Todays Highly Competitive Business Environment - Essay Example

Introduction Today’s highly competitive business environment pressurizes business even huge business entities to perform better than ever (KPMG, ; Johnson, & Turner, 2010). These pressures and competition threats led companies towards adopting malpractices in reporting financial facts (Griffin, Pustay, & Liu, 2010). Governance, ethics, reporting manipulation, increased materiality in numbers, polished earnings in terms of creative accounting and auditing frauds are the widespread outcomes of the said competitive pressures (Ricks, 2009; Verbeke, 2013). The beginning of 21st century witnessed a number of scandal regarding accounting measures (Piketty and Goldhammer, 2014). One of the major and unexpected cases was of Xerox Inc., a huge reputed global technology entity. It was reported that the company practiced creative accounting techniques to manipulate its performance during the period from 1997 to 2000. Considering the case, below presented is a critical review of the case via investigating the underlying matter deeply with its circumstances and consequences. The discussion will be an effort of aligning and comparing case evidences with the defined code of conduct in the regard by authorities and authentic literature of the underlying discipline. I. Case study question 1 The background of the company Being a global entity in document technology business, Xerox inc., is known for quality and innovation in the field (Mui, 2012). Founded in 1906, Xerox is currently working with around 140000 employees, 12000 active patents and reported $19.5 Billion revenue for the year 2014 (Xerox, 2015). The company got entangled in an accounting scandal for the period of 1997-2000 by SEC. At that time, company’s worth was 92,500 employees, 87th rank in Fortune 500 and reported $18.7 billion sales for the year 2000 (Jessup, & Nance, 2011). The nature of its business Known for innovation in document technology, Xerox deals in a variety of products and services related to the digital documentation measures (Xerox, 2014). The portfolio of the company holds mainly ranges of printing devices, scanning machines, communication devices, publishing systems (Jessup, & Nance, 2011) and a wide range of offered outsource services as well (Girod, Alter, Harris and Junglas, 2011). Claiming to be the leader in document technology, Xerox admits the volatile nature of its business due to the association with the ever-changing technology. Girod, Alter, Harris, and Junglas, (2011) suggest that technology businesses work under high pressures of current competitive scenario. Slow paced innovation, technologically outdated products, cheaper substitutes and entry of new businesses increased the uncertainty about the future performance of industry’s entities and led to various unexpected declines in the performance measures. The nature of fraud committed by the company and how it was discovered Critically analyzing the practices adopted by Xerox during the reported fraud period suggests that company was highly involved in the practice of false creative accounting techniques including topside accounting, misrepresentation, manipulation, first call estimation and creative numbers game. The manipulation was done in the measures that are required to be disclosed under the guidelines of GAAP. The taken actions were not in compliance with the GAAP standards. Instead of employing guided principals, hypothetically built models were utilized for manipulation purposes with misrepresentation of incidents in many regions of the business. The nature of fraud is called for the misconduct under governance, ethic and accounting fraud regards. The reported fraud was intended to disguise the investors of the company about the actual performance and financial worth of the company. It was the outcome of extreme competitive pressure during 1997-2000, which lead company’s performance far down from the optimistic estimations. This scenario in turn made company make manipulations in accounting measures to formulate a harvesting landscape in front of investors. The allegation of Mexican accounting irregularities by Xerox in its annual report 2000 was the first instance that aided the fraud to be revealed (CNN, 2002). Publically revealed alleges allowed SEC to launch an investigation for the overall conduct of the matter for Mexican subsidiary, which was then incrementally enhanced due to revelation of connected errors, irregularities and malpractices in different regions (KPMG, 2015). The name and background of the external auditor of Xerox At the time of scandal disclosure, KPMG institution was the external auditor of Xerox (Jessup, & Nance, 2011). KPMG has a historical heritage of serving for three centuries to the world. The company offers services of audit, advisory, and tax management. The company works for a variety of industries in 155 countries via delivering the said services with a huge base of 162,000 professionals and 9000 partners. Company reports its combined group revenue $24.8 billion for the fiscal year 2014 (KPMG, 2015). Known for providing quality services in the world, KPMG had a forty-year strong relationship with Xerox. According to the given case, SEC also suspected KPMG for the possible participation in the said accounting manipulation and investigated its actions under the law. The consequences of the fraud case to Xerox According to the (Seip, Kinsella and Lindberg, 2011), Xerox had to face legal allegations as the consequences of the fraud committed revelation. Xerox and its six executives had to pay high physical, reputational and mental costs. Xerox without making a statement of acceptance or denial of the matter agreed to be penalized for $10 million for the settlement of SEC allegations and agreed to restate its earnings for the manipulated accounting period. Further, a committee of outside directors was appointed to review internal accounting control practices, as well as policies. Six of Xerox auditors were also penalized with collective fine of $ 5 million, and they had to sacrifice their stock profits as well as had face career bans and cancelations (Jessup, & Nance, 2011). The consequences