How the Sarbanes-Oxley Act Will Impact the Audit Function

Topics: Internal control, Auditing, Audit Pages: 6 (2015 words) Published: January 28, 2006
Before the Enron-Arthur Anderson scandal, auditors were generally viewed as independent and trustworthy professionals. They protected the interests of the individual investor by ensuring that corporations presented financial statements that accurately reflected the financial results of operations. The auditor was trusted to present the facts as he saw it, regardless of the implications. When events such as the academy awards used the services of a CPA, it was done not because the counting of ballots was a technically difficult task, but because people believed CPA's could be trusted. The recent problems encountered by many of the nations top accounting firms "has taken something important from all accountants: the assurance that practicing or teaching others to practice accounting is an honorable way to spend one's life (Williams 2003)."

The traditional audit involved many time consuming practices that increased the likelihood of detecting fraud, such as site visits to multiple locations, observation of assets, and random sampling of non-material levels. Also, the audit was closely supervised by senior partners who thought their firm's integrity was at stake at every engagement. However, as the revenues from consulting services grew, the audit function became merely a part of a package which accounting firms offered in conjunction with the more lucrative consulting services. As the financial rewards from audits diminished so did the scope and depth of procedures performed. Audits, in recent years, have been reduced to computer based test controls and statistical modeling. Another development is that junior accountants are often assigned the crucial oversight roles that were traditionally filled by senior partners who are now too busy selling to prospective clients (Frieswick, 2003).

While many view the Arthur Anderson scandal as the classic case of the deterioration of the audit function, there are other cases which demonstrate the predictability and inadequacy of the audit processes employed by many of the top accounting firms. One such case involves healthcare provider HealthSouth Corporation. HealthSouth and its former CEO Richard Scrushy orchestrated a scheme to overstate their earnings in order to meet the earnings estimates of financial analysts. Between 1999 and 2002 the company overstated income by $1.4 billion. This was done by making false journal entries that overstated the amount of third party insurance reimbursement, and by decreasing expenses. HealthSouth was able to avoid detection by its auditors Ernst & Young LLP by using the auditor's own process against it. Executives increased earnings not by booking revenues directly which auditors would have almost certainly have found, but by reducing a revenue-allowance account which was netted against revenues. These amounts were based on estimates, had very little paper trail, and was difficult to verify. HealthSouth executives also knew that Ernst &Young did not question fixed assets additions below a certain dollar amount, so random entries were made to its balance sheet for fictitious assets worth less than that threshold amount. Senior accounting personnel also created false documents to support these false purchases. This allowed the company to overstate fixed assets by $800 million (Frieswick, 2003).

There have been numerous attempts over the years to improve the audit process. Studies conduced by the Treadway Commission in 1987, the Jenkins Committee in 1994, and the Panel on Audit Effectiveness of the Public Oversight Board (POB) in 2000, issued reports recommending changes in audit procedures. The 2000 POB study, considered the most comprehensive study of the profession ever done, recommended the use of forensic techniques in every audit, and suggested the insertion of the element of surprise into audits. The study also advised auditors to assume the possibility of dishonesty at various levels of management including, collusion, override...

References: Bloch, G. (2003, April). Sarbanes-Oxley 's effects on internal controls for revenue. The CPA Journal, 73(4), 68.
Colson, R. (2003, April). Maintaining public credibility: An interview with Charles D. Niemeier. The CPA Journal, 73(4), 18.
Frieswick, K. (2003, July). How audits must change. CFO, 19(9), 42-44, 46-48, 50.
McConnell Jr., D. K., Banks, G. Y. (2003, September). How Sarbanes-Oxley will change the audit process. Journal of Accountancy, 196(3), 48-55.
Nyberg, A. (2003, September). The true cost of Sarbanes-Oxley compliance. CFO, 19(11), 57.
Williams, P. (2003, April). Association for integrity in accounting enters the discussion of accounting reforms. The CPA Journal, 73(4), 14.
Wolosky, H. (2003, July). Living with Sarbanes-Oxley. The Practical Accountant, 36(7), 4.
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