The Internal Control Environment - Research Proposal Example

Requirement The Committee of Sponsoring Organizations of the Treadway Commission (COSO) came into being in the year 1985 in response to increased financial reporting on the part of United States' corporations. The Treadway Commission was basically formed to support the National Commission on Fraudulent Financial Reporting, which was supposed to study the causes of misrepresentation in financial statements and provided recommendations to both companies as well as independent auditors. The Treadway Commission was formed as an independent privately held organization destined to work for the purpose of preventing the financial reporting fraud. The COSO issued a report named "Internal Control-Integrated Framework" in the year 1992, which stated five components as follows (Biegelman para.12): 1- The control environment 2- Risk assessment 3- Control activities or policies 4- Information and communication by management 5- Monitoring The internal control environment makes the organization aware of the control process and provides a structure in which it is supposed to be carried out (Biegelman para.12). This component serves as the basis for the rest of the internal control components. The major elements of this component include corporate ethics, moral values, style of management, delegation of authority within the organization and most importantly, people management (Committee of Sponsoring Organizations). This relates to TPC in the way that the company needs to create an internal control environment through effective people management and keeping the whole organization aware about the internal control structure. Risk assessment is the component which enables the management to assess and analyze the risk associated with accomplishment of objectives (Biegelman para.12). As in TPC, the elements of risk assessment includes an analysis of all three divisions and realizing the sources which could probably lead to control failure. For this purpose, TPC must set an internal control objective and then figure out the causes which would lead to deviations from the objective. The third component includes control activities or policies to create and implement strategies throughout the organization that ensures that objectives of internal control and minimization of risk would be achieved (Biegelman para.12). The major elements of this component are verification, performance reviews and separation of responsibilities etc. At TPC, this component involves implementing strategies and policies at headquarter as well as the three separate divisions. These policies might include a thorough system of performance measurement as well as control procedures (Committee of Sponsoring Organizations). The fourth component of internal control refers to management information and communication which entails communicating with employees on the internal control objectives as well as procedures and to instigate their efforts in meeting the goals (Biegelman para.12). TPC needs to enhance communication and information system among all the three divisions so as to ensure that the objective is communicated all over the organization. The fifth and last component of internal control refers to monitoring which involves overseeing the whole internal control process and procedure to know if the process is carried out as planned and proceeding towards the desired objectives. The TPC's management as well as independent auditors could keep check over the proceeding of control procedure in the organization and achievement of internal control objectives (Biegelman para.12). Reference List Biegelman, Martin T. Designing a Robust Fraud Prevention Program (2004). Association of Certified Fraud Examiners ACFE. Retrieved January 29, 2007 from the World Wide Web: http://www.acfe.com/fraud/view.aspArticleID=239 Committee of Sponsoring Organizations of the Treadway Commission. Wikipedia. Retrieved January 29, 2007 from the World Wide Web: http://en.wikipedia.org/wiki/Committee_of_Sponsoring_Organizations_of_the_Treadway_Commission Requirement 2: According to AICPA standards, a standard unqualified audit report should contain the following parts (AU Section 508, 2006): Title Introductory paragraph Scope paragraph Opinion paragraph The introductory paragraph includes the identification of financial statements audited by the auditors, a statement in which the auditor associates the responsibility of financial statements with the company's management and renders him or herself responsible for the expression of audit opinion. The scope paragraph includes elements such as a statement which confirms the compliance of audit with the Generally Accepted Auditing Standards. The same paragraph should also include a statement that states that the audit was planned and performed to obtain reasonable assurance that the financial statements are free of material misstatement. This paragraph also includes a statement stating that all amounts and disclosures in the financial statements were supported with evidence along with examination on test basis, a statement saying that the audit assesses the accounting principles used and significant estimates made by the management and a statement that mentions that the audit evaluates the overall financial statement presentation. This should also accompany a statement mentioning that the auditor believes his audit provides a reasonable basis for his or her opinion (AU Section 508, 2006). The final part of the audit report is the opinion paragraph which states if the financial statements present fairly, in material respects, the financial position of the company in consideration. Then, the audit report contains sign of the auditor and the date of audit (AU Section 508, 2006). When