of the fraud case to Xerox’s audit firm SEC also presented the evidences of KPMGs involvement in the fraud case due to its negligent and overlooked behavior. In order to maintain a relationship with Xerox, KPMG found persuaded to support the manipulation via not revealing the actual findings. This scenario brought the almost same consequences for the KPMG. SEC alleged KPMG as fraud partner with Xerox. KPMG was charged to surrender its auditing fee earned by Xerox, which was about $ 9.8 million and $ 2.675 million interest on that fee as well as $ 10 million civil penalty. Along with monetary losses, company was regarded under law to reform audit policies under GAAP requirements. II. Case study question 2 IFAC, (2009a) describing the auditor’s duty of finding and assessing fraud maintained that specifically ISA 315 and ISA 320 are developed to address the issue of material misstatement with the indicated possibility of fraud intention (IFAC, 2009a). The responsibility of external auditors relating to the detection of material misstatements In addition to the description of auditor’s role in finding material misstatement by ISA 240 as presented above, ISA 315 defines job duties in terms of action that auditor should perform during auditing (IFAC, 2009b). (Clause 5, ISA 315) addressed the auditor should perform that risk assessment measures in order to find misrepresentation of data. (Clause 6, ISA 315) discussed that auditor should perform inquiries from management, utilize analytical measures and employ observation. (Clause 7, ISA 315) sources of information in between auditor and client should be assessed. (Clause 8, ISA 315) should assess that employed information is viable or not to find material misstatement. (Clause 9, ISA 315) longitudinal comparison of multiple audits should be taken into account. (Clause 10, ISA 315) effective discussion about the possibility of material mismanagement among auditing partners should be done. The fraud factors that external auditors should consider when assessing the likelihood of material misstatements due to fraud. According to ISA 240, auditor is responsible to detect risks of frauds via assessing the misstatement practices and extent of those practices. Clauses regarded with the responsibility are elaborated below. (Clause 4, ISA 240) Discussed the need of financial reporting assessment as auditor’s responsibility to detect and prevent fraud. Indication of unnecessary influence during the audit process was highlighted. (Clause 5, ISA 240) maintained that it is auditors’ responsibility to assure the accuracy and credibility of financial statements in terms of not finding misstatement of material. (Clause 6, ISA 240) discussed the ability of the auditor to sense material misstatement concealed in manipulation schemes. (Clause 8, ISA 240) highlights that it is auditor’s responsibility to utilize professional skepticism during whole audit process to find out misstatement. Factors existed during the 1997 through 2000 audits of Xerox that created an environment conducive for fraud According to the given case, Xerox was able to influence its auditing firm in many aspects (Securities And Exchange Commission, 2005) which developed a conductive environment to commit fraud. Some instances are indicating the overriding capability of Xerox on KPMG and misconduct of KPMG in the case that aided the fraud conducted environment are listed below. The “topside” accounting practice to polish quarterly reviews was evident in the reports but not indicated by KPMG. It was evident in the case that company kept reserves of more than $ 400 million collectively and KPMG was the authority to review quarterly and annual reports and addressed that reserves as either unspecified or opportunities but not properly investigated the matter. Case report provides evidence that KPMG was persuaded on many occasions either to hide or not to discuss the manipulations and irregularities found in the measures. Reported irregularities and another important measure from other regions were ignored by the firm as well as KPMG. Red flags, as discussed below, were evident but not taken into account by KPMG. Xerox was finally supported by the KPMG via particular actions. For instance, Safran was appointed as an engagement partner for five years but after reporting irregularities replaced after two years only. All above are the indications extracted from the case suggests the relaxations provided by KPMG that aid Xerox committing fraud in a suitable environment for doing so. III. Case study question 3 Cressy, Cumming, and Mallin, (2012) discussing SAS 99 definition of the conditions that allow firms and/or employees to commit fraud as incentives/pressures, opportunities and rationalization. Factors that are indicative in the Xerox belong to all three categories of the fraud factors included incentive/pressure, opportunities, and rationalization. Factors present at Xerox Corporation those are indicative of incentive/pressure According to (AU section 316, effective from 2002), explains that incentive and/or pressures are the characteristics of fraud that allow firms or employees to commit fraud. It was discussed that there are certain economic or competitive pressures or estimation of incentives in terms of improved profits or image that can lead companies or employees towards committing frauds (AICPA, 2014). In the case of Xerox, incentive/pressure factors were evident as listed below. Increased competitive pressure during the period which led to the need of showing growth in the revenues to improve company’s image (Jessup, & Nance, 2011). Pressures from the side of investors due to not meeting expectations, as a consequence company was facing decline in stock value (Jessup, & Nance, 2011). Failure to meet estimated margin targets (Jessup, & Nance, 2011). Management rewards associated with higher performance. Factors present at Xerox Corporation those are indicative of opportunities AU section 316, suggests that management’s ability to overrule controls and/or there is a lack of control in accounting system that provides an opportunity to commit fraud. Xerox case held the indications that provide firm’s management the opportunity to