Practice ch. 3,4, & 8

Fraud

a deliberate misrepresentation to gain an advantage over another party (or have them do something they might not ordinarily do)

What are the different forms of fraud?

Fraud in the financial statements, the misappropriation of assets (theft), subsequent cover-up, and disclosure fraud

Asset Misappropriation Schemes

when an employee steals or misuses resources, such as charging personal expenses to the company card while traveling on business trips

Corruption Schemes

include misusing one's position or influence in an organization for personal gain

What was the most commonly reported detection method in the 2016 Association of Certified Fraud Examiners (ACFE) survey?

a tip (43% reported)

What was the most common disciplinary action taken in occupational fraud cases?

termination (66%)

Fraud red flags include:

- living beyond means (42%)

- financial difficulties (26%)

- unusually close association with vendor/customer

- control issues, unwillingness to share duties

- no behavioral red flags

- "wheeler-dealer" attitude

- irritability, suspiciousness, or defensiveness

- divorce/family problems

- addiction problems

- complained about inadequate pay

- excessve pressure from within the org

- refusal to take vacations

- past employment-related problems

- social isolation

- past legal problems

- complained about lack of authority

- excessive family/peer pressure for success

- other

- instability in life circumstances

According to the Association of Certified Fraud Examiners (ACFE) Study

payroll schemes accounted for 9% of the asset misappropriations, had a median cost of $62,000, and lasted a median of 2 years before being detected

Factors that discourage the reporting of fraud, according to report by the Anti-fraud collaboration, include:

- poor tone at the top

- dominating and intimidating personalities

- mistrust

- excessive team loyalty

- management doesnt want to hear about problems

- a lack of sound policies and procedures

- the perception that wrongdoing will not be addressed if misconduct is reported

Factors that discourage employees from coming forward include:

- fear of the unknown

- fear that the report will not be handled anonymously or confidentially

- fear that the reporters identity will be revealed to other in the organization

- concern that the person perpetrating the misconduct will not be held responsible

What are the potential consequences for reporting suspected fraud?

- retaliation by coworkers

- termination

- future reputation

- impact on others

- results of investigation determine that the misconduct unsustainable

- emotional cost

Financial Statement Fraud

occurs when an employee, typically a member of top management, causes a misstatement or omission of material in the organization's financial reports

What are some examples of financial statement fraud?

recording ficticious revenues, understating reported expenses, artificially inflating reported assets, failing to accrue expenses at the end of the year, and accelerating the recording of revenue into an earlier period (timing differences)

What are the elements of the fraud triangle that explain why financial statement fraud occurs?

situational pressure, perceived opportunity, and rationalization

What does the organizations culture represent?

"how we do things around here"

What does the ethical culture represent?

"how we do things around here in relation to ethics and ethical behavior in the organization"

Ethical Collapse (according to Marianne Jennings)

"occurs when any organization has drifted from the basic principles of right and wrong"

Who wrote "The 7 signs of Ethical Collapse"?Signs

Marianne Jennings

What are the 7 signs of ethical collapse?

1) pressure to maintain numbers

2) fear and silence

3) young'uns and a bigger than life CEO (loyalty to the boss)

4) weak board of directors

5) conflicts of interest overlooked or unaddresses

6) innovation like no other company (sometimes too much)

7) goodness in the some areas atones for evil in others

Ethics Resource Center (ERC)

the oldest nonprofit advancing high ethical standards and practices in public and private institutions

Ethics Compliance and Officer Association (ECOA)

a memeber driven association for practitioners responsible for their organization's ethics and compliance programs

What two programs joined together to form the ECI (Ethics Compliance Initiative)?

ERC (Ethics Resource Center) and ECOA (Ethics Compliance and Officer Association)

Ethics Compliance Initiative (ECI)

provides leading ethics and compliance research and best practices, networking opportunities, and certification to its membership (the go-to organization for ethics and compliance resources in the workplace)

What 5 factors separate the "good" from the "great" compliance programs?

1) tone at the top

2) corporate culture

3) risk assessments

4) the CCO (Chief Compliance Officer)

5) testing and monitoring

Who stated that "integrity has no need of rules"?

Albert Camus

What were the key findings found in KPMG's Integirty Survey in 2013?

- Nearly 3 out of 4 employees reported that they had observed misconduct within their organizations in the previous 12 months

- more than 1/2 of the employees reported what they observed could potentially cause a significant loss of public trust if discovered

- some of the driving forces behind fraud and misconduct in the corporate environment included pressure to do "whatever it takes" to meet targets, not taking the code of conduct seriously, believing employees will be rewarded based upon results and not the means used to achieve them, and fear of losing one's job for not meeting performance targets (64% reported the root cause of misconduct was the pressure to do "whatever it takes")

- nearly 1/2 of the employees were uncertain that they would be protected from retaliation if they reported concerns to management. And more than 1/2 suggested a lack of confidence that they would be satisfied with the outcome

- Ethics and compliance programs continue to have a favorable impact on employee perceptions and behaviors

According to KPMG's survey in 2013, what would employees do if they observed a violation of their organization's standard conduct?

