Truthfulness in Financial Controls - Case Study Example

?Auditing Table of Contents Question 2 3 Question 3 4 Question 4 6 Question 5 7 Question 7 8 Works Cited 11 Question 2 “The tone at the top” is the term used to denote most significant component for encouraging trustworthiness in organization as well as truthfulness in financial controls. For any organization, the top level persons such as CEO or Directors set the tone for commercial performance and corporate governance for any company (Crowe Horwath, “Setting the Tone at the Top: Sustaining Ethical Behavior”). The case of Societe Generale provides a perfect example indicating the importance of auditing in an organization. Due to reluctance of tone of Societe Generale, the company had to face a loss of almost $7.2 billion in 2008. It is in this context that Societe Generale provided higher concentration on the front office activities and there was less consideration towards back office performances. As a consequence, there was imbalance between the control of front office and back office functions (Beasley, M. S. & Et. Al., “How a Low Risk Trading Caused a $7.2 billion Loss”). Due to this reason, Societe Generale was incompetent to develop acute inspections essential for controlling the roles and responsibilities of employees. From the case study, it can be observed that like other organizations, Societe Generale had also become quite determined about drumming up its market worth. Thus, it did not provide much attention towards the traders and its responsibilities for managing the risks, while it rendered high significance for financial organizations in order to maintain profitability (Wartzman, “Executives Are Wrong to Devalue Values”). According to Canadian Auditing Standard (CAS), ‘Tone at the Top’ outlines the principles of a business unit and administration’s obligation to aptitude and beliefs (Hartley, “Tips for Cost-Effective CAS Application”). Tone at the top is necessary for better financial control in any organization. By judging the tone at the top of Societe Generale it can be characterized that it had certain lacunas of internal control which can be categorized as the reason for huge loss faced by the company. For any organization, the top level administration must be clear regarding the rules of business because different organizations have different risk desires. In Societe Generale the management was unable to apply the rules of business throughout the internal working culture. There is need for better internal management which can scrutinize the activities of all employees so that any kind of illegal activities can be detected and prevented accordingly (Beasley, M. S. & Et. Al., “How a Low Risk Trading Caused a $7.2 billion Loss”). Question 3 CAS describes that maltreatments in the financial statements ascend from either fraudulent activities or accidental mistakes (OAS, “Canadian Auditing Standards”). Fraudulent activity comprises three aspects which are pressures or incentives, opportunity and rationalization. Pressure or incentive is the aspect which influences or tends to give reasons to an individual to conduct fraud. With respect to Jerome Kerviel (one of the traders of Societe Generale), as a trader, the earning of Kerviel was quite low in comparison with other top level traders. He even did not consider himself as a trader due to his low earnings. Thus, his incentive for conducting fraudulent activity was to enhance his reputation within the company and thus increase the bonus amount (Beasley, M. S. & Et. Al., “How a Low Risk Trading Caused a $7.2 billion Loss”). Hence, he was constrained for gaining more money by undertaking monetary risks. Rationalization is the other aspect in majority of fraud cases. It involves reconciling the behavior of the individual alleged for committing fraudulent activities. After disclosure of the fraudulent activity of Kerviel, his rationalization was to make sure that his superiors were aware regarding his activities. Kerviel had articulated that his superiors knew about the fabricated trades he made in the company but had not taken any steps (Boise State University, “Fraud Triangle”). The most important among all aforementioned three aspects for conducting fraudulent activities is opportunity. Opportunity is the capability to commit fraud. Opportunity is naturally accomplished by fraudsters through planning and instigating an environment which can help to prevent fraud detection. Fraudsters do not wish to be trapped, thus they conduct their actions in such a way so that it cannot be noticed by others (Bell, “Time for an Anti-fraud Checkup”). In case of Kerviel, the poor internal control of Societe Generale had