founded the firm in 1913. Tales of his integrity are legendary, and the culture of the firm was very much in his image. For example, “Just months after [Andersen] set up shop in Chicago, the president of a local railroad insisted that he approve a transaction that would have inflated earnings. Andersen told the executive there was “not enough money in the City of Chicago” to make him do it.”1 In 1954, consulting services began with the installation of the first mainframe computer at General Electric to automate its payroll systems. By 1978, AA became the largest professional services firm in the world with revenues of $546 million, and by 1984 consulting brought in more profit than auditing. In 1989, the consulting operation, wanting more control and a larger share of profit, became a separate part of a Swiss partnership from the audit operation. In 2000, following an arbitrator’s ruling that a break fee of $1 billion be paid, Andersen Consulting split completely and changed its name to Accenture. AA, the audit practice, continued to offer a limited set of related services, such as tax advice.2

Changing Personalities and Culture

Throughout most of its history, AA stood for integrity and technical competence. The firm invested heavily in training programs and a training facility in St. Charles, a small town south of Chicago, and developed it until it had over 3,000 residence beds and outstanding computer and classroom facilities. AA personnel from all over the world were brought to St. Charles for training sessions on an ongoing basis. Even after the consulting and audit operations split, both continued to use the facility.

Ironically, AA was the first firm to recognize the need for professional accountants to study business and professional accounting formally. In the late 1980s, AA undertook a number of programs to stimulate that formal education, including the development of ethics cases, the creation of an approach to the resolution of professional ethical problems, and the hosting of groups of 100 accounting academics to get them started in the area. Most had no formal ethics training and were uncertain how to begin ethics teaching, or even if they should. It is likely that AA’s far-sighted policies are responsible for the genesis of much of the professional ethics education and research in accounting that is going on today.

What happened to the AA culture that focused on integrity and technical competence? What changed that would account for AA’s involvement in the major scandals noted on Table 1 as the audit firm that failed to discover the underlying problems?
TABLE 1: Arthur Andersen’s Problem Audits

CLIENT

PROBLEM MISSED, DATE

LOSSES TO SHAREHOLDERS

JOB LOSSES

AA FINE

WorldCom

$4.3 billion overstatement of earnings announced on June 25, 2002

$179.3 billion

17,000

N.A.

Enron

Inflation of income, assets, etc., bankrupt Dec. 2, 2001

$66.4 billion

6,100

$.5 million (for shredding)

Global Crossing

Candidate for bankruptcy

$26.6 billion

8,700

Waste Management*

Overstatement of income by $1.1 billion, 1992–1996

$20.5 billion

11,000

$7 million

Sunbeam*

Overstatement of 1997 income by $71.1 million, then bankruptcy

$4.4 billion

1,700

Baptist Foundation of Arizona

Books cooked, largest nonprofit bankruptcy ever

$570 million

165

Source: “Fall from Grace,” Business Week, August 12, 2002, 54.
*

Cases are in the digital archive for this book at www.cengagebrain.com

Some observers have argued that a change in AA’s culture was responsible. Over the period when the consulting practice was surpassing the audit practice as the most profitable aspect of the firm, a natural competitiveness grew up between the two rivals. The generation of revenue became more and more desirable, and the key to merit and promotion decisions. The retention of audit clients took on an increasingly greater significance as part of this program, and since clients were so large, auditors tended to become identified with them. Many audit personnel even looked forward to joining their clients. In any event, the loss of a major client would sideline the career of the auditors involved at least temporarily, if not permanently. For many reasons, taking a stand against the management of a major client required a keen understanding of the auditor’s role, the backing of senior partners in your firm, and courage.

The pressure for profit was felt throughout the rest of the audit profession, not just at Arthur Andersen. Audit techniques were modified to require higher levels of analysis and lower investment of time. Judgment sampling gave way to statistical sampling, and then to strategic risk auditing. While each was considered better than its predecessor, the trend was toward tighter time budgets, and the focus of the audit broadened to include development of value-added nonaudit outcomes, suggestions, or services for clients. Such nonaudit services could include advice on the structuring of transactions for desired disclosure outcomes and other work on which the auditor would later have to give an audit opinion.

