In the late 1990’s, internet companies experienced a booming period with their stocks soaring. Nextcard was one of these companies that saw overnight success, generating massive wealth. However, unlike brands like eBay, Yahoo, and Monster, Nextcard did not survive the stock market crash due to their lack of transparency regarding their financial status. As a result, the Federal Deposit Insurance Corporation (FDIC) took over Nextcard.
When an unqualified opinion was issued for a company being investigated for issuing materially misstated financial statements, it caused an audit partner from Ernst & Young (E&Y) to make unethical decisions in order to conceal the situation. In response to the uncovering of multiple fraudulent instances, the American Institute of CPAs (AICPA) and Public Company Accounting Oversight Board (PCAOB) have implemented standards and a code of conduct to prevent such unethical behavior.
To discuss the possibility of public accounting firms manipulating audit work papers and records of clients engaged in fraudulent activity, it is important to consider the oversight provided by the PCOAB and the AICPA Code of Conduct. Personally, I do not believe that even with the presence of PCOAB and the AICPA code of conduct, complete elimination of manipulation of audit work papers is achievable. The PCOAB Audit Standard No. 3 defines the requirements for retention of audit papers, including specifying the responsible entities, duration, and the scope of papers to be retained by the auditing firm.
If there is a need for more documentation related to the audit papers, article 16 explains that changes can be documented. It states that in specific situations, additional information may be included in the audit documentation after the report release date. However, it is essential to not delete or discard the existing documentation after the completion date. The added documentation should specify the date of addition, the preparer’s name, and the reason for inclusion. (Public Accounting Oversight Board, 2004-06)
However, even when the PCOAB reviews the firm’s audits, they may be able to verify if changes are documented, but they are depending on the honesty of the audit firm to guarantee ethical practices. The AICPA also depends on voluntary cooperation, peer, and disciplinary proceedings to prevent any manipulation of client work papers and records. The AICPA Section 54 – Article III – Integrity emphasizes that in order to enhance public trust, members should carry out all professional duties with utmost integrity. (American Institute of CPAs)
The AICPA and most state societies have established the Joint Ethics Enforcement Program (JEEP), which handles complaints by responding, investigating, and concluding the investigation. While this program does impose penalties on those who violate conduct, it also provides the offender with the opportunity to take corrective action. If the offender chooses corrective action, the investigation and its findings remain confidential, thus resulting in minimal deterrence against violations.
I think that SOX Section VII will discourage certain types of fraud by criminalizing the alteration or destruction of audit documents and providing protection for whistleblowers. However, since it depends on the voluntary cooperation of standards and codes, it may assist in preventing, but not completely eradicating, the manipulation of client work papers and records. Analyzing fraud risk factors is a crucial aspect of any audit.
Analyze the fraud risk factors discussed during the 2000 Nextcard audit and their impact on the audit procedure. According to the appendix to SAS No. 99, there are three fraud risk factors: Incentives/Pressures, Opportunities, and Attitudes Rationalization. In the case of Nextcard, the managers felt a strong incentive and pressure to rapidly expand the company. One of the founders, Lent, had a specific goal of acquiring over 1 million credit card customers.
To meet Lent’s objective of extending over $1 billion in credit, a significant amount of credit was extended. This should have raised concerns for the audit team, as such a large extension of credit would require close examination of the allowance for bad debts account to ensure accurate posting of the appropriate amounts. Additionally, Nextcard had an opportunity to manipulate the account and potentially misrepresent it.
According to the case, Nextcard had graphs and charts that showed problems, but because the audit partner gave an unqualified opinion, users of the financial statements were unaware of these issues, resulting in a continued rise of Nextcard’s stock prices. It was inappropriate to give an unqualified opinion if there were signs of problems. This could have occurred because the audit partner was on a fast track and the senior auditor had limited auditing experience. The third factor is attitude and rationalization.
The Nextcard managers may have used various justifications. It is clear that they wanted to become the biggest credit card company, so they might have thought that the company could make profits. Alternatively, they might have believed that they deserved the money or that it wasn’t their fault if many customers didn’t pay back what they owed. Regardless of the specific reasoning, it was important for the audit team to fully understand where management stood ethically. This was necessary to determine if fraud was possible for them. Financial investors rely on a company’s financial statements being accurate and count on external auditors to ensure there are no major misrepresentations in these statements.
Discuss how Ernst & Young’s motivation to destroy audit work papers in the Nextcard case aligns with its duty to provide assurance to financial investors. The case clearly reveals signs of issues with Nextcard’s charge-off numbers and trends. This becomes evident when Trauger instructs Mullen to remove problematic charts, parts of tables, and discussion sections.
