In today’s tumultuous and multifarious economic environment, the level of fraud has drastically increased in many organizations. Globalization and technological advance have further made the situation to become complex, as auditors have to compete with knowledgeable and well equipped fraudsters. The annual report of the Association of Certified Fraud Examiners (ACFE 2006) estimates that organizations lose up to 5% of their revenue to fraud related activities. This trend has worried most managers forcing them to look for external auditors to verify their daily transactions. For standardization purpose, the America Institute of Certified Public Accountants (AICPA) came up with set of rules known as the Generally Accepted Auditing Standards. Generally Accepted Auditing Standards provide general guidelines for organizations and CPA firms on how they can present and prepare their business financial statements, income and expense statements and assert and liabilities report. In addition, the GAAP is not a single rule, but a combination of several principles that can govern transaction of businesses.
The purpose of this study is to evaluate the effectiveness of the Generally Accepted Auditing Standards in an organization. In addition, the study will explore and explain the effect of fraud in an organization and its operation. Propose recommendation on how an organization can reduce fraudulent activities.
Case study
Having been selected as one of several accountants on a team of autonomous auditors by a new CFO, the team evaluated the corporation’s accounting practices. The audit was conducted in accordance with the standards of the Public Companies Accounting Oversight Board. The primary objective of the audit was to provide reasonable assurance that the financial statements of the corporation were fairly represented according to the Generally Accepted Auditing Standards. First, the auditors assessed the risk of fraud in every audit, both misappropriation of asserts and fraudulently financial reporting, in order to detect in causes of fraud. Secondly, the team planned and performed an audit, which responded to the identified risks and whether the financial statements were free from material misstatements, whether caused by fraud or human error. In addition, the team conducted the audit with an attitude of professional skepticism and due professional care. The audit team objectively evaluated all the evidence with a mindset that acknowledged fraud might be present regardless of the past relationship with the corporation. Furthermore, the audit also included the assessment of the effectiveness of accounting principles used by the corporation and overall financial statement presentation.
Based on the accounting principles stated by Generally Accepted Auditing Standards (GAAP) the auditors suspected possible fraud in the corporation. First, the auditors discovered that lease on technology asserts were significantly inflated. Secondly, there was underestimation of e-commerce state tax payment provided by the employees. Thirdly, the auditors discovered that fabricated employees were receiving post-employment benefits. In addition, the employees were hiding cash to be used in future in case they do not attain the corporation goals. Finally, the inventory of the corporation was shrinking, but the employed concealed it from the management since it was low for the industry.
The appropriate GAAP rule
The procedures of reporting using the GAAP are multifaceted since they have developed over a long time (Crovitz, 2008). Choosing the correct rule to follow can at times become a difficult challenge for most auditors. Needless to say, Generally Accepted Accounting Principles are essential since they govern organizations accountants when they are presented to stakeholders and auditors. Although the rules cannot be entirely relied upon since some organizations manipulate and bend the rules for their advantage. It is imperative to ensure that organizations follow the rule for accountability, transparency and reliability (Holmes et al 2002). The next section will briefly discuss the GAAP rules that can assist auditors in determining if fraud is taking place.
Adequate technical proficiency and training
Barnes (2005) explains that the competency of the auditors plays an important role in determining fraudulent activity in an organization. The first law of GAAP stipulates that an auditor must receive adequate technical training and proficiency. Holmes et al (2002) explains that the proficiency of the auditor is determined by formal university training, experience and practical training and continuous professional improvement in auditor career. For auditor to discover the fraudulent activities discussed above it is important for them to have the required knowledge and experience. From the finding of the investigation it is clear that the level of fraud involves knowledgeable employees who can easily cover their activities.
Independence in mental attitude
AICPA (2005) explains that having the right knowledge is not only sufficient, but the auditors must not be influenced by the management of the corporation. Furthermore, the AICPA’s Code of Professional Conduct stipulates that auditors must ensure that they remain autonomous from the management being audited. This ensures that the corporation being investigated provides the full information without interfering with the evidence. In addition, being autonomous will enables the auditors to work without pressure from the management. This rule will be useful to the investigation of the corporation since the auditors will work without pressure from the management.
