Transcript Professional Skepticism

Overview
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Understanding Occupational Fraud and
Material Misstatement
The Current Environment
The Regulators Response
Sarbanes Oxley Section 404
Moving Forward
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Understanding
Occupational Fraud and
Material Misstatement
Defining the Terms
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Occupational Fraud – The use of ones occupation
for personal enrichment through the deliberate
misuse or misapplication of the employing
organizations resources or assets.
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Asset Misappropriations
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Corruption
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Cash
Theft of inventory
Accepting Kickbacks
Engaging in Conflict of interest
Fraudulent Statements
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Financial
Non-Financial
Source: “2002 Report to the Nation”; ACFE
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Defining the Terms
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Material Misstatement – The omission or
distortion of accounting information that
makes it probable that the judgment of a
reasonable person relying on the information
would have been changed or influenced by
the omission or distortion.
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Can occur with intent or without
Can be monetary or non-monetary (notes
to financial statements)
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Perspectives on Fraud
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6% of annual revenue
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Costs $600 billion annually
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$4,500 for every employee
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37% of companies worldwide suffered
during previous two years
Source: “2002 Report to the Nation”; ACFE
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Perspectives on Fraud
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The average fraud goes undetected for 18
months
The median loss for schemes involving
falsification of an organizations financial
statements is $4.25 million
Management accounts for more than 40%
of cases
Source: “2002 Report to the Nation”; ACFE
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So…whatever happened to……..?
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Worldcom (improper profits, loans, overstated cash
flows)
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Rite Aid (inflated earnings, improper use of
company funds, conspiracy, obstruction)
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Enron (hid losses in off balance sheet entities,
controls failed)
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Tyco (unauthorized pay, deception regarding
company financial condition)
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Many others!!!
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So, Why all the Fraud?
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Changes in Culture
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Downsizing
Diminished loyalty
Bottom-line pressures
Executive incentives skyrocketing
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Technology
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Globalization
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The Regulators Response
SAS 99
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Professional skepticism
Brainstorming
• How can fraud occur?
Inquiries
• Fraud risk
• Fraud occurrence
• Corroborative evidence
Management override of I/C
Revenue recognition
Unpredictable audit test
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A Proactive Approach
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Passage of Sarbanes-Oxley in 2002
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Formation of PCAOB
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President Bush states the act as, “...the most far
reaching reforms of American business practices
since the times of Roosevelt.”
Chairman and members appointed by SEC
Increased SEC Enforcement
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Enforcement actions initiated increased 25% over
last five years
Complaints and questions rose 71% over last five
years (48,169 to 82,337)
Increased Enforcement staff
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What Does all this Mean?
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All of these initiatives put more pressure on
company stakeholders to focus on the
prevention and detection of fraud and
material misstatement
BUT HOW???
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One way...strengthen and monitor the
internal control environment
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That is the mandate of Sarbanes-Oxley
Section 404
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Sarbanes-Oxley Section 404
Understanding the Requirements
•Management
•Independent Auditors
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Management Assertion (Not SEC Approved)
Management of W Company, Inc. (the Company) is responsible for
establishing and maintaining adequate internal control over financial
reporting. This internal control contains monitoring mechanisms, and
actions are taken to correct deficiencies identified.
Management assessed the Company’s internal control over financial
reporting as of December 31, 200X. Based on this assessment,
management believes that, as of December 31, 200X, the Company
maintained effective internal control over financial reporting, including
maintenance of records that in reasonable detail accurately and fairly
reflect the transactions and dispositions of the assets of the Company,
and policies and procedures that provide reasonable assurance that
transactions are recorded as necessary to permit preparation of
financial statements in accordance with accounting principles generally
accepted in the United States of America and that receipts and
expenditures of the Company are being made only in accordance with
authorizations of management and directors of the Company, based on
the criteria for effective internal control over financial reporting
established in Internal Control — Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission.
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Auditor Attestation (Not SEC Approved)
We have examined management’s assertion included in the accompanying
[title of management’s report] that W Company, Inc. maintained effective
internal control over financial reporting as of December 31, 200X, including
maintenance of records that in reasonable detail accurately and fairly reflect
the transactions and dispositions of the assets of the Company, and policies
and procedures that provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with accounting principles generally accepted in the United
States of America and that receipts and expenditures of the Company are
being made only in accordance with authorizations of management and
directors of the Company, based on the criteria for effective internal control
over financial reporting established in Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission. W Company’s management is responsible for
maintaining effective internal control over financial reporting. Our
responsibility is to express an opinion on management’s assertion based on
our examination.
In our opinion, management’s assertion that W Company, Inc. maintained
effective internal control over financial reporting as of December 31, 200X,
is fairly stated, in all material respects, based on criteria established in
Internal Control-Integrated Framework, of the Committee of Sponsoring
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Organizations of the Treadway Commission.
Timing of 404 Implementation
WAS
All Companies
April 15, 2005
FY on or after
Accelerated Filers
June 15, 2004
FY on or after
Foreign Filers
April 15, 2005
FY on or after
NOW
July 15, 2005
November
15, 2004
July 15, 2005
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Considerations for Management
Management’s Responsibilities
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Assess effectiveness of controls over
financial reporting
Provide auditor with assertions
Submit control report with annual
report
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Considerations for Management
Develop an Internal Control Self
Assessment Methodology
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Identify Objectives
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Develop Project Plan
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Develop the Self-Assessment Model
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Populate the Model for Evaluation
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Considerations for Audit Committees
Section 404 reinforces the SarbanesOxley Act’s requirement for the audit
committee to oversee the company’s
internal control over financial reporting
Key Actions
 Understand Increased Independent
Auditor involvement
 Monitor progress
 Hold management accountable
 Self-assess
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Considerations for Independent Auditor
Key Elements of an Internal Control
Audit
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Audit and render an opinion on
management’s assessment of internal
controls over financial reporting
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Communicate significant deficiencies
and material weaknesses
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Evaluate management’s report for
appropriateness
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Sounds Involved...What’s in it for me?
The Business Case for a Strong Internal Control Program
Strong Internal Control Weak Internal Control
 Reduce potential for
 Increased exposure to
fraud
fraud
 Gain (or regain) investor
trust
 Misstated financial
 Comply with laws and
statements
regulations
 Unfavorable publicity
 Gain visibility into
operating inefficiencies  Negative impact on
shareholder value
 Minimize whistleblower
actions
 SEC sanctions
 Set the “tone at the
 Lawsuits or other legal
top”
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actions
Moving Forward
Outlook for the Future
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Accept that the environment has
profoundly changed
Promote understanding of internal control
within the organization
Factor into your business model the cost
of developing an internal control program
Monitor developments and refinements in
the Regulators standards
Understand the limits of internal control
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