Patrick S. Fields
Fraud and the Creation of Sarbanes-Oxley
Following the multitude of fraud scandals in the early 2000’s, such as Enron and WorldCom, many accounting firms found themselves as part of a thorough investigation to determine what exactly caused the sudden outburst of accounting fraud. As investors and creditors pursued their lost money from the these business failures, accounting firms began to garner attention for not fulfilling their due process during the audit to detect the fraud before it grew to the extent in which it did. In the case of the Enron scandal, it ultimately turned into the indictment and conviction of Arthur Anderson, one of the Big Five auditing firms at the time. These scandals reignited a debate over the GAAP based rules at the time and led to the establishment of the Sarbanes-Oxley Act in 2002. The act provided a much stricter set of guidelines for auditing standards, increased corporate responsibilities, and created the PCAOB to overlook specific processes and procedures for compliance to these standards. The fraud scandals leading to Sarbanes Oxley changed the accounting world and in particular, auditing. While there were definite deficiencies in the auditing practices at the time, such as the independence issues, the argument can be made that even while following precise auditing standards, an accounting firm cannot escape the possibility of litigation if a client’s business happens to fail. The connection between an auditor and a client’s financial statements will always be there and thus there is an inherit audit risk that will never be eliminated. There is always the chance of issuing a wrong opinion, even if the auditor follows all possible procedures and fulfills his professional due process; all auditors can do is limit this risk as much as possible. This is largely due to the auditor’s use of sampling procedures and the fact they do not cover 100 percent of the transactions involved in any account. Unfortunately, it is also the case that if the company involved experiences any sort of business failure, the auditor will immediately be under question and find themselves in risk of potential litigation. While Sarbanes Oxley provides guidelines on certain aspects of the audit and established an oversight board to help auditors adhere to these policies, it is also important for the auditors to look internally to determine what can be done in their own planning and decision process that can help them avoid certain situations that might be more risky (Pelletier 2008). While much has been done externally in the form of new laws and standards, it is important for accounting firms to also look internally and determine what can be done to help reduce the risk of potential litigation. In order to reduce these risks the auditors should understand more about the industry and the enterprise of the audited company when receiving audit authorization and planning the audit. They should also use and plan the audit work in order to upgrade the audit quality and further reduce the risk of lawsuits (Krishnan 1997). An Overview of the Risk Assessment Model
The process of client acceptance and audit planning revolves around the audit risk assessment model. The model is used for discovering certain areas within a particular business that are more susceptible to potential misstatement or fraud and focusing the bulk of resources and substantive testing to these riskier areas. The current risk assessment model includes: control and inherit risks, which make up the risk of material misstatement, and detection risk. Control risk is the risk that certain controls may not detect a fraud or misstatement and tend to be the more straight forward risk to account for since the controls in place can easily be evaluated for failures. Inherent risk is the susceptibility of an account or assertion to material misstatement,...