In the year 2002, the US reached a land mark decision when the Sarbanes Oxley act was finally affected into law which principally changed the way auditing and financial reporting was being conducted. This act was prompted by high level frauds that public companies engaged in with regard to financial reporting and auditing practices. The act therefore recommended the setting up of a Public accounting Oversight board which was mainly to conduct regulatory and supervisory roles in auditing public audit firms and individual auditors.
This was done through establishment of proper quality control measures on the work of auditors to minimize the audit risks that firms could face while conducting their work. The Ligand Pharmaceuticals case presents a perfect situation where the Sarbanes Oxley act was violated and required the enforcement of the law by the PCOAB. The questions that follow will therefore try to address the auditing provisions that were brought by the SOX, the role of the individual auditors and the audit firms under the new act, and the responsibility of PCAOB in enforcing the law. . Discuss the accounting standards and concepts that dictate the proper accounting of sales returns. Revenue recognition is one of the major problems that businesses normally face as there are many ways of recognizing revenues. They may include during production, when production is finished, at the point of sale, when cash is collected, and finally after the sale has been made. Most companies recognize revenues at the point of sale where there is transfer of ownership of the product from the seller to the buyer.
But at certain points, the sales are normally done with a right of return due to several reasons. This leads to the creation of sales returns which basically reduces the benefits of the sales process as the seller will be forced to refund the equivalent amount returned. According to SFAS 48, a specific process is used in recognizing revenues with the right of return. The amount of sales returns needs to be reasonably estimated and the transition must have a fixed sales price.
In addition, there are no contingent obligations relating to the seller. The buyer must have an independent obligation to complete the sales transaction and finally, the buyer if acquiring the product for resale has a substantial economic interest other than what is provided by the seller. The general rule however is that revenues are only recognized when realized and earned. (Norton, Diamond &Pagach, 2006). The Sarbanes Oxley act came up with changes that relate to internal control systems within the organization.
This was due to the fact that the GAAP revenue recognition policies vary from one company to another and hence there was need to establish a strong organizational structure that included the revenue recognition committee. This committee was to ensure that the company followed the revenue recognition policies that relates to that company. Their duties included ensuring compliance with revenue recognition policies, conducting reviews on significant transactions, supervising other departments with revenue recognition roles and training of other departments and sales team on the proper revenue recognition procedures. nysscpa. org) 2. Discuss how these accounting standards and concepts were violated by Ligand. The company did not meet all the conditions set out in revenue recognition and hence the earning process was not effectively completed. One major condition is that the products involved must be for resale and that realization and earning of the revenue can only be completed when all the goods have been sold by the buyers otherwise the company must provide allowance for the unsold goods. This is due to the fact that the goods could be returned and this can substantially reduce the company’s earnings.
In this case, the wholesalers had not sold all the goods. At the same time, the company did not know with certainty the amount of goods that could be returned. In this case, the conservatism principle could have been applied hence avoiding the recognition of revenues without providing appropriate allowances for the sales returns. 3. During the review of Ligand’s first-quarter financial statements for 2004, the Deloitte auditors learned that the company had significantly underestimated its future sales returns at the end of 2003. Discuss what responsibility, if any, this discovery imposed on Deloitte auditors.
The auditors normally have a duty to scrutinize the quality of earnings of the company as indicated by the financial statements to evaluate their sustainability. This should also include assessment of the financial reports and their conformity to the economic reality. According to the international standards on auditing 240, auditors have a responsibility to consider errors and frauds in financial statements. They also have a responsibility to critically look at the quality of the company revenues and gains with a view to identifying risk factors within the process. Pcaobs. org). Early recognition of revenues without following the due process set up by the accounting standards should raise alarm to the auditing officer. The auditors therefore have a responsibility to notify the client about any material errors in the financial statement that might affect the final outcome. Deloitte auditors did not however inform the clients and proceeded to give unqualified audit report. (Bragg,2010). 4. Since its inception, the PCAOB has been criticized by many parties. Discuss the principal complaints that have been directed at the PCAOB.
Since its inception in 2003, the PCAOB has done a tremendous job in its supervision and regulatory roles but this has not been without criticism by all major stakeholders. The organization has been under accusations over its inability to prevent audit failures especially from the financial service industry where most companies have had financial distress and gone under. Public accounting firms have also accused PCAOB of being very harsh in its reports done after inspections. They claim that the organization normally produces reports only after inspection of a few audit activities which cannot warrant the harsh assessments.
They therefore question the quality of the inspection reports that PCAOB normally generates. This claim has been in many occasions supported by third parties external to the accounting practice that accuse PCAOB of not being very comprehensive in their reports and at times does not give timely feedback on their inspection activities. 5. Discuss the measures that the PCAOB could take to improve its effectiveness and efficiency as a regulatory body. PCAOB has been accused of complacency and inability to conduct conclusive inspections of audit work by auditing firms.
There is therefore an urgent need for the body to increase its scope and level of operations to produce quality inspection work hence they need additional resources to facilitate them in this process. They must also engage all the stakeholders in the auditing fraternity to identify the best approach to inspection and also take note of the firms that exhibit a substantial risk in their auditing work. They also need to work closely with auditing firms and their clients to establish best procedures and strategies for conducting their work as well as share valuable information that can improve the quality of their inspection role.
Bragg,S.M.(2010). Wiley Practitioner’s Guide to GAAS 2011: Covering All SASs, SSAEs , SSARSs, and Interpretations. Hoboken, N.J. : Wiley ; Chichester : John Wiley [Distributor]. Bloch, G.D. (2003).”Sarbanes-Oxley’s Effects on Internal Controls for Revenue.” The CPA Journal. Retrieved March 11, 2011.From http://www.nysscpa.org/cpajournal/2003/0403/dept/d046803.htm. Norton, L.C, Diamond, A.M. ; Pagach, P.D. (2006).Intermediate accounting: Financial Reporting and analysis.2nd ed. Boston: Houghton Mifflin Co. Pcaobss.org(2004).” AU Section 561Subsequent Discovery of Facts Existing at the Date of the Auditor’s Report”Public Accounting Oversight Board.Retrieved March 11,2011. from http://pcaobus.org/Standards/Auditing/Pages/AU561.aspx.