According to discussions in the business and professional press, many audit professionals did not see the conflicts of interest involved as a problem. The conflict between maximizing audit profit for the firm and providing adequate audit quality so that the investing public would be protected was considered to be manageable so that no one would be harmed. The conflict between auditing in the public interest with integrity and objectivity that could lead to the need to roundly criticize mistakes that your firm or you had made in earlier advice was considered not to present a worry. In addition, the conflict between the growing complexity of transactions, particularly those involving derivative financial instruments, hedges, swaps, and so on, and the desire to restrain audit time in the interest of profit was thought to be within the capacity of auditors and firms to resolve. The growing conflict for auditors between serving the interests of the management team that was often instrumental in making the appointment of auditors, and the interests of shareholders was recognized but did not draw reinforcing statements from firms or professional accounting bodies. Some professional accountants did not understand whether they should be serving the interests of current shareholders or future shareholders, or what serving the public interest had to do with serving their client. They did not understand the difference between a profession and a business.

Ethical behavior in an organization is guided by the ethical culture of that organization, by any relevant professional norms and codes, and particularly by the “tone at the top”3 and the example set by the top executives. Also, presumably the selection of the CEO is based partly on the choice of the values that an organization should be led toward. Joe Berardino was elected AA’s CEO on January 10, 2001, but he had been partner-in-charge of the AA’s U.S. audit practice for almost three years before. He was the leader whose values drove the firm from 1998 onward, and probably continued those of his predecessor. What were his values? Barbara Ley Toffler, a former Andersen partner during this period and before, has provided the following insight:

When Berardino would get up at a partners meeting, all that was ever reported in terms of success was dollars. Quality wasn’t discussed. Content wasn’t discussed. Everything was measured in terms of the buck…. Joe was blind to the conflict. He was the most aggressive pursuer of revenue that I ever met.4

Arthur Andersen’s Internal Control Flaw

Given this “tone at the top,” it is reasonable to assume that AA partners were going to be motivated by revenue generation. But if too many risks are taken in the pursuit of revenue, the probability of a series of audit problems leading to increasingly unfavorable consequences becomes greater. That is exactly what happened. Unfortunately, the leaders of AA failed to recognize the cumulative degree to which the public, the politicians, and the SEC were angered by the progression of AA audit failures.

If they had recognized the precarious position they were in, the AA leadership might have corrected the flaw in the AA internal control that allowed the Enron audit failures to happen. AA was the only one of the Big 5 to allow the partner in charge of the audit to override a ruling of the quality control partner. This meant that at AA, the most sensitive decisions were taken by the person who was most concerned with the potential loss of revenue from the client in question, and who was most likely to be subject to the influence of the client. In all of the other Big 5 firms, the most sensitive decisions are taken by the person whose primary interest is the compliance with GAAP, the protection of the public interest, and the reputation of the firm.

On April 2, 2002, the U.S. House Energy and Commerce Committee5 released a memo dated December 18, 1999, from Carl Bass, a partner in AA’s Professional Services Group in Chicago, to David Duncan, the AA partner in charge of the Enron account. That memo asked for an accounting change (believed to be in regard to SPE transactions) that would have resulted in a $30–$50 million charge to Enron’s earnings. In February 2000, Bass emailed Duncan to object to the setting up of an LJM partnership because he indicated that “this whole deal looks like there is no substance.”6 On March 4, 2001, Bass wrote that “then-chief financial officer Andrew Fastow’s role as manager of special partnerships compromised deals Enron made with the entities.”7 Duncan overruled Bass on the first issue, and Bass was removed from Enron audit oversight on March 17, 2001, less than two weeks after he questioned Fastow’s role in Enron’s SPEs. In any other Big 5 firm, Duncan would not have been able to overrule a quality control partner on his own. History might have been different if a quality-focused internal control procedure had been in place at AA, rather than one that was revenue focused.
Arthur Andersen’s Apparent Enron Mistakes.

Questions below

1.

What did Arthur Andersen contribute to the Enron disaster?
2.

Which Arthur Andersen decisions were faulty?
3.

What was the prime motivation behind the decisions of Arthur Andersen’s audit partners on the Enron, WorldCom, Waste Management, and Sunbeam audits: the public interest or something else? Cite examples that reveal this motivation.
4.

Why should an auditor make decisions in the public interest rather than in the interest of management or current shareholders?

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