Risk Assurance (Auditing)
Emmett, Orr & Peterson LLP (EOP) is an auditing firm based in the United States that was formed back in 1927. The management of EOP disposed of documents that contained vital information related to the one of its longstanding client, Brown-Torrington regarding its special purpose enterprises (SPEs). Emmett, Orr & Peterson LLP claimed that the records provided by its clients were unreliable to use in the auditing process despite them containing information of the high indebtedness of the client’s SPEs. Brown-Torrington is a pharmaceutical company in the United States that was formed after the merger of Brown Pharma and Torrington Stills in 1994. The company had formed a series of special purpose enterprises (SPEs) for its own new drugs and for new drugs developed by other companies, hoping to capitalize on them when the patents of their competitors expired. However, the more than 20 SPEs were financed by private debt mainly even though it speculatively booked the expected profits from these investments between 1999 and 2002 totaling to over 3 billion dollars. Favorable profit outlook for the company raised its share price at the stock exchange and subsequently attracted more investors, making the company appear to be highly competitive in the pharmaceutical industry.
The two companies have had a close longstanding auditor-client relationship, with several of employees from Emmett, Orr & Peterson LLP having gained employment in Brown-Torrington. However, trouble started brewing when the collapse of Brown-Torrington was attributed to auditing malpractices perpetuated by both Brown-Torrington and Emmett, Orr & Peterson LLP. The management at Brown-Torrington did not disclose the debt ridden financial position of its special purpose enterprises in its balance sheet and therefore was not transparent to its shareholders, which turned the spotlight to the auditing practices of Emmett, Orr & Peterson LLP. Questions related to the ethical practices at Emmett, Orr & Peterson LLP could lead to the demise of the company following the fiasco as Brown-Torrington, with questions being raised regarding the responsibility of the company in the downfall of Brown-Torrington and how the company can survive the scandal.
Evaluate Brown-Torrington’s practices (BT). Were ethical barriers crossed? What is the problem with what BT is doing? Were Brown-Torrington’s practices with the special purpose entities fraudulent or just excessively optimistic?
According to the Securities and Exchange Commission (SEC) revenues should be recognized once a sale transaction has been effected and deferred to a later time upon meeting the revenue recognition criteria. The criteria asserts that revenue should be recognized when the probability for collection of payment is high, when the delivery of goods is complete, and when there is persuasive argument indicating that a transaction has occurred. From this premise, Brown-Torrington crossed the ethical barriers in its financial disclosure by not being truthful in its revenue recognition. Specifically, although the company estimated the probable income from its SPEs, it did not apply the principle of conservatism in which it would have made the less optimistic estimate and instead opting to overstate its estimates (Shah and Butt 100). In addition, the revenues of the company were not matched to the cost of doing business thus transgressing the matching principle of accounting. Further, the timing of the exclusion of the disclosures of the financial position of the SPEs made the company appear profitable at a given financial year thus contravening the timing and objectivity principles (Kiabel and Nwanyanwu 199).
Therefore, the activities of Brown-Torrington were fraudulent and not just excessive optimism because the top management of the company knew about the indebtedness of its SPEs and had requested the auditing firm, Emmett, Orr & Peterson LLP, to facilitate in presenting the positive outlook of the company, leading to overlooking and expunging of crucial financial documentation. In addition, the company knowingly omitted SPEs from its disclosure to its shareholders with the full knowledge of their high indebtedness, which had tied the finances of the company speculatively. The excessive coziness between the two companies encouraged and facilitated the commission of fraud in that some of the employees at Brown-Torrington formerly worked for of Emmett, Orr & Peterson LLP, and were therefore familiar of the importance of Brown-Torrington as a client. This made the accounting department complacent with adherence to proper accounting practices to ensure that the wishes of the management at Brown-Torrington were met regardless of their legal and ethical implications.
What are some lessons learned from this SAGA? Specify according to actor.
The chief executive officer, the finance manager and the auditors are key actor from whom lessons can be learnt.
- Chief executive officers
The chief executive sets the tone of ethical practice in an organization. Since their instructions reflect the level of adherence to ethics in their leadership, they should avoid placing the company and its employees in ethical dilemmas or in situations that invite unethical behavior. In addition, the CEO is the individual with whom the responsibility of the company rests and should not escape crises in the manner in which Wheelright did.