- 78% would notify their supervisor or manager

- 54% would try to resolve the matter directly

- 53% would call the hotline

- 26% would notify someone outside of the organization

- 23% would look the other way or do nothing

National Labor Relations Act

protects the rights of employees to act together in a concerted manner to address conditions at work, with or without a union

Internal Mechanisms

help manage, direct, and monitor the corporate governance activities to create substainable stakeholder value

What are some examples of internal mechanisms?

the board of directors (particularly independent directors), the audit committee, management, IC, and the internal audit function

External Mechanisms

intended to monitor the company's activities, affairs, and performance to endure that the interests of insiders (management, directors, and officers) are aligned with the interests of outsiders (shareholders and other stakeholdders)

What are some examples of external mechanisms?

financial markets, state and federal statutes, SEC regulations, court decisions, and shareholder proposals

Due Care

provides that a director or officer act in good faith, exercise the care that an ordinarily prudent person would exercise in similar circumstances, and act in a way that is considered to be in the interests of the corporation

Duty of Loyalty

requires faithfulness; a director must place the interests of the corporation ahead of their personal interest

Good Faith

requires an honesty of purpose that leads to caring for the well-being of the constituents of the fiduciary

Business Judgement Rule

a corporate director or officer may be able to avoid liability to the corporation or to its shareholders for poor business judgements

To obtain the business judgement rule's protection:

- directors must be independent and disinterested as to the matter acted upon

- director must act with due care and in good faith

- the burden of proof is on the party challenging the board's decision, to establish facts rebutting the presumption in favor of upholding the decision

Chancery Court

The preeminent forum for the resolution of commercial business litigation matters, including the duties of officers and directors

What is the foundational purpose of the chancery court?

to be an equity court - to provide relief suited to the circumstances when no adequate remedy is available at law

What was the characterization of corporate governance provided by Ferrell et al?

"Accountability aligns with how closely workplace decisions align with a firm's strategic direction and it compliance with ethical and legal consideration. Oversight provides a system of checks and balances that limit employees and managers opportunities to deviate from from policies and strategies aimed at preventing unethical and illegal activities. Control is the process of auditing a improving organizational decisions and actions"

The role of corporate governance systems is to:

- maximize shareholder wealth

- represnt all stakeholders

- stewardship function - fiduciary duty of managers

What is an example of corporate governance oversight and regulation?

to appoint nonexecutive (members of the board who are not apart of the executive team) directors to the audit committee

Public companies in the US that list their equity securities on the New York Stock Exchange (NYSE) or the Nasdaq Stock Market are required to have in place a board of directors with:

- independent directors must comprise a majority of the board

- company must have a minimum three-member audit committee composed of entirley independent auditors

- the audit committee must meet the requirements enumerated in Sec 301 of SOX and the Securities Exchange Acts Rule 10A-3(b)(1)

- SEC regulation S-K required disclosure in annual reports whether or not the audit committee includes at least one "financial expert"

What are the key audit committee responsibilities?

- to meet at least annually with the independent auditor and review the audit report describing independent auditors internal quality control procedures

- to discuss all relationships between the independent auditor and the company and to enable assessment of the auditors independence

- to discuss earnings, press release, and financial information and earnings guidance given to analysist and rating agencies

- to discuss policies with respect to risk management and risk assessment

- to meet separately, from time to time, with management, with internal auditors, and with independent auditors

- to reveiw with the independent auditor any audit problems or difficulties and management's response to such issues

- to report regularly to the board of directors

- to evaluate the work of the audit committee annually

Corporate Social Repsonsibility

refers to the ethical expectations that society has for business, ethical repsonsibilities are those things that we ought to, or should do, even if we prefer not to

Corporations have an ethical responsibility to prevent harm such as:

sexual harassment, other forms of discrimination, and workplace safety

What are the forerunners of conscious capitalism?

sustainability and the triple bottom line

Sustainability

describes the ability to maintain various systems and processes - environmentally, socially, and economically - over time

Triple Bottom Line

the three aspects of sustainability, the three P's (people, planet, and profit)

What three broad areas does the triple bottom line describe the scope of reporting in?

economic, ecological, social

According to the CSR study, how many millennials on average would switch brands to one associated with a cause?

9 out of 10

Millenials are very passionate about social causes, they are prepared to make personal sacrifieces to make an impact on issues they care about such as:

- paying more for a product

- sharing products rather than buying new

- taking a pay cut to work for a responsible company

What is the main difference between concsious capitalism and CSR?

conscious capitalism is a more comprehensive and holistic approach

What are the 4 guiding principles of conscious capitalism?

