Board of Directors and Auditors Roles and Responsibilities in Accounting Frauds - Case Study Example

Accounting Table of Contents Introduction 3 Board of Directors 4 Auditors’ Roles and Responsibilities in Accounting Frauds 7 Government Intervention 9 Conclusions 10 References 11 Introduction Accounting frauds can be segregated into two types, viz. the inclusive type and the exclusive type. In the inclusive type of accounting frauds, unreal entries are made in the company’s books of accounts with an intention to overstate (or understate) company expenses or assets to persuade investors mostly and at times, to escape tax liabilities. On the other hand, in the exclusive type of accounting fraud, financial entries are omitted from the company’s books of accounts, to replicate a false picture of the company’s well-being to the public and its stakeholders (both internal and external). Detecting frauds in both these cases is a time consuming process owing to the underlying assumption that typical perpetrators, for conducting accounting frauds, intent to conceal every possible proof to the forgery to the longest possible tenure and often remain undetected by the professionals (Skalak & et. al., 2011, pp. 233-234). Hence, experts have been striving to eradicate any possible gaps in the accounting procedure, with the assistance of regulative measures and legislative penalty provisions, so that such intentions amid the perpetrators can be discouraged. Nevertheless, these strategies have been observed to possess limitations, resulting in fraudulent occurrences, which even though identified, cause immense legal costs to both the offended and the offender (Day, 2000). As argued in Imhoff, Jr. (2003), company’s corporate governance system, speculating the roles and responsibilities of the company directors and the internal auditors, play a major role in omitting chances of such practices. In the similar context, the importance of governmental interventions to ensure uniform audit standards and the credible involvement of third-party auditors in the accounting process is also not negligible when concerning auditing fraud occurrences (Lennox & Pittman, 2010). Emphasising these occurrences in the recent accounting practices and the participatory roles played by company directors and the auditors, this essay will discuss about the roles and responsibilities shared by the Board of Directors in setting up strategies to eradicate chances of fraudulency risks, auditors’ accountability in ensuring the same and governmental interventions to prevent such future occurrences. In order to gain an in-depth and practical understanding of the stated issue, few recent occurrences of accounting frauds will also be considered in the discussion. Board of Directors As mentioned above, Board of Directors (BOD) have specific roles and responsibilities towards ensuring that the company is accountable for its financial reporting in the most reliable and responsible manner. To ensure such an intention, it is necessary that the directors are appointed based on specific guidelines to eradicate biases and ensure transparency in company decision-making. According to UK Corporate Governance Code, the first directors of a company must be appointed at the incorporation date of a company. Following the first directors’ appointment, all further director appointments are carried out in accordance to the rules and regulations stated in the Articles of Association of the company. It is worth mentioning in this context that the company’s AOA principally states the qualification criteria required during the appointment of a new director (ICSA, 2013). However, when in case of listed companies, the AOA must also be aligned with the general corporate governance practices laid down by the national of international (as applicable) regulatory body of financial reporting. For instance, in the UK, the general policies for appointing directors in listed companies are developed by the Financial Reporting Council. As specified by the council, the UK Corporate Governance Code directs in favour of the involvement of shareholders to appoint directors based on a formal, transparent and rigorous framework or guidelines. Moreover, the appointment of the directors must be on the basis of merit and against the objective-oriented selection procedure to ensure maximum transparency in terms of diversity including gender. A succession planning is also necessary in this regard to ensure that the board is working refreshingly and progressively towards imbibing skills and updated experiences to align the company operations with the external business environmental changes (Financial Reporting Council, 2012). Furthermore, the company shareholders must set a nomination committee including majority of independent non-executive directors to decide upon the appointment of the directors as per the company AOA. The chairman selected from the non-executive independent directors shall be responsible to chair the committee, excluding when the succession of chairmanship is under consideration. Maintaining diversity in the selected members, balance of skills, knowledge, independence and experiences must be signified with utmost importance. The code also specifies that appointment of the directors must be guided under specific terms and conditions subjected to the considerations for re-elections of the directors, in general, above the tenure of six years. The specifications followed by the nomination committee in appointing directors, including the