given him the opportunity to commit fraud. He was quite confident to enter fake trades into the business system of Societe Generale because there was gap in the tone of management system of the company. In this context, CAS defines that probable impact of intrinsic restrictions are important in exploitation resulting from fraud (OAS, “Canadian Auditing Standards”). This restriction in management policies had provided the opportunity to place wrong trades without being noticed by others (Bell, “Time for an Anti-fraud Checkup”). Question 4 Controls reliance strategy is a method used by auditors in order to simplify effectiveness in the combined audit. The choice of auditors for implementing controls reliance strategy depends on specific realities and conditions. In certain fields, auditors might choose to depend on controls reliance strategy in order to decrease the functional testing of certain claims concerning accounts and disclosures. Besides, controls reliance strategy is followed in organizations because it is quite challenging for auditors to attain adequate indications regarding suspicious banking transactions through functional analyses, as banks process numerous transactions regularly (The Center for Audit Quality, “CAQ Lessons Learned – Performing an Audit of Internal Control in an Integrated Audit”). In case of Societe Generale, the auditors had not gathered much controls related evidences about “Delta One trading desk” (a job position in Societe Generale) because it was planned to generate profit on huge amount of transactions and it was impossible for auditors to analyze every transaction separately. Furthermore, Delta One Trading Desk was considered to be a low risk part by the auditors in comparison with other complex trade fields of Societe Generale which in turn influenced them to overlook the aspect to a certain extent. Hence, it can be observed that the external auditors had not provided much attention to this area (PwC, “In-Depth Guide to Public Company Auditing: The Financial Statement Audit”). Question 5 One of the most important necessities of CAS is to communicate all internal control deficiencies throughout audit. CAS comprises comprehensive and rigorous requirements and requires recognizing the auditing procedure, including internal controls applied by administration in order to make appropriate accounting estimations (Beaudin, “Changes Ahead”). Control deficiency in organization occurs when strategy or procedure of internal controls does not let administration or other employees in the usual sequence of performing their allotted roles, and to notice misstatements already caused or likely to be caused in an efficient way. If any deficiency exists in internal control, organizations will be unable to prevent any fraudulent activities. The deficiencies in internal control can occur in several ways such as: Inadequate certification of the mechanisms of internal controls Poor strategy of management on financial statements being reviewed Insufficient plan of internal control on major accounts or procedures Lack of isolation of responsibilities in important accounts or processes Lack of control on protection of assets Improper plan of information technology and application control to stop fraudulent activities Inappropriate strategies for evaluating the operational efficiency of organization’s internal control system and Lack of internal procedure to report lacunas in internal controls to the administration on a timely manner Source: (Mississippi Department of Finance and Administration, “Deficiencies in the Design of Controls”) Hence, in case of Societe Generale, the three most serious control deficiencies can be regarded as the inadequate verification and mechanisms of internal control, poor strategy of management and lack of internal procedure to report suspicious activities to the administration. Due to these deficiencies, Kerviel was able to enter fake trades into the financial statements to counterbalance the real trades. There was lack of inadequate verification of the mechanism of internal controls as well. The management of bank did not verify the data provided by Kerviel and acknowledged his fake records. There was inappropriate mechanism for internal control and hence the superiors of Kerviel only concentrated on his net trading position, rather than his fictitious entries in the financial system. Due to lack of proper mechanism his activities remained undiscovered and he was able to equipoise his financial accounts without reporting large amount of gain or loss to the management (Beasley, M. S. & Et. Al., “How a Low Risk Trading Caused a $7.2 billion Loss”). The lack of efficient internal procedure