Conflicts between Public Auditor and CFO on Internal Controls - Case Study Example

Inherent Conflicts Between the Public Auditor and the CFO on Internal Controls The case study analyses the potential and inherent conflicts that mayarise between an external auditor and the management, specifically the Chief Financial Officer of the company during the course of the audit. Moreover, the ways through which the potential conflicts can be mitigated are also discussed in detail. Introduction The internal controls of the company are seen as the “primary line of protection” in order to mitigate the insufficient governance and control of the financial reporting function as well as the detection and prevention of fraud activities. (Internal Audit Independence and Corporate Governance, 2003) The public auditor, whose primary job is to give an opinion on the financial statements of the company after necessary examination of the statements, also places his reliance on the internal controls established by the management of the company to prevent, detect and mitigate the events of frauds and errors which may lead to erroneous financial reporting and deception of the shareholders. This is the reason that the auditor lays great emphasis on the establishment of strong and well defined internal controls where the occurrence of material misstatements can be prevented, and if not, then properly detected and appropriate actions be taken to mitigate the same from occurring again. background In the course of the audit, the strong emphasis laid by the auditors on establishment of the internal control department may create conflicts between the auditor and the management of the company, specially the Chief Financial Officer. roles and resposibilities of auditor and chief financial officer The auditor and the CFO initially have their roles clearly defined as to the extent of their jobs and are required to work independently with clear objectivity without interference in each other’s work. Role and responsibility of auditor: The auditor’s responsibility is to report on the financial statements prepared by the management whether they are free from material misstatements and give a true and fair view. The auditor also has to report on the internal controls established by the management if they are organized enough to prevent and detect the frauds and errors. The auditor has to ultimately report to the shareholders on the safeguards established by the management to safeguard their rights. Role and responsibility of CFO: Conventionally, the role of the CFO is understood to be in the position of manager and regulator concerning the implementation of principles of accounting. Further, the post of the CFO also includes the preparation of the financial statements and related reports along with the supervision of the capital structure of the company as well as taking of major financial decisions in the best interest of the company. Ultimately, the CFO has to report to the Board of Directors who have empowered the CFO to carry out the tasks that he has undertaken to do. the inherent conflicts There can be numerous inherent conflicts between the Chief Financial Officer and the auditor with regards to the internal controls. Costs involved in the establishment of internal controls The auditor emphasizes on the establishment of the internal controls such that the hectic exercise of the audit can be reduced with respect to the audit of the financial statements by placing reliance on the effective internal controls established by the management of the company, especially the CFO. (Hoitash, 2007) The established of effective and adequate internal controls demands a handsome cost, such as the hiring of well trained personnel and usage of expensive and effective internal control programs such as the Information Technology related tools. The CFO and the management would stress on the auditor to use its skepticism in order to conduct the examination of the environment to detect any frauds which may affect the shareholders and other stakeholders of the company while the auditor will always stress on the management to have adequate controls and safeguards where they take necessary steps to prevent, detect and mitigate the errors and frauds. This is where the conflicts between the two may arise. segregation of duties involves hiring of additonal staff The auditor lays great emphasis on the segregation of duties of the finance personnel to prevent frauds occurred by events such as collusion etc. This involves the hiring of additional personnel in order to suffice the cause which involves an additional cost in form of remuneration of the employee. Some controls such as the maker and checker are also advised by the auditor which also involves a time consuming exercise on part of the staff as well as the fact that it involves a significant cost. The CFO pleads the case that his job is to maximize the profit of the company and to provide the shareholders with sufficient returns for their investments along with the minimization of the costs which can be utilized to make additional profits. This point of view of the CFO and the management tends to create a conflict between the auditor and the CFO. establishment of a separate internal audit department The auditor lays emphasis on the establishment of a separate internal audit department where the department has authority and independence to work for the benefit of the organization in looking after the controls of the organization and to identify the instances of fraudulent activities taking place within the organization. This also involves significant costs as a department has comprise of well trained and skilled staff who have knowledge and expertise of identifying possible weaknesses and loopholes in the internal control of the management. Along with this, the scope of work of the internal control department may also conflict with that of the finance department where the finance department may feel more comfortable working in a particular manner which may not be deemed as the best practice by the internal audit function. management override of controls The CFO has a preference to present the financial statements which are desired by the top management to impress the shareholders and the prospective investors to invest in the company. This is why there can be instances that the CFO may himself override the controls which are established under his guidance and supervision in order to ensure the presentation of the position of the company which is desired by the management. (AN AUDIT OF INTERNAL CONTROL OVER FINANCIAL REPORTING, 2009) This, in the terminology of audit, is termed as window dressing and is considered as fraudulent activity whereby the audit may express his concern over these and such instances may result in conflict between the auditor and the CFO. ethical considerations for auditor and the cfo The auditor and the CFO both have reporting responsibilities and stand under a fiduciary relationship with the respective persons which they have to report to. The auditor has to report to the shareholders, to whom the audit report is intended for. Therefore, the ethical responsibility of the auditor is to ensure that the necessary safeguards are in place in the organization to protect the interest of the shareholders. Similarly, the responsibility of the CFO is also to fulfill the desire of the shareholders i.e. to earn reasonable profit for their investments but this may also be done at the expense of the cost which can be used to establish and strengthen the internal controls. The CFO would rather seek to save the money of the shareholders which can be invested to provide a safeguard against potential frauds and invest them where maximum profit can be gained by the shareholders of the company. mitigation of conflicts and reconcilliation of roles There are ways through which the conflicts can be eradicated and the roles and responsibilities can be reconciled with each other wherever a conflict arises on matters of internal controls. The CFO can take steps in establishment of effective internal controls to ensure that the potential loss, which can be caused by fraud and other potential threats to shareholder interest, can be mitigated rather than investing the same funds for profit making. The auditors can themselves carry out reasonable examination of the internal controls of established by the management and can report any necessary deficiencies as well as recommendations by which the internal control can be made strong and prove to be a line to defense to the shareholders interest. The CFO shall, on his part, make sure that the recommendations are given proper regard and necessary actions are taken as the CFO himself stands in a position of trust to the shareholders to conduct the business. conclusion In case there are different viewpoints presented by both the parties, the management can take under consideration the stance which is both cost effective and necessary for the purpose of establishment of effective internal controls that prevent, detect and mitigate the control insufficiency. It can be learnt from both the parties that they try to achieve the goal of fulfilling the desire of the shareholder, but by different ways, and make the most to benefit and safeguard the interest of the shareholder, however, at the expense of one another. Works Cited (2009). AN AUDIT OF INTERNAL CONTROL OVER FINANCIAL REPORTING. Washington, D.C: PCAOB. Hoitash, U. (2007). The Effects of Internal Control Quality. Newark: Rutgers University. (2003). Internal Audit Independence and Corporate Governance. Chicago: Institute of Internal Auditors. Read More