Accounting Theory Case 1-6

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Chapter 1 Case 1-6

During the early 2000s, the roles of accounting and the auditing profession changed and several accounting scandals were uncovered.

A. What conditions caused accounting and the auditing profession role to change during this time?
In the mid 80s, the AICPA lift on the ban on advertising caused revenue generation to become more critical to partner’s compensation. The profit structure of CPA firms changed, and in 1999, revenues for management consulting accounted for more than half of the then-Big Five’s revenue. As a result, the audit function evolved into a loss leader that public accounting firms offered in conjunction with vastly more lucrative consulting engagements. But as public accounting firms competed more aggressively on price for audit engagements, they were forced by cost considerations to reduce the number of procedures performed for each client engagement. This resulted in increased tests of controls and statistical models, and fewer of the basic, time-consuming tests of transactions that increase the likelihood of detecting fraud. In addition, junior auditors were frequently assigned the crucial oversight roles usually filled by senior partners, who were otherwise engaged in marketing activities to prospective clients. This reduced the effectiveness of the instructor-new accountant training process.

B. What major changes occurred as a result of the accounting scandals at that time?
Two major changes took place. Arthur Andersen, formerly one of the Big Five audit firms, went out of business. Also, in July 2002, President George W. Bush signed into law the Sarbanes-Oxley Bill, which imposes a number or corporate governance rules on publically traded companies.
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