Trauger wanted to delete the information because if the SEC or the public discovered that E&Y had knowledge of the problems with the charge-off numbers, they would question why an unqualified opinion was given. By altering the documentation, it would create the perception that E&Y found nothing during the audit, thus justifying the unqualified opinion and maintaining trust from the investing public. Ethics can be subjective, and individuals may approach ethical dilemmas differently when deciding how to address them.
Imagine yourself as Oliver Flanagan in the scenario where Robert Trauger requests your assistance in modifying the 2000 Nextcard audit work papers. Describe the actions you would have taken in response to this request and explore other possible courses of action. It is crucial to consider various steps to ascertain the most ethical approach when faced with a dilemma.
- Identify the issue.
- Identify the affected parties and their rights.
- Determine the most important rights.
- Develop alternative courses of actions. Determine the likely consequences for each course of action. Asses the possible consequences, the greatest good for the greatest number of people.
- Decide on the appropriate course of action. If this was me I feel that under no circumstances would I have altered the records. Depending on the situation I may or may not have reported Trauger. The circumstances dictating my decision would be if I felt I could go to another audit partner.
If I believed that Trauger was less ethical than the other partners, I would have reported him. If not, I would have sought alternative employment or potentially reported him to an authoritative agency. Depending on how threatened I felt, I might have even consulted with a lawyer to understand my legal obligation to report. Regardless, altering the documents was not the right ethical choice as it caused harm to many individuals. Therefore, I believe it was best to refrain from altering the documents for the greater good.
The task required searching the Internet for a public accounting firm that has recently engaged in the destruction of audit evidence related to a client. The objective was to identify said firm and evaluate the punishment they received for violating the Professional Code of Conduct. In order to determine whether the severity of the punishment was appropriate, an assessment was conducted. Unfortunately, no current case of a public audit firm destroying audit evidence could be found. However, it is worth mentioning the case of former Skamania auditor, Garvison, who misused thousands of dollars in public funds through unauthorized travel, education expenses, and obtaining office equipment. It should also be noted that this individual shredded key documents.
Gavison was sentenced to 168 hours of community service and a restitution payment of $62,000 to the county. Additionally, he was permanently banned from holding any governmental finance management position. Many citizens believed that the punishment did not adequately match the severity of the crime. However, since no evidence was found proving that Gavison embezzled money, I believe that the punishment was appropriate. He was required to repay the unauthorized funds and is now permanently restrained from obtaining a position where he could potentially commit the same crime again.
If this were a public accounting firm, the destruction of documents could be deemed a felony. Nextcard executives achieved millionaire status by misrepresenting the financial state of the company, leading to an inflated stock price. They deceived investors into believing that the company’s outstanding debts were significantly lower than they truly were and that the company would swiftly generate substantial profits. Thanks to the complicity of an audit firm willing to provide an unqualified audit opinion, they successfully concealed the truth.
The AICPA and PCAOB established standards and a code of ethical conduct to ensure auditors’ ethical behavior, resulting in the payment of 1.4 million in fines and other monetary damages.
References
- American Institute of CPAs. (2006, June 19). Appendix to SAS No. 99, Fraud Risk Factors. Retrieved October 28, 2012
- American Institute of CPAs. (n. d. ). ET Section 54 – Article III – Integrity. Retrieved October 28, 2012,
- Joint Ethics Enforcement Program (JEEP) Manual of Procedures. Retrieved October 28, 2012, from AICPA: http://www. aicpa. org/InterestAreas/ProfessionalEthics/Resources/EthicsEnforcement/Pages/jointenforceprocedures. aspx
- Knapp, Rittenberg, Johnstone, & Gramling. (2012). Contemporary Auditing. Mason : Cengage Learning.
- McVicker, L. (2012, October 25). Former Skamania auditor pleads guilty. Retrieved October 28, 2012, from The Columbian: http://www. columbian. com/news/2012/oct/25/former-skamania-auditor-pleads-guilty/
- Pennsylvania Institue of Certified Pulblic Accountants. (n. d. ). Joint Ethics Enforcement Program (JEEP). Retrieved October 28, 2012, from PICPA: http://www. picpa. org/Content/Resources/Ethics/JEEP. aspx
- Public Accounting Oversight Board. (2004-06). Auditing Standard No. 3. Retrieved October 28, 2012, from PCOAB: http://pcaobus. org/Standards/Auditing/Pages/Auditing_Standard_3. aspx#retentionandsubsequentchanges
