Question

In: Accounting

The International Bank of Commerce (IBC) is an audit client of your public accounting firm. IBC...

The International Bank of Commerce (IBC) is an audit client of your public accounting firm. IBC is a multinational financial institution that operates in 23 countries. During the current year’s audit, you have discovered the following problems: a. Improper loans were made to stockholders and other related parties. b. Loans were recorded on the books that appear to be either false or deceitful. You are especially concerned about these findings because it appears that members of senior management were aware of, and participated in, these illegal activities. In accordance with professional standards, you have communicated these illegal acts to IBC’s audit committee of the board of directors. However, you are not satisfied with the committee’s reaction to the situation. The chair of the audit committee thanked you cordially, but the committee took no action to investigate the activities or prevent their occurrence in the future.

a. Describe the consequences if you immediately communicated these matters directly to the SEC.

b. Describe your appropriate course of action in this situation.

c. Present arguments

Solutions

Expert Solution

1. An auditor has to maintain client confidentiality while performing its role of audit and shall not disclose information outside except otherwise expressly required by the law. In the given case, intimation to SEC directly could lead to possible violation of PCOAB standard AS 2401 by the auditor and may invite legal action by the Company and shareholders of the Company including action by SEC. Further, SEC involvement would bring spotlight on the matter and may lead to erosion of wealth of the shareholders.

2. Appropriate course of action-

AS2401 of PCOAB provides that the auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.

Further para 79 of the standard provides fraud involving senior management and fraud (whether caused by senior management or other employees) that causes a material misstatement of the financial statements should be reported directly to the audit committee in a timely manner and prior to the issuance of the auditor's report. In addition, the auditor should reach an understanding with the audit committee regarding the nature and extent of communications with the committee about misappropriations perpetrated by lower-level employees.

Further, the auditor has a responsibility, under certain conditions, to disclose possible fraud to the Securities and Exchange Commission to comply with certain legal and regulatory requirements. These requirements include reports in connection with the termination of the engagement, such as when the entity reports an auditor change and the fraud or related risk factors constitute a reportable event or are the source of a disagreement.

In the given case, the Auditor should discuss with the audit committee on the action taken to correct the material misstatement. If the discussion leads to disagreement then appropriate course of action shall be to inform SEC and resign from the audit. In case sucessor auditor request for information, disclose information transparently within framework of PCOAB standard.


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