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Court Decisions and Auditing Procedures A 1939 investigation by the SEC revealed that Coster and his...

Court Decisions and Auditing Procedures

A 1939 investigation by the SEC revealed that Coster and his confidants had stolen around $2.9 million of McKesson & Robbins’s cash in the previous 12 years. However, due to the lack of two “then-not-required” audit procedures, physical observation of inventory and direct confirmation of accounts receivable, Price Waterhouse failed to detect $19 million nonexistent assets (out of total assets of over $87 million) and $1.8 million gross profit on fictitious sales of $18 million that were included in McKesson’s 1937 certified financial statements.

Up until 1940, the auditor was allowed to rely on the representations of management concerning the accuracy of physical quantities and the costs of its inventory. The SEC criticized the accountants for inaccuracies in the corporation’s audited financial statements and set forth several findings in the McKesson & Robbins case:

  1. The accounting firm “failed to employ that degree of vigilance, inquisitiveness, and analysis of the evidence available that is necessary in a professional undertaking and is recommended in all well-known and authoritative works on auditing.”
  2. Although the accounting profession claims that the auditor is not a guarantor and should not be liable for fraud, the SEC ruled that “the discovery of gross overstatements in the accounts is a major purpose of such an audit even though it [may] be conceded that [the audit] might not disclose every minor defalcation.”
  3. The SEC advised the accounting profession to take physical inventories and to require confirmations of accounts and notes receivable.
  4. Page 356The SEC recommended that the board of directors nominate the auditors and that the activities of management be included in the audit.

The SEC made additional recommendations to the AICPA, including to distinguish auditing “standards” from auditing “procedures.” Also, the auditor’s certificate should state whether “the audit was made in accordance with generally accepted auditing standards applicable in the circumstances.” Subsequently, the AICPA adopted these procedures and eventually codified them in the Statement on Auditing Standards.

Answer the following discussion question:

Do you think that the inability of auditors to detect a financial statement misstatement due to gross deficiencies in internal controls over financial reporting should expose auditors to litigation? Why or why not?

Solutions

Expert Solution

I personally think that gross negligence in internal controls over financial reporting should not be exposing auditors to litigations because it is the duty of the organisation to prepare proper books of accounts and present it to the public disclosure and auditor can only have access to those books of accounts which the management has prepared and it has manufactured accordingly.

The management of a company are always trying to window dress the books of account as per their convenience in order to influence their overall profit and they are trying to capitalise upon some deficiency in Generally accepted accounting principles and they are trying to exploit that to their advantage so the auditor is not able to to catch them up.

Even though auditors are responsible for auditing of the books of accounts but auditing is just a task for expressing an independent view of the auditor and it has its limitation to because it is a time bound process and this can be highly managed by the management of the company to avoid various litigation proceedure and the auditor will not be able to catch them because of various irregularities in internationally accepted accounting standard and modifications in them according to structure of various business.

Auditors are often faced by these companies for conducting audit so there is also a conflict of interest because there is not optimum independence on the part of the auditor's, that should expose them to litigation issues because that would be restricting auditor to express an independent opinion because they would be afraid to statutory audit so the accountability should be fixed on the part of the management in order to prepare proper books of accounts and held them accountable when there is misrepresentation and fraud.


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