1) Higher Purpose - while profits are essential for a sustainable business, conscious capitalism focuses on purpose beyond profit

2) Stakeholder Orientation - concentrate on optimizing equal values for all stakeholders

3) Conscious Leadership - embrace the company's purpose, create value for all stakeholders, and inspire actions that contribute to a conscious culture

4) Conscious Culture - contribute to a culture of trust, care, cooperation among the company's employees, and all other stakeholders

Economic Model of CSR:

- business's sole social responsibility is to fulfill the economic functions they were designed to serve

- managers must work to further the owner's interests

- dominant model of CSR

- places shareholders at the center of the corporation

- ethical responsibility is to serve those shareholders

- argued for by Milton Friedmen as the one and only social responsibility of business

Stakeholder Model of CSR:

stakeholder orientation is the degree to which an org understands and addresses stakeholder demands, consist of:

- generation of data about stakeholder groups and assessment of the firm's effects on these groups

- distribution of this information throughout the firms

- the responsiveness of the organization to this information

Sec 301 of SOX

• Independent audit committee 

• Receives whistleblower complaints

Sec 302 of SOX

Certification of financial statements by CEO & CFO 

Sec 404 of SOX

External auditor report on management assessment of effectiveness of internal controls  

Sec 406 of SOX

Code of ethics for financial officers 

Sec 806 of SOX

prohibits retaliation against whistleblowers

Sec 906 of SOX

• Written statement by the CEO and CFO about compliance with the SEC reporting requirements: financial statements present, in all material respects, the financial condition and results of operations 

What kind of access should internal auditors have to the audit committee?

direct and unrestricted

Internal Auditors:

- monitor corporate governance activities and compliance with organization policies

- review effectiveness of the organization's code of ethics and whistle-blower provisions

- assess audit committee effectiveness and compliance with regulators

- considered the "eyes and ears" of audit committee

- oversee IC and risk management processes

External Auditors

- have an obligation to the public interest that underlies their corporate governance repsonsibilities

- protects the interests of shareholders

- conduct audits independent of any influence of management or the company

- ensure accountabiltiy for the financial reporting process

- communicate effectively with the audit committee ; accounting policies and procedures, estumates by management, quality of financial reporting, and personal violations of laws

Internal Controls:

- prevent and detect errors and fraud

- ensure that management policies are followed

- can be overridden by top management

COSO Framework

emphasizes roles of board of driectors, management, internal auditors, and personnel

COSO is designed to provide reasonable assurance to achieve:

- effectiveness and efficiency of operations

- relability of financial reporting

- compliance with laws and regulations

What are the 5 componenets of the COSO framework?

1) control environment

2) risk assessment

3) control activities

4) monitoring

5) information and communication

Control Environement

sets the tone of the organization; it is the foundation for all aspects of internal controls

Risk Assessment

the entitiy's identification and evaluation of how risk might affect the achievement of objectives

Control Activities

strategic actions established by management to ensure that its directives are carried out

Monitoring

The process that assesses the efficiency and effectiveness of internal controls over time

Information and Communciation

these systems provide the information in a form and at a time that enables people to carry out their responsibilities

Internal Control weaknesses:

- an effective system of IC is critical to establish an ethical corporate culture that should be supported by the tone at the top

- an IC system, no matter how well conceived and operated, can provide only reasonable - not absolute - assurance to management and the board of directros regarding achievement of an entitiy's objectives

- management override of IC may be a problem

What are the four elements of the whitsleblowing process?

1) the whislteblower

2) the act or complaint

3) the party whom the complaint is made about

4) the organization involved in the complaint

Organizational Dissidence

similar to civil disobedience, the whistleblower laws protect employees who provde information on a fraud against retaliation

Autonomy

means to act according to reasons and motives that are taken as one's own and not the product of policies, laws, etc.

Who considers whistleblowing to be morally required when it is required at all

Michael Davis

What 5 criteria does DeGeorge identify that morally permit whistleblowing?

1) the firms actions will do serious and considerable harm to other

2) the whistleblowing act is jsutifiable once the emoloyee reports it to her immediate supervisor and makes her moral concerns known

3) absent any action by the supervisor, the employee should take the matter all the way up the board, if necessary

4) documented evidence must exist that would convince a reasonable and impartial observer that one's view of the situation is correct and that serious harm may occur

5) the employee must reasonably believe that going public will create the necessary change to protect the public and is worth the risk to oneself

Retaliatory Climate

primary barrier to blowing the whistle on corporate wrongdoing in the organization

Organizations Ethics Officer

ensures that the organization is in compliance with the laws and regulations, including SEC securities laws, SOX, and Dodd-Frank

Dodd-Frank Wall Street Reform and Consumer Protection Act (2010):

