Auditing earliest days of the profession, accounting firms rendered

Auditing is the conduction of an examination of several events to verify that those events are being managed and documented in agreement with established guidelines, policies and procedures.

The auditing profession initially existed for governmental accounting purposes. It was mainly involved with reporting instead of accounting procedures. It wasn’t until the Industrial Revolution, that the auditing profession began progressing into an area of fraud discovery and financial liability. As businesses expanded immensely during this extent of time, company owners could not directly manage all of their operations and had to hire managers. Those owners recognized an expanding need to oversee managers’ financial tasks, both for accuracy and for fraud avoidance. In the years between the McKesson & Robbins scandal and the Enron and Worldcom scandals, administrators made many changes to accounting and auditing policy in the United States.

One of these numerous changes was that of the Sarbanes-Oxley Act of 2002 (“SOX”). The auditing profession in the United States was subject to self-regulation before SOX was introduced. Self-regulation is the fact of something such as an organization regulating itself without interference from external bodies. According to the International Federation of Accountants (2011), “Self-regulation with public oversight and accountability would typically involve some form of oversight being carried out by an independent agency (p.4).” Independent agencies are important because audit requires bringing attention to the audit profession challenges, weaknesses, and risks. Zeff (2003) discussed the need for self-regulation as follows: From the earliest days of the profession, accounting firms rendered consulting services. By the 1910s, they included the installation of factory cost systems, studies of organizational efficiency, investigations in connection with possible investments in other businesses, and an array of other services to management, which, as Carey writes, were often rendered in conjunction with audits (Carey 1969, 146).

But accounting, auditing, and taxation constituted the solid core of the firms services. In 1922, the American Institute of Accountants, now known as the American Institute of Certified Public Accountants (AICPA), banned certain forms of self-promotion by accounting firms. The following year, A. C. Ernst and two of his partners in Ernst & Ernst, by then a national firm, were accused of violating the Institutes rules against soliciting and advertising, and all three promptly resigned their Institute membership.

Even after his firm no longer engaged in those practices, A. C. Ernst never rejoined the Institute (Carey 1969, 233-234). Federal agencies sought the advice of the organized accounting profession because of its growing reputation. In 1917, at the request of the Federal Trade Commission (FTC) and the Federal Reserve Board, the Institute supplied a technical memorandum for publication by the Board as a bulletin on auditing procedures.

The FTC sought to promote uniform accounting, while the Board wanted to apprise commercial bankers of the importance of securing audited financial statements from their borrowers. Despite the title of the bulletin, Uniform Accounting, it actually dealt with recommended auditing procedures and the format of the balance sheet and profit and loss statement. This represented the first authoritative guidance on auditing procedures published in the U.S. In 1929, at the request of the Federal Reserve Board, the memorandum was revised by the Institute and published anew (Carey 1969, 129-135, 159-160; Previts and Merino 1998, 229-234, 250-251; Zeff 1972, 113-115, 118-119).

Audit work developed apace in the 1920s, as an increasing number of listed companies issued audited financial statements. By 1926, more than 90 percent of industrial companies listed on the New York Exchange were audited (May 1926, 322), even though the Exchange did not require audited statements by newly listed companies until 1933 (Rappaport 1963, 39-40). Yet the Exchange had informally encouraged companies to publish audited financial statements for some years before then (Staub 1942, 14-15). (p.191)  Reporting by the professional accountancy organizations to an independent agency in the dismissal of its responsibility, and oversight tasks exercised by that agency, enhance and add substance to self-regulation. The early implementation of regulation amongst the auditing profession made it easier to adopt SOX.  Many cases shaped the auditing profession to what it is today. From McKesson & Robbins to Enron and WorldCom, they each played a major part in developing SOX.