TPC's management restricted the auditors by not allowing them to confirm the raw material receivables", the auditor can give a qualified opinion according to the AICPA standards (para. 20a). The auditor should use the words "Except for" or "Except as" to refer to the event that rendered him incapable to give an unqualified opinion. The auditor can include a statement in his audit report preceding the audit opinion viz. "We were unable to confirm the raw material receivables stated at $_________ and $_________ at December 31, 2004 and 2005, which is included in the current assets of the company's balance sheet for the year then ended, as explained in the Note X of the financial statements." In the audit opinion also, the auditor should mention the words "Except for the effects of" before expressing the audit opinion (AU Section 508, 2006). In case of valuation of fixed assets at their replacement cost, the auditor can give a qualified opinion in the audit report. According to AICPA, he should mention the deviation from US GAAP in the paragraph preceding the audit opinion. The auditor can use these words "The company has valued its fixed assets at replacement cost, which in our opinion, should be valued at acquisition cost in order to conform with the accounting principles generally accepted in the United States. If these were valued at acquisition cost, the fixed assets would be decreased by $_________ and consequently the net asset in balance sheet will decrease by $________ for the year then ended." The words "except for the effects of" should also precede the audit opinion (AU Section 508, 2006). An auditor needs to be independent from the company's board of directors. GAAS requires that "In all matters relating to the assignment, an independence in mental attitude is to be maintained by the auditor or auditors" (Generally Accepted Auditing Standards, 2006, p. 81). The auditor does not qualify for expressing the audit opinion if he is not able to conduct the audit independently (AU Section 508, 2006). Reference List AU Section 508 Reports on Audited Financial Statements (June, 2006). AICPA. Retrieved January 29, 2007 from the World Wide Web: http://www.aicpa.org/download/members/div/auditstd/AU-00508.PDF Generally Accepted Auditing Standards (June, 2006). AICPA. Retrieved January 29, 2007 from the World Wide Web http://www.aicpa.org/download/members/div/auditstd/AU-00150.PDF Requirement 3: As an unqualified report refers to the auditors' belief that the company's financial statements truly and fairly represent its position and performance, it is best report the company's management can desire to receive from the auditor. There can be several cases (AU Section 508, 2006) that prevent an auditor to give a true and fair view or an unqualified opinion on a company's financial statements. An auditor cannot give an unqualified opinion in the cases like: When the auditor is not able to access or obtain appropriate evidence to support the financial information presented by the management. In this case the auditor can give a qualified opinion . When the financial information exhibit any deviation from the US Generally Accepted Accounting Principles. In this case the auditor can give a qualified opinion. When the financial statements of a company, as a whole, are not presented in compliance with the US GAAP. Here, an auditor would give an adverse opinion. When the available information and evidences are so insignificant that the auditor feels incapable of forming any opinion with regard to the audit. In such a situation, the auditor would give a disclaimer of opinion. It is the utmost responsibility of TPC's management to ascertain that auditor does not face any difficulty in forming the audit opinion. The management can do the following things to ensure an unqualified opinion from the auditors' side: Before the external audit, the company should be prepared to undertake an audit of financial statements From the very beginning, compliance with the US GAAP standards should be ensured in organization for the purpose of accounting record keeping as well as the statements. The internal control system of the company should be very efficient and effective in minimizing the extent of departures from accounting standards or principles. The objective of receiving an unqualified report from the auditor should be communicated to different organizational levels so as to ascertain compliance with accounting standards and principles from the outset. The internal auditors should make a point to figure out and correct any deviations from the US GAAP in the accounting records and financial information. TPC should avoid hiring an external auditor having close relationships with any of the top managers or members of board of directors. The management should, in all respects, endeavor to present the financial information and statements with integrity and professionalism. Any efforts to misrepresent the true and fair position of the company might lead to a qualified or even adverse audit report. The management should make available all the evidences the auditor might need to support the information provided in the financial statements. The auditor should also be provided an ability to physically inspect and count inventories etc if considered important. Management should also endeavor to cooperate with the auditor at all levels. If the auditor figures out any departures from US GAAP or any misstatements in the financial statements, the management should show willingness to make changes. Reference List AU Section 508 Reports on Audited Financial Statements (June, 2006). AICPA. Retrieved January 29, 2007 from the World Wide Web: http://www.aicpa.org/download/members/div/auditstd/AU-00508.PDF Requirement 4: Like all other business