policy measures to ensure diversity within the board formations in terms of gender, experiences and any other measurable objectives, also clarifying about the inclusion or non-inclusion of open advertising or external-search consultancy in the appointment process, must be conveyed through the company annual report (Financial Reporting Council, 2012). In case of listed companies, the roles and responsibilities of the directorial members are mostly governed by the various codes of conducts laid by the UK government in its recent practices. As per the mentioned guidelines of the FRC, the board of directors should be responsible towards the effective and transparent implementation of their leadership skills with the intension of achieving effective control and proper business related risk assessments (Financial Reporting Council, 2012). The board members are also entitled to hold the shareholder’s interest as their top priority along with formulate strategic future goals for the company through proper management of financial and human resources, which again encourages them to withdraw from getting involved with any fraudulent activities and function in an accountable manner. Adding to the above facts, the government codes also demand that the annual report of the company should contain detailed information about each and every board member along with the amount of insurance coverage taken by the company in cases if the directors are charged with any sort of legal action (Financial Reporting Council, 2012). It is worth mentioning in this context that such regulative provisions allow stakeholders to gain confidence on the actions of the BOD concerning the appointment and the functioning of the directors on the basis of their experiences, skills and moral duties. The government code of conduct also demands a clear division of responsibilities among the board members to avoid perplexities in the decision-making process and thereby, minimising possible occurrences of fraud. For instance, according to the FRC, the chairman and the chief executive of the company should have differentiated roles and responsibilities, which should be established in terms of written agreements and specifically, under the supervision of the other board members (Financial Reporting Council, 2012). The affectivity of the code has however been criticised to be largely depended on the level of commitment, experience, know-how, skills and independence of every board member with respect to the company in order to carry out the accounting functions in the most responsible manner (Financial Reporting Council, 2012). Auditors’ Roles and Responsibilities in Accounting Frauds Auditors’ specific roles and responsibilities include ensuring that the authenticity of an organization’s financial statements are maintaining to the highest possible extent. Based on this primitive intention, which grounds the formations of various auditing groups, the roles and responsibilities of the auditors can be segregated into four categories. Firstly, it is the responsibility of the auditors to upkeep confidentiality and confidence in the process of financial reporting. Secondly, the auditor is also responsible for improvising an organisation’s financial statement quality. Thirdly, they are entitled to act rationally and in an unbiased way towards providing assurance about the company’s financial health to banks and other investors. And fourthly, the auditor’s responsibility is to work in favour of the public interest (ACCA, 2011). However, to perform these responsibilities in an effective way, auditors must be able to work independently, with minimum bias influences from the company officials, which further give base to the strategic principle of auditor independence. Accordingly, in the UK, various regulatory measures have been taken to ascertain that the auditors are able to function independently to secure the basic intentions of financial reporting within the country. It is worth mentioning in this context that the occurrences of Enron and WorldCom scandals have led to massive reformations in the UK accounting and auditing policies, whereby the enacted norms have been reconsidered and amended to allow better independence to the auditors in judging the accuracy as well as reliability of the financial reporting conducted by organisations. Currently, the UK guidelines follow a principle-based approach to integrate the various principles of auditing. According to the prescribed rules of Statement on Auditing Standards (SAS) 240, it is one of the foremost responsibilities of the audit firms prior to be engaged with any intended client organisation to secure its independence. It can be said that the auditors enjoy sufficient independence when they are able to decide upon their discontinuation with the company on the identification of any fraudulent accounting practices, are free to communicate their concerns to the responsible bodies and are able to provide their independent review on the company stance (Fearnley & Beattie, 2004). In this context, the Auditing Practices Board (APB), which is the regulatory body responsible to ensure transparency and uniformity in auditing practices, have laid due significance on the aspect of auditor rotations on a regular basis (The Auditing Practices Board, 2010). It is in this context that the code of conduct in the UK accounting policies states that auditors must be rotated on a continuous basis so as to ensure adequate independence to these professionals (Financial Reporting