In 1937, McKesson & Robbins recorded total assets of $87 million. It was later detected that this $87 million was comprised of $10 million in nonexistent inventory and $9 million in phony receivables. The fraud was executed by the c-suite executives of McKesson & Robbins and involved fabricated purchases from and sales to counterfeit Canadian companies, which were indeed just vacant offices staffed by secretaries who forwarded mail. The widely known McKesson & Robbins fraud triggered the auditing profession to endorse two auditing standards that are adhered to today. Cengage described the two standards as follows: 1. The physical existence of inventory must be confirmed through direct observation. This simple procedure applied in the McKesson & Robbins case would have revealed that the reported purchases from the Canadian suppliers were phony.

 2. The existence and accuracy of reported receivables must be independently confirmed by contacting a sample of the parties who allegedly owe the money. Sixty-two years after the original McKesson & Robbins scandal, this simple procedure, applied by a staff auditor at Deloitte & Touche, uncovered the modern-day McKesson HBOC fraud. The accounting scandal of McKesson & Robbins was only the beginning of many issues to be uncovered within the auditing profession. The cases that changed the auditing profession took place some thirty years later. The case of Enron played a valuable part in illustrating what the auditor-client relationship should not be. It is the main accounting scandal that gave way to the implementation of SOX. Arthur Andersen LLP (“Andersen”) was Enron’s, a corporation during the 1990s that swapped its business from operation of natural gas pipelines to an energy conglomerate, auditor.

They audited Enron’s publicly filed financial statements and provided internal audit and consulting services to it. In 2000, Enron began to suffer financially and continued to diminish in 2001. Enron was headed by global managing partner David Duncan (“Duncan”). On August 14, 2001, Jeffrey Skilling, Enron’s CEO, surprisingly resigned.

Within days of his resignation, Sherron Watkins, a senior accountant at Enron, informed Kenneth Lay, Enron’s new CEO, Duncan, and Michael Odom, an Andersen partner who supervised Duncan, of the potential accounting problems facing Enron.  A key accounting problem involved Enron’s use of special-purpose entities (“SPEs”) used to engage in “off-balance-sheet” activities. Andersen’s engagement team had allowed Enron to “aggregate” the SPEs for accounting purposes so that they showed a positive return, an infraction of generally accepted accounting principles. On August 28, 2001, the SEC opened an informal investigation. On October 8, Andersen retained outside counsel to represent it in any litigation that might emerge from the Enron matter. On October 10, Odom spoke at a general training meeting stating that if all documentation is destroyed in the normal course of business, then it is acceptable. Odom was informed by Enron’s lawyer that each engagement file should contain only information compatible with the work completed.  On October 16, Enron announced its third quarter results, disclosing $1.

01 billion charge to earnings. The following day, the SEC sent a letter to Enron about the investigation against them and they forwarded it to Andersen. A meeting was called with Enron’s crisis response team to make sure everyone was complying with the document retention policy.

  On October 30, the SEC opened a formal investigation and petitioned for accounting documents from Enron. As a result, Andersen continued to destroy documents. On November 8, Enron restated its earnings and assets. The SEC also subpoenaed Enron and Andersen for its records. In March 2002, Andersen was indicted on one count of breaching witness tampering provisions 18 U.S.C.

§ §1512(b)(2)(A) and (B). The indictment alleged that Andersen knowingly, intentionally, and corruptly persuaded Andersen’s employees, with intent to cause them to withhold documents from, and alter documents for use in, an official proceeding. The case of WorldCom, a telecommunications company, turned out to be one of the largest accounting scandals in United States history. An internal audit of the company found that improper accounting practices were employed. More than $3.

8 billion in expenses were reported as capital investments over five quarters. Tran (2002) stated, “WorldCom’s chief executive, John Sidgmore, blamed the company’s former chief financial officer, Scott Sullivan, and the former controller, David Myers. The two were fired for claiming $3.8bn in regular expenses as capital investment in 2001.” Also, as another client of Anderson, they began to feel the pressure.