professionals, auditors might also face ethical dilemmas in providing their opinion on a company's financial statements. It is thus very important to understand the term 'ethics' before analyzing the ethical dilemma that an auditor might face. Mintz delineates that "ethics refers to standards of conduct that indicate how one ought to behave based on specific values and moral duties and virtues arising from principles about right and wrong" (1995, p. 251). Ethics or code of ethics, therefore, largely depends upon the auditor's moral as well as his or her professional and ethical values. In order to analyze the ethical dilemmas, the following six-step strategy can be used: 1- The issues that could lead the auditor to face ethical dilemma are: - A client company might ask the auditor to forego his or her integrity and independence by threatening to seek a new auditor unless an unqualified opinion is issued. - A conflict of interest between the auditor and the management may occur in the case when a client company's top managers are not willing to disclose a particular item in the financial statements which is necessary to be reported. - A client company might obstruct the auditor's independence by not allowing him to conduct appropriate inspection and examination. - The auditor was a relative of one of the directors of the client company and is not independent in giving the audit opinion - An auditor faces an ethical dilemma when he has to choose between his loyalty with the management and the public in the cases when disclosure of an item debilitates the position of management. 2- Mintz (1995) suggests that virtues enable an auditor to analyze the ethical dilemma that come up in the course of his or her profession. Besides these also empower the auditor to resolve the conflicting ethical issues in the best possible manner. He says that the auditor's virtues depend on his integrity, independence and also loyalty with the management as well as the general public. When an auditor confronts conflicting ethical issues as to loyalty with the management and public, for example pressures from a client company's CEO to exclude an important item from the financial reporting, the auditor should place his professional virtues at the top. The three ethical issues that the auditor might confront with respect to the above facts are (Code of Ethics and Auditing Standards): - Independence: The auditor might confront with the ethical dilemma of not being able to provide the professional audit opinion due to increased pressure, close association or relationship with management. - Integrity: The management might try to influence the auditor's opinion through various means. However, according to the auditing professional Code of Ethics, an auditor should always maintain highest levels of integrity and honesty. - Competence: The standard Code of Ethics for auditing profession suggests that an auditor should always perform his duties in the light of his professional qualification. Partiality in any form is not acceptable. 3- These ethical dilemmas bear the capability to affect many groups concerned with the financial statements and financial information presented by TPC. - Shareholders, creditors and customers are all highly interested in the information presented in any company's financial statements. The financial statements go a long way in influencing the decisions of these groups. These ethical dilemmas might mislead the shareholders, creditors and customers and cause them great financial loss. - Top managers need financial information for critical internal decision making. They expect audited financial statements to be providing right information. These ethical dilemmas can also affect the decisions taken by top management and thus cause severe losses to the company. - Finally, the group that will be affected with these ethical dilemmas is the auditing profession. It should be noted that general public and government expect the auditors to provide financial information with integrity. If the auditors do not follow the code of ethics necessary to carry out the audit, they would lose confidence and trust in auditing profession, which will badly hurt the reputation of all the auditors. 4- The alternatives available to an auditor in such a situation is: - Consult with the management team and educate them on the importance of disclosing the information. 5- If the auditor gives an opinion based on integrity and honesty, he will comply with the standards of Code of Ethics and the users of financial statements would not be misguided. 6- The appropriate action in this case would be most likely to resolve the issues with management and provide consultation. However, if it does not reap any benefit, the auditor should perform his duty and give an opinion with full integrity. To conclude it would be worth noting that auditors should consider their moral and ethical duties as a crucial aspect of audit. Certain situations might take place leaving the auditor into ethical dilemma concerning the integrity, confidentiality, objectivity and independence of the audit. However the auditor should consult the code of ethics in order to resolve the issue and arrive at the best possible decision. The users of financial statements trust the opinion mentioned in the audit report therefore it is an auditor's foremost duty to always put the interest of users above that of the management and ascertain the reliability financial statements. Reference List Code of Ethics and Auditing Standards. INTOSAI. Retrieved January 29, 2007 from the World Wide Web: http://intosai.connexcc-hosting.net/blueline/upload/1codethaudstande.pdf Mintz, S. M. (1995), Virtue Ethics and Accounting Education, Issues in Accounting Education, Sarasota: Fall, 10(2), pp. 247-267 Read More