- established benefits for whistleblowers who aid in recovery of $1 million or more and they can receive 10-30% of the recovery

- defines a whistleblower as any individual who voluntarily provides infomrtaion to the SEC relating to a violation of federal securities laws

- creates the concern of whether individuals will want to go external rather than internal with their information in order to receive a reward

- sets aside the confidentiality requirement

Why are internal accountants excluded from receiving whistleblower awards under Dodd-Frank?

because they had a pre-existing legal duty to report the wrongdoing

Internal accountants are eligible to become Dodd-Frank whistleblowers if:

- disclosure to the SEC is needed to prevent "substaintial injury" to the financial interest of an entity or its investors

- the whistleblower "reasonably believes" the entitiy is impeding investigation of the misdonduct (destruction of evidence etc.)

- the whistleblower has first reported the violation internally and at least 1230 days have passed with no action

Process in deciding to report fraud:

- whether the violations have a material effect on the FS

- has management or the board taken action?

- if not, auditor must report to the board

What was the largest ever whistleblower award?

$50 million

Digital Reality Trust v Sommers:

- may drive would be whistleblowers to the SEC sooner

- may restrict reports because of fear of retaliation

- seems to contradict the need for internal reporting before going outside and reporting to the SEC

- may create unnessesary stress between accounting/compliance officials and top management

Erhart v Bofl Holdings:

- clarifies that employer confidentiality agreements fo not supersede federal whistleblower rirghts

- signals that relaitory lawsuits against whistleblowers are unlikely to succeed

- provides guidance to corporate whistleblowers concerning the use of company documents to blow the whistle

AICPA Revised Code: Independence for Members in Public Practice

- conceptual framework incorporates a "threats and safeguards" approach

- new section on "Ethical Conflicts"

- violaton of the rules for a CPA to permit others acting on his behalf to engage in behavior that would have been a violation for the CPA

- when differences exist between AICPA and those of the licensing state board of accountancy, the CPA should follow the state board's rules

AICPA uses risk based approach for analyzing threats using the following steps:

- identifying and evaluating threats to independence

- determining whether safeguards already eliminate or sufficiently mitigate identified threats and whether threats that have not yet been mitigated can be eliminated or sufficiently mitigated by safeguards

- if no safeguards are available to eliminate an unacceptable threat or reduce it to an acceptable level, indpendence would be considered impaired

Sec 201 of SOX states that the following nonattest services may not be performed for attest clients in addition to bookkeeping or other services related to the accounting records or financial statements of the audit client:

1) financial information systems design and implementation

2) appriasal or valuation services, fairness opinions, or contribution-in-kind reports

3) actuarial services

4) internal audit outsourcing services

5) management functions or HR

6) broker or dealer, investment advisor, or investment banking services

7) legal services and expert services unrelated to the audit

8) any other service that the board of directors determines, by regulation, is impermissable

What kind of relationships might impair independence?

financial relationships, business relationships, employment or association with attest clients, providing non-attest services to an attest client, nontraditional forms of ownership

Independence may be impaired when a partner or professional employee leaves the firm and is subsequently employed by the client in a key position unless the following is met:

- amounts due to the former professional are not material to the firm

- the former professional is not in a position to influence the accounting firm's operations or financial policies

- the former professional employee does not participate in or appear to participate in or is not associated with the firm once the relationship with the client begins

Attest clients must agree to perform the following functions:

- assume all management responsibilities

- designate a competent overseer of these services

- evaluate adequacy and results of services performed

- accept responsibility for the results of the services

3 principles that underlie auditor independence:

- an auditor cannot function in the role of management

- an auditor cannot audit their own work

- an auditor cannot serve in an advocacy role for their client

If a situation results in any of the following, the auditors independence may be impaired:

- creates a mutual or conflicting interest between an accountant and his audit client

- places an accountant in the position of auditing his or her won work

- results in an accountant acting as management or employee of the audit client

- places an accountant in position of being an advocate for the client

What actions did the SEC take against the big 4 audit firms?

PWC - violated independence rules when it performed restricted nonaudit services to audit clients

EY - audited partners engaged in personal relationships with client's CEO

KPMG - former partner engaged in insider trading of non-public information

Deloitte - deloitte manager maintained bank accounts with audit client

Using a materiality criterion to determine whether certain nonaudit services should be allowed opes a can of worms. Logical questions would be:

1) Is independence a standard left to the individual judgment of the auditors or is it based on SEC regulations and PCAOB standards?

2) Where do you draw the line in making materiality determinations?

Safeguards of integrity and objectivity include:

- implementing mechanisms to prevent disclosure or violation of confidentiality

- senior individual not involved in the engagement regularly reviewing safeguards

- member of the firm not involved in the conflict reviews the work performed to assess whether key judgements and conclusions are appropriate

- consulting with thirs parties, such as professional body, legal counsel, or another CPA