Due professional care
Hodge & Pratt (2006) assert that the auditors need to be careful and diligent in performing an audit and issuing a report to the main stakeholders. In fulfilling this rule, the auditors should critically review the evidence without any biasness or negligence. The standard of due professional care requires that the auditors perform their duty in good faith without negligence and biasness. This policy will be of significant importance while investigating the corporation fraudulent activities. Barnes (2005) explains that due professional care enables auditors to separate mistake and intentionally committed fraud.
Proper supervision and adequate Planning
Barnes (2005) explains that for auditing to be effective, it require proper planning and supervision from both auditors and management. Both the management and auditors need to play their role to ensure that the auditing becomes successful. Holmes (2001) explains that the management needs to provide all the necessary material and information that the auditors require. Furthermore, auditors are supposed to plan their evidence in order to support their allegation. In the above case study, the auditors are required to plan their evidence since the allegation are supposed to be based on facts (Hodge, 2006).
Understanding the corporation and its environment, which include internal control
Hodge (2006) explains that understanding the nature of the corporation and its environment is important in understanding the fraudulent activities that take place in that organization. The auditors need to have wide knowledge of the corporation objectives, business risk and strategies, which is often connected with the risk of material mistreatment in financial statement (Barnes, 2005). The auditors need to be aware of the corporation internal control system. Secondly, the nature of the corporation accounting policies and its risk assessment process are vital information for the auditor. The corporation system of internal control is also an imperative factor in an audit. For instance, effective internal control system prevents the corporation assets from being fraudulently taken by employees. While ineffective internal control system provide opportunity for misappropriation of assets, which result to unreliable financial information. This clearly suggests that it is important for the auditors to understand the corporation environment, which include its system of internal control and external factors to develop a comprehensive perspective regarding the fraudulent activities of the organization (Holmes, 2002).
Sufficient evidence
Holmes (2002) explains that the ultimate objective of the audit is to gather enough evidence to prove that the employees in the organization are involved in fraud. The auditors require enough prove to express an opinion on the corporation fraudulent activities. Barnes (2002) explains that it is important for the auditors to plan their evidence to enable them to prove the fraudulent activities.
Financial statements presented in accordance with GAAP
Barnes (2005) explains auditors are required to ensure that the corporation followed the GAAP as the established criteria for evaluating their financial statement assertions. The auditors are required to ensure that they look for any instances where GAAP have not been followed by the corporation. This is important since the auditors can compare the previous audit report with the current one to ensure consistency.
Effectiveness of the GAAP rules
From the discussion it is clear that the GAAP are very effective in preventing fraud in organization and corporations. The rules are useful since they provide potential creditors and investors with useful information in making rational investment decision. This enables the corporations to keep their business transaction open to many investors and reduces chances of fraud (Saksena, 2001). Furthermore, the rules enable auditors to have standardized rules and regulations for auditing firms. The Generally Accepted Accounting Principles provide the basic foundation that enables the corporation to detect fraud and misappropriation of fund in the organization.
Hodge et al (2006) explains that GAAP provide understandable information, which can be used to predict current and future cash flow of an organization. This clearly suggests that the management can easily detect fraud and misappropriation of fund when the company income declines. The GAAP also enables the corporation to keep their property, business traction and accounting statement in check. This prevents employees from committing fraud in the organization. In addition, the GAAP provide guidelines that ensure the corporation maintain accountability, transparency and profitability (Barnes, 2005). Compliance with the GAAP also determines whether the corporation transactions comply with the regulations of the financial and operational activities. Needless to say, the GAAP provide guideline and basic rules that enable organization detect fraud and misappropriation of funds (Saksena, 2001).
Effects of fraudulent activities in organization
Saksena (2001) explains that fraudulent activities have caused many organizations millions of shillings. Most organizations have been declared bankrupt because of fraud and misappropriation of funds. The effects of fraudulent activities cannot be tolerated by organizations. Holmes (2002) explains that fraudulent activities have negative impact on the investor confidence. Most organization loses potential investors because of fraud related activities in their organization. In addition, some investors fear to invest more in the organizations because of numerous cases of fraud. This situation prevent corporation from expanding their business, which eventually result to bankruptcy.