Anderson audited the company’s 2001 financial statements and reviewed their books in the first quarter of 2002. Andersen accused Mr. Sullivan of withholding material information from them. The deputy US attorney general, Larry Thompson (“Thompson”), said: “We have to ask where the professionals were, the accountants and the lawyers.” Two major accounting scandals have happened before WorldCom. The question posed by Thompson was a valid one to ask. Why were there no accountants who caught the fraud from the beginning?  From these three cases, one should understand the importance of auditing and the responsibilities that go along with it.

Auditors are held accountable for having relevant competence and capabilities to execute the audit, complying with relevant ethical requirements, and maintaining professional skepticism and exercising professional judgment throughout the preparation and performance of the audit. The Public Company Accounting Oversight Board (“PCAOB”) SAS No. 1, section 110, detailed the responsibilities and functions of the independent auditor. They are described as follows: 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. Because of the nature of audit evidence and the characteristics of fraud, the auditor is able to obtain reasonable, but not absolute, assurance that material misstatements are detected. The auditor has no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements, whether caused by errors or fraud, that are not material to the financial statements are detected.

.. The auditor’s responsibility is to express an opinion on the financial statements. Each auditor is held accountable to his profession, the responsibility to adhere to the standards accepted by his fellow auditors. Knowing this, each auditor should know the importance of their role.

 SOX was created with the intent to address the confusion and animosity in the country over the bankruptcies of WorldCom and other accounting scandals. The goals of SOX are to complement the clarity of financial information, redeclare auditor independence, and detail aspects of corporate governance. SOX assigned specific SEC oversight and altered the self-regulatory, peer review environment in which accounting firms had conducted business. It decreed that the SEC set up the PCAOB which would “establish auditing and related attestation, quality control, ethics, and independence standards and rules to be used by registered public accounting firms in the preparation and issuance of audit reports.” SOX held c-suite executives to a greater standard of accountability, required the use of independent audit committees, and enhanced auditor independence. Today, the auditing profession is in a continual state of growth.

Auditors are held to a higher standard so that accounting scandals are not as prevalent. There are four things that stand out amongst the auditing profession today. These four things are explained by Daniel Goelzer, a board member of the PCAOB. The first is the refocus on auditing.  “The profession is beginning to again view auditing as its core business — not merely an adjunct to consulting.

Many non-audit services have been prohibited. For those that remain legal, audit committee pre-approval is required, and audit committees are more reluctant to let their auditors perform significant non-audit services.” Secondly, the impact of inspections.  “While there is a place for enforcement proceedings and a place for liability to private parties who are injured by bad auditing, in my view, a well-thought-out inspection is more likely to improve the day-to-day quality of auditing than are those other, blunter tools.”  Next, auditor risk aversion and client selectivity.

 “Our inspections and published figures show that the major firms have “fired” some clients, particular those that are riskier. Firms also have developed more sophisticated tools for assessing client risk and using those assessments to tailor how they audit.”  Last, but not least, Section 404 internal control audits.  “The audits of internal control have added an important new dimension to the auditor’s work. The auditor is required to have a more complete understanding of the strengths and weaknesses of the client’s financial reporting systems. Audit committees are also being forced to learn more about those systems in order to assess significant deficiencies that the auditor reports to them.

” The auditing profession will continue to develop to become adaptive to the new pressures placed on the profession. Constant training and development must be required for auditors to adapt to the changing culture of auditing. The auditing profession has experienced many setbacks, but it is much stronger than it was years ago.

McKesson & Robbins, Enron, and WorldCom were included amongst the many accounting scandals that led towards the implementation of SOX. The implementation was a stride in the right direction for the auditing profession. SOX helps to support audit quality and investor assurance. It also enhances the audit effectiveness and efficiency, while also increasing the reliability of financial reporting. Because the profession will continue to grow, the auditing profession must continue to set regulations to push auditing in the right direction. In the years to come, regulations will make it easier for auditors to do their jobs.