- Finance manager
The financial manager is pertinent in ensuring that correct information regarding the financial position of an organization reaches the management and shareholders of a company. The manager is also responsible to setting up structures that facilitate prudent financial practices in an organization and thus address issues of concern with the management and auditors as well. In this case, Rajinder would have done more than just acknowledging the issue by addressing it comprehensively with the management of the company.
Auditors should adhere to the legal and regulatory requirements of the jurisdiction in which they operate to endure that their organizations are compliant. As such, they should resist any machinations of the management to falsify financial reports and whistleblow when they observe malpractice in order to save the investments of the shareholders and for public interest as well. As such, the complacency displayed by the members of the accounting department at Brown-Torrington worsened the saga to their detriment and the detriment of their company.
What recommendations would you advice for accounting firms so that these types of incidents do not re-occur? What about senior managers at BT? Shareholders? Banks? Credit Agencies? Government? Regulatory Bodies? Other stakeholders?
- For accounting firms to avoid such incidents, there has to be a strict code of conduct on the level of professionalism exhibited by all employees and affiliated partners. The need to address professionalism has to be placed as a source of profitability cause as opposed to friendship.
- The senior managers have to create a holistic leadership platform that accelerates communication and decisive decision-making procedures in all the operations of the firm. Strict control measures on all auditing measures have to be relayed by the senior managers to all subordinate members and entrusting them with the right solutions to any dilemmas.
- Banks and credit agencies have a role to play in the determination of credit worth that the companies rely on when delivering audit verifications and counterchecks for all statements declared. The inclusive stakeholders of other organizational bodies have an input on standard practices used in accounting especially where indebtedness is realized.
- Shareholders on the other hand have to be empowered in taking charge of influencing the relations and appropriate issues that will affect the auditing company.
- The government and regulatory bodies have a role in ensuring that the practices are in accordance with the auditing standards especially where it is needed to deal with indebtedness and un-sustainability in such a situation that BT faced. They can offer guidelines and monitoring services as oversight bodies and encourage organizational growth in the process.
How do you measure, control, and manage ethics within large corporations?
Ethical measurements, controls, and management have to be effective on the transparency and follow-through of the reports. Once the assets and declarations have been made, it is the duty of the statements to reflect on the same without hidden agendas. On the other hand, for large corporations to abide by the ethical standards, a database that is comprehensive is advised. It has to give the representation in full without any errors on an internal basis, give auditors a layout that is honest, and open for concurrence (Houghton and Campbell 24). Risk assessment will also provide the basis for managing dilemmas such as the one realized in the organization. Risk responses as per COSO initiative show that the company should carry out a quantification process where accepting the results and preparing the monitoring framework. Elimination follows with proper auditing measures while institution controls would be welcome.
If you were a consultant to Emmet, Orr & Peterson, What course of action would you recommend? Explicitly take into account the balance between, legal, financial, and ethical consideration.
First, I would help in complete disclosure of the occurrences that are pertinent to enable the employees, regulators and the management form informed opinions and decisions. This would help the company make legal defense in any lawsuits that would ensue and prepare the shareholders for any financial repercussions that may follow. Secondly, I would champion a practice change that stipulates the ethical conduct at the organization. It should follow as a way to guarantee employee and shareholder trust and confidence (Houghton and Campbell 7). In this case, I would introduce a code of ethics, which would be necessary. It stipulates avenues of reporting misconduct confidentially, controls of avoiding malpractice and the consequences of engaging in such practices. The step would include disclosing any information that raises malpractice suspicions such as the documents that were discarded by the company. Thirdly, I would request for the management to avail an assessment of the risk appetite and risk tolerance. It is pertinent and should be weighed against the willingness to maintain old clients and engage new ones. In this case, I would advise on the status of the company’s role in care for auditing processes. The care should be taken to avoid relating with organizations that show an appetite for perpetrating financial malpractices.
Houghton, Keith, and Tom Campbell. Ethics and auditing. ANU Press, 2013.
Kiabel, Bariyima D., and Loveday A. Nwanyanwu. “Some basic concepts of accounting: a critical appraisal.” Research journal of finance and accounting, vol. 7, 2014, pp. 197-204.
Shah, Syed Zulfiqar Ali, and Safdar Butt. “Creative accounting: A tool to help companies in a crisis or a practice to land them into Crises.” International Conference on Business and Economics Research, vol. 16, 2011, pp. 96-102.
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