Barnes (2005) further explains that fraud reduces the profit of organizations and increases regulatory pressure from the government. Most corporations have lost their licenses because of fraudulent activities in their organizations (Saksena, 2001). In some cases, the organizations lack the mechanism to detect fraudulent activities in their organization, which result to bankruptcy and liquidation. Hodge (2006) explains that the credibility and accountability of a company become badly dented because of fraudulent activities. Hodge (2006) further explains that once a corporation loses confidence from the general public it becomes hard for them to transact business with other companies. In addition, the employees become negatively affected since the financial situation of the corporation become blink.
Recommendation on How to reduce fraudulent activities in an organization
Hodge (2006) explains that there are various methods that can be employed to reduce fraudulent activities in an organization. First, the corporation can seek the assistance of forensic accountants and certified fraud examiners. This external certified fraud examiners conduct analysis and investigation, which detect employee financial statement fraud, kick backs, post-employment benefits and embezzlement of funds. The external forensic accountants quantify and document the losses, which are incurred by an organization. Holmes (2002) explains that the services of forensic accountant and certified fraud examiners will drastically reduce the cases of fraud in the corporation.
Holmes (2002) explains that the corporation can come up with antifraud program to eliminate the cases of fraud. The main aim of antifraud program is to create awareness of the consequences of committing fraud and minimize or eliminate the opportunities that are available in an organization to commit fraud. Barnes (2005) explains that the opportunities to commit fraud can be controlled through strong internal controls system. In addition, awareness can be created through constant education and ensuring every employee receives formal fraud policies of the company. From the analysis, most frauds are committed by individual employees who have worked for long in that corporation. The individual are able to override the internal control system and commit fraud. This clearly suggest that fraud may occur when the management over trust one individual in an organization. The corporation can ensure that there is adequate separation of duty to enable them arrest employees who commit fraud (Holmes, 2002).
Internal control
There are several internal systems that a corporation can implement to prevent fraudulent activities in their organization. Barnes (2005) explains that the first step is that the management should create an environment and culture that does not tolerate fraud in their organization. secondly, the management should ensure that each employee understand the internal control system. Most employees lack the knowledge of their internal control system and they become easy target from fraudster. The corporation can implement in-service courses, which will educate the employees on the internal control system (Saksena, 2001).
Barnes (2005) further explains that the corporation can implement mechanism for reporting fraud related activity that is suspected to be taking place in an organization. Holmes et al (2002) further explains that the management should set good example to employees buy obeying the laid down rules of the company. If the top management portrays high ethic and zero tolerance on fraud the rest of the employees would become afraid to commit fraud. Holmes et al (2002) explains that by setting high standards employees become afraid of being caught, which deter future crime.
From the analysis, it is that fraudulent activities have negatively affected many corporations in their daily activities. GAAP rules have significantly improved the performance of many organization through annul auditing. Needless to say, without the guidance of GAAP it would have become hard for 0companies to detect fraudulent activities in their organization.
References
American Institute of Certified Public Accountants (AICPA). (2005). Management Override of Internal Controls: The Achilles’ Heel of Fraud Prevention. NY: AICPA
Barnes, P. (2005). REDUCING AN ORGAIZATION’S SUSCEPRTIBILITY TO OCUPOTIONAL FRAUD: FACTORS AFFECTING ITS LIKELIHOOD AND SIZE, BUSINESS RISK AND SECURITY MANAGEMENT. Pg 1-11,
Crovitz, L. Gordon (2008). Closing the Information GAAP. The Wall Street Journal. Web.
Hodge, F., Martin, R. & Pratt, J. 2006. Audit qualification of income-decreasing accounting choices. Contemporary Accounting Research. Vol. 23: 369-394.
Holmes, S.A., Langford, O.J. & Welch, S. T. (2002). Associations between internal controls and organizational citizenship behavior. Journal of Management Issues 14(1): 85-99.
Saksena, P. (2001). The relationship between environmental factors and management fraud. International Journal of Conflict Management, 11(1): 120-139.