Council, 2012). Furthermore, during the rotation of the auditors, the principles also aim at ensuring that the interests of these professionals are secured to the maximum extent from the perpetrators of accounting frauds allowing sufficient degree of accounting scepticism (Harris & Whisenant, 2012). The principles further ban provisioning by incumbent professionals to the organisation associated with non-audit services from interfering in auditing processes and thus, inhibiting auditor’s independence. It is often assumed that adherence to these principles are likely to enrich audit quality, assuring highest degree of reliability and accuracy in audit reports (ACRA, 2013). Government Intervention In the recent phenomenon, the government in the UK has applied various regulative measures, in order to control the accounting practices of corporate organisations and allow adequate auditing transparency within the process. For instance, the UK Fraud Act 2006 was enacted with an intention to mitigate chances of fraudulency in company reporting, following the fraudulent cases worldwide, such as the case of Enron and WorldCom in the recent past. This act is thus intended to help organisational decision-makers and auditors in developing a clear definition of various offences related to fraudulences and preventing the same in the practical scenario (Crown, 2014). The Companies Act 2006 is also noteworthy in this context, which elaborates on the roles and responsibilities of the company officials, especially the decision-makers to discourage, prevent and withdraw from any fraudulent activities to ensure the stakeholders of the company with complete satisfaction in realising their interests (Department for Business Enterprises & Regulatory Reform, 2009). This particular Act not only focuses on elaborating the directors’ roles and responsibilities to ensure auditor’s independence, but also speculates the significance of audit reports, determining the inclusionary and exclusionary clauses to involve auditors and empower them to deliver their unbiased views on the financial stance of the company (Crown, 2006). Conclusions From a generalized perspective, the entire process of recording, comprehending and conveying information regarding company assets, liabilities and regular utilities through financial codification is referred to as accounting. Accounting has long been used as an effective and reliable mechanism of summarizing every financial activity occurring within the organization to ensure its smooth functioning. Communication of these summarizations is further stated to help decision-makers in making sound decisions to secure organisational and its stakeholders; interests in the most productive manner. Activities such as preparation of financial positioning statement, income statement, cash flow statement and change in equity statement significantly helps in forecasting the profitability of the business and likewise, assists decision-makers in ensuring better sustainability in alliance with the relevant regulations and preventions of any illegal or fraudulency occurrence. However, recent occurrences of accounting frauds have challenged this particular ideology, indicating poor affiliations of the directors and the auditors (as communicators of financial reports and summarizations). Governmental interventions to such occurrences have however been quite active followed by the enactment or reformation of accounting rules and standards. References ACCA, 2011. Role & Responsibilities of an Auditor. The Role of Audit In Enhancing Confidence in Financial Reporting, pp. 6-7. ACRA, 2013. Auditor Independence – Serving As An Officer Or Director On The Board Of Assurance Clients. AUDIT PRACTICE BULLETIN NO. 2 OF 2013. Crown, 2014. The Fraud Act 2006. Legislation.gov.uk. [Online] Available at: http://www.legislation.gov.uk/ukpga/2006/35/contents [Accessed March 13, 2014]. Crown, 2006. Companies Act 2006. Legislation.gov.uk. [Online] Available at: http://www.legislation.gov.uk/ukpga/2006/46/pdfs/ukpga_20060046_en.pdf [Accessed March 13, 2014]. Day, R. G., 2000. UK Accounting Regulation: An Historical Perspective. School of Finance & Law Working Paper Series No. 20. Department for Business Enterprises & Regulatory Reform, 2009. Directors and Secretaries. GBA1. [Online] Available at: http://www.companieshouse.gov.uk/about/pdf/gba1.pdf [Accessed March 13, 2014]. Fearnley, S. & Beattie, V., 2004. The Reform of the UK’s Auditor Independence Framework after the Enron Collapse: An Example of Evidence-Based Policy Making. International Journal of Auditing, Vol. 8, pp. 117-138. Financial Reporting Council, 2012. The UK Corporate Governance Code. Section A: Leadership, pp. 5-10. Financial Reporting Council, 2012. The UK Corporate Governance Code. Publications. [Online] Available at: https://www.frc.org.uk/Our-Work/Publications/Corporate-Governance/UK-Corporate-Governance-Code-September-2012.pdf [Accessed March 13, 2014]. Harris, K. & Whisenant, S., 2012. Mandatory Audit Rotation: An International Investigation. The University of Houston, pp. 1-2. Imgoff, Jr., E. A., 2003. Accounting Quality, Auditing and Corporate Governance. Accounting Horizons, pp. 117-128. Lennox, C. & Pittman, J. A., 2010. Big Five Audits and Accounting Fraud. Contemporary Accounting Research, Vol. 27, No. 1, pp. 209-247. Skalak & et. al., 2011. A Guide to Forensic Accounting Investigation. John Wiley & Sons. The Auditing Practices The Board, 2010. Auditor Scepticism: Raising the Bar. Discussion Paper, pp. 1-34. Read More