Question

The Securities and Exchange Commission (SEC) regulates public companies. The SEC has found that some of these companies have violated GAAP by using creative accounting practices to mislead investors and creditors regarding the health of their company.

1. Analyze the audit report that the CPA firm issued. Ascertain the legal liability to third parties who relied on financial statements under both common and federal securities laws. Justify your response.
2. Speculate on which statement of generally acceptable auditing standards (GAAS) that the company violated in performing the audit.
3. Compare the responsibility of both management and the auditor for financial reporting, and give your opinion as to which party should have the greater burden. Defend your position.
4. Analyze the sanctions available under SOX and recommend the key action(s) that the PCAOB should take in order to hold management or the audit firm accountable for the accounting irregularities. Provide a rationale for your response.

Answer 1

Answer:

Detailed Report

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In July 2010, Dell Inc. was charged by Securities and Exchange Commission with failing to reveal its material information to the investors. The company used fraudulent accounting for falsely appearing consistent and minimizing its operating costs. Dell Inc. is a well known American company, which is privately developing, repairing, selling and giving technical and other support for computers and other related products.

The SEC discovered that the Dell Inc. did not disclose the large payments that it received from Intel Corporation. The Dell Inc. received this amount for not making the use of Central Processing Units manufactures by the rival companies of Intel Corporation in its computers and other devices.

This payment by Intel Corporation, made Dell achieve its earnings targets, and the company showed that these targets are achieved by company’s operations and management. After these payments were cut down by Intel, Dell Inc. had a decreased profitability, however, the company still does not disclosed to its investors that the true reason for this decreased profit is Intel’s cutting down of payments.

Audit Report Analysis

The audit report proposes that the financial reporting must develop the investor confidence under auditor independence. The company should be able to exercise ‘Professional Skepticism’ which refers to the inclusion of critical assessment of the evidences produced by audit.

However, Dell Inc. tried to seek for its independence under Rule 14a-8(i) (7). But Dell Inc. failed to satisfy its independence by showing that it was a matter of ordinary business. The company does not fully satisfy its investors and presented a false report about the company’s profits. Therefore, it is exempted from following its independence.

Legal Liability to the third party

There are basically three common liabilities, Deceit (The Duty of Honesty), Negligent Misrepresentation (The Duty of Care) and Strict Liability (The Duty of Correctness). In this case of the Dell Inc. misguiding its investors, the company is liable for the Deceit (The Duty of Honesty) under both common and federal security laws.

A legal action can be taken in tort for deceit. Deceit is abolished if any person of company deliberately misrepresents a material of fact to another party who trusts and relies on that person or company, and is damaged due to this misrepresentation.

In this case also, the investors rely on Dell Inc. and therefore, if the company has represented a false audit report to the investors who could get damage due this misrepresentation than a legal action can be taken against the Dell Inc. The audit report reveals that the Dell Inc. was not true to the investors in revealing them about the actual causes of the company’s profit and meeting the annual targets.

Statement of generally acceptable auditing standards (GAAS) that the company violated in performing the audit

The GAAS statement was that the Dell Inc. has failed to satisfy the investors and thus, does not seek persuasion under the Rule 14a-8(i) (7). To get the support of this rule the Dell Inc. needs to show the real audit statements. The Dell Inc. should also omit the Fund’s Audit firm independence report proposed under its proxy materials of 2012.

Responsibilities of both management and the auditor for financial reporting

In this case, the responsibility of the management of the Dell Inc. was more than the auditor in financial reporting. It seems that the company tried to deliberately hide the exact reasons of profits from the investors. If it was the due to the fault of the auditor than the company management would not have been involved into it.

Thus, this fault auditing occurred due to the deliberation of the management of the Dell Inc. The SEC also charged Michael Dell, CEO and Chairman of Dell Inc., Kevin Rollins, former CEO and James Schneider, former CFO for the violations of the disclosure.

Sanctions available under SOX and recommendations for the actions taken by PCAOB against the management for accounting irregularities

The key element of the Sarbanes Oxley Act (SOX) 2012 is the enforcement program of the Public Company Accounting Oversight Board (PCAOB). The examination of PCAOB’s enforcement program under this act reveals that in this case of Dell Inc., prior to this act, approx. 24% of the actions were taken.

After this act in 2012, PCAOB has imposed penalty of payment of $100 million to settle the charges of SEC on Dell Inc. A penalty of $4 million was imposed on Michael Dell and Rollins both and $3 million on Schneider to settle charges of SEC on Dell Inc.

References

Goldberg, J., & Kelly Jr, W. F. (1967). Accountants' Liabilities to Third Parties Under

Common Law and Federal Securities Law. BC Indus. & Com. L. Rev., 9, 137.

Securities and Exchange Commission. (2012). Audit Report of Dell Inc. Retrieved from:

http://www.sec.gov/divisions/corpfin/cf-noaction/14a-8/2012/unitedbrotherhoodcarpenters050312-14a8.pdf

Tackett, J., Wolf, F., & Claypool, G. (2004). Sarbanes-Oxley and audit failure: A critical

examination. Managerial Auditing Journal, 19(3), 340-350.

U.S. Securities and Exchange Commission. (2010). SEC Charges Dell and Senior

Executives with Disclosure and Accounting Fraud. Retrieved from: http://www.sec.gov/news/press/2010/2010-131.htm