commit fraud as depicted below. Ability of the firm to employ numerous manipulation methods to bridge estimation and actual gaps. Application of hypothetically built complex valuation methods instead of applying GAAP standards. Misrepresentation of lease values via utilizing creative accounting measures. Authority to restrain auditing firm discuss gaps in practices. Factors present at Xerox Corporation those are indicative of rationalization Rationalization is the condition of fraud where company and/or employee can rationalize their actions in terms of explaining underlying circumstances (AU section 316, effective from 2002). For instance, (Cressy, Cumming and Mallin, 2012) suggests that management can define that there were pressures to adopt the practice. Rationalization elements present in Xerox case are. In compliance with GAAP standards. Ability to persuade audit firm via incentive/pressure methods as depicted by actions making audit partner’s sign off as well as restraining from discussing ineffective measures. Accounting control by the management via involvement of internal accounting team. Rationalization was also utilized by employing own models. IV. Case study question 4 The responsibility of external auditors to the different internal control components According to the COSO model of Internal Control, there are five interrelated elements that if employed correctly allow management to control internal environment effectively (Protiviti, 2014). The five elements include control environment, risk management, control activities, information and communication and monitoring activities (IFAC, 2006). Johnstone, Gramling, and Rittenberg, (2013) discussed the importance of internal control measures in auditing practices. They highlighted that there is a certain risk that the organization would not be able to meet financial reporting needs, but internal control allows firms to mitigate that risk via achieving its objectives. According to Dinapoli, (2010), external auditors are not responsible for the design or effectiveness of internal control system of the client however external auditors’ duty is to evaluate internal control of an organization in the auditing process. It was maintained by (Westin at el.) the external auditor is to record a verdict on the viability of financial statement and can suggest improvement to the Board regarding internal control effectiveness (Branches, 1997). Further, as reported risk assessment of the audit report is the integral part of the audit process planning (DiNapoli, 2010). As evident by the suggested notions, external auditors possess the authority to identify and communicate the lacks of internal control in one or more components that are evident in financial reporting. . IFAC (2009b) suggested that it is dependent on the judgment of the auditor that which component of internal control throw impact on audit and should assessed. According to IFAC (2009b), the auditor’s responsibility for each element of COSO internal control framework is summarized below. Control Environment: auditor should assess governance practices as well as environmental factors sufficiency to make other components work. Risk Assessment: a comprehensive set of practices should be employed in terms of identifying risk associated with financial reporting, estimating significance of said risks, highlighting probability of occurrence and developing coping strategy. Control Activities: understanding and assessment of risks associated with audit in terms of misstatement risks and response of the company to cope with the said possibility. Information and Communication: in terms of documents and relevant information, inquiries and another related document that facilitate the audit procedures. Monitoring Activities: auditor should assess activities that are used to monitor and correct deficiencies of internal controlling measures. The red flags that were present during the audit of Xerox Corporation that may have suggested weaknesses in Xerox’s internal control system Experian (2008) defined that red flag refers to an emerging pattern of practices that can indicate a particular deficiency. The concept of the red flag was highly valued in auditing discipline. Vona, (2011) maintained that red flags should be addressed via investigation during the audit process to resolve the matter and mitigate the risk of possible fraud. The red flag as reported in the given case was the pace of revenue pattern in quarterly assessment for the years 1996 and 1997. Some other red flags found during critical assessment of Xerox case as per fraud detection techniques are. Patterned changes in leases, revenue and earnings streams. As reported partner of the external auditor was changed before completion of its duration for being auditor of Xerox. Clear use of manipulation creative accounting techniques. Restrictions on audit firm for discussing found lacks. Incompliance of accounting practices with the GAAP rules. Continuous reporting of irregularities from different regions where business was performing. Conclusions Above presented is a thorough assessment of the Xerox 1997-2000 accounting scandal. It was observed that the company was intentionally involved the in accounting malpractices to show improvements in firm’s financial health. The reason found the practice was to cope with the environmental competition challenges and to give the sense of meeting investors’ expectation. Critically reviewing the case, it was found that many instances suggest an involvement of external audit firm KPMG in the overall conduct. It was evident from the case, locating problematic areas continuously, external auditors were either bound not to take corrective measures or persuaded to hide the irregularities. Announcement of Mexican irregularities revealed the fraud conduct. Afterward, both Xerox and KPMG had to face punishments under SEC rules. In the presented document, solution of case questions was crafted to not only reveal and discuss the fraud indications but also to compare with the provider code of conduct in the regard. References AICPA. (2014). Fraud Risk Factors Specific to Employee Benefit Plans. 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