also helped Kerviel to conduct illegal activities related to organizational finances. In this regards, the lack of internal control such as routine review was the other factor for not identifying the fraudulent activities of Kerviel. For instance, from the study it has been observed that the other employees associated in the back office did not report to the administrators of Societe Generale because it was not their role. Even when the managers alerted regarding the suspicious behavior of Kerviel, they does not bother to respond actively (Beasley, M. S. & Et. Al., “How a Low Risk Trading Caused a $7.2 billion Loss”). Question 7 The “tone at the top” is a moral tactic of conducting business which is the keystone for inhibiting fraud. Management which lacks moral business practices feast to the employees and thus open the opportunity for fraudulent threats. The management demonstrates a genuine obligation to the code of ethics and commercial activities (Morris, “The Role of Management in Preventing Fraud”). In the case of Societe Generale’s loss, it can be considered as a management failure rather than an auditor’s failure. The controllers of the bank failed to report internally regarding the activities of Kerviel to the board which in turn significantly influenced the auditors’ judgment. Besides, the management was not competent enough to monitor and control the risks of business (Bennhold, “Business”). It is worth mentioning that in several cases the failure of audit resulted in loss of millions of dollars in organizations. There is significant gap in the defense of auditor which resulted in failure to detect the fraudulent activities. In the year 2011, one of the biggest accounting and consulting organizations was blamed of being unsuccessful to notice fraud throughout its auditing operations. The complaints were made by a director supervising the auditors, appealing loss of US$7.6 billion. In this regard, it was observed that the duty of auditors were vigilant on the activities of fraud and searching for the root cause for such act. Unable to do that can make organizations suffer huge losses (ABP Pvt. Ltd Publication, “Failing to Detect Fraud”). The other significant case indicating the failure of auditors is “Ernst & Young”. In the year 2010, this company was also litigated by Attorney General of New York for purposefully assisting the “Lehman Brothers Holding Inc” in deceiving the depositors. The major concentration for the lawsuits was on the auditors who had revised the financial statements and facilitated Enrst & Young to restrain the amount of liabilities. It was the violation of the role of auditors as they were supposed to inhibit the misstatement of financial statements (Freifeld & Sandler, “Ernst & Young Said to Face Fraud Lawsuit from Cuomo over Lehman Audits”). Hence, it can be inferred that auditors need to review the transactions of organizations strictly and initiate the major role to prevent the intentional manipulation of financial statements for deceptive purposes. Works Cited ABP Pvt. Ltd Publication. “Failing To Detect Fraud”. April 05, 2012. Business World, 2011. Beaudin, Annie. “Changes Ahead”. April 05, 2012. CA Magazine, No Date. Beasley, Mark. S. & Et. Al. How a Low Risk Trading Caused a $7.2 billion Loss. Pearson Education, 2009. Boise State University. “Fraud Triangle”. April 05, 2012. Internal Audit, 2012. Bell, Erick O. “Time for an Anti-fraud Checkup”. April 05, 2012. Deloitte Development LLC, 2008. Bennhold, Katrin. “Business”. April 05, 2012. The New York Times Company, 2008. Crowe Horwath. “Setting the Tone at the Top: Sustaining Ethical Behavior”. April 05, 2012. Corporate Governance White Paper, No Date. Freifeld, Karen. & Sandler, Linda. “Ernst & Young Said to Face Fraud Lawsuit From Cuomo Over Lehman Audits”. April 05, 2012. Bloomberg L.P., 2010. Hartley, Stuart. “Tips for Cost-Effective CAS Application”. April 05, 2012. Chartered Accountant of Ontario, 2012. Mississippi Department of Finance and Administration, “Deficiencies in the Design of Controls”. April 05, 2012. Examples of Control Deficiencies, No Date. Morris, Francis D. “The Role of Management in Preventing Fraud”. April 05, 2012. PICPA, 2012. OAS. “Canadian Auditing Standards”. April 05, 2012. CICA Standards and Guidance Collection, 2011. PwC. “In-Depth Guide to Public Company Auditing: The Financial Statement Audit”. April 05, 2012. Center for Audit Quality, 2011. The Center for Audit Quality. “CAQ Lessons Learned – Performing an Audit of Internal Control In an Integrated Audit”. April 05, 2012. News Room, No Date. Wartzman, Rick. “Executives Are Wrong to Devalue Values”. April 05, 2012. Bloomberg L.P., 2009. Read More