Business organizations are usually keen on remaining financially healthy, as this is one of the main ways of attracting investors. Moreover, corporate executives are aware that a company must be financially healthy to receive higher compensations or salaries. With this in mind, most business organizations tend to overstate revenues and assets while understating expenses and liabilities. This kind of manipulation not only affects the company but also the company’s auditors who are held liable and the third parties who unknowing conduct business with such organizations. However, the Securities and Exchange Commission (SEC) has stepped in to reduce these financial manipulations. SEC has tried to reduce these incidents though it has not succeeded mainly due to the enormous latitude, which is afforded by the Generally Accepted Accounting Principles (GAAP). Following this, most corporations are continually becoming involved in financial accounting, which in turn misleads investors and shareholders. One of the companies that have been involved in the financial accounting scandal is Toshiba
Analyzing the audit report that the CPA firm issued
In July 2015, Toshiba was involved in an about $ 1.2 billion financial accounting scandal in overstated operating profits. The accounting scandal can be tracked to 2008 when Toshiba inflated its profits to deal with the global financial crisis. In essence, Toshiba pushed back losses, booked f profits early as well as pushed back charges to come up with overstated profits. According to Hass, Burnaby, and Nkashima (2018), the corporate managers demanded the employees achieve some strict profit targets and failure would not be accepted. Consequently, the business unit presidents were forced to achieve the targets using irregular accounting practices. As it is, Toshiba had poor controls in finance, risk management, and corporate auditing divisions. The Securities and Exchanges Commission investigated Toshiba over the financial accounting scandal. In as much as Toshiba had overstated its profits, SEC did not impose any fine on Toshiba. However, Toshiba’s woes are not yet over as foreign investors have sued this company for damages amounting to $162.3 million following the scandal.
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Ascertaining the legal liability to third parties who relied on financial statements under both common and federal securities laws
Toshiba owes legal liability to the third parties who relied on financial statements under both the common and federal law. The main third parties are investors, stakeholders, and banks. Under the common law, the third party is allowed to sue the company if the claimant incurred loss after relying on the information in the financial statements. The legal liability to third parties allows financial institutions, banks, vendors’ customers, employees actual and potential stakeholders to sue the auditors who have failed to recognize a financial accounting error (PCAOB, 2018).
The GAAS principle that was violated in the Toshiba financial accounting scandal
The Toshiba financial accounting scandal violated several principles of the Generally Accepted Auditing Standards. For one, Toshiba failed to adhere to the principle of consistency, which calls for business corporations to apply the same standards throughout the auditing process to prevent discrepancies and errors. Moreover, Toshiba failed to adhere to the principle of prudence, which calls upon business organizations to report factual financial data instead of relying on speculation. In Toshiba’s case, the figures are not representative of the factual financial data but rather speculation to fill in the profitability deficit. Furthermore, Toshiba failed to adhere to the principle of materiality, which calls upon accountants to embrace full disclosure of the company’s financial status (Public Company Accounting Oversight Board, 2018). On the contrary, Toshiba understated its liabilities and expenses while overstating its profits and assets. Finally, Toshiba forewent the principle of utmost faith in financial reporting, as it did not embrace honesty in its financial reporting
Comparison of the responsibility of both management and the auditor for financial reporting, and an opinion as to which party should have the greater burden
The management and the auditors have several responsibilities when it comes to financial reporting. The management initiates the financial reporting process through the various departments. Each of the department is required to submit its budgetary needs as well as receipts to indicate its pending. At the center of the company is the financial division, which collates all of the financial information to determine a company’s assets, liabilities, expenditures, and income. The management is tasked with the responsibility of ensuring that its accountants capture all of the financial information to come up with comprehensive and reflective financial statements. In this case, the financial division under the leadership of the management comes up with balance sheets, trading profit and loss accounts, and other financial statements. From here, the management enlists the help of auditors who can be both internal and external to ascertain where the financial records and stamen adhere to the generally accepted auditing standards or not.
Auditors play a crucial role in the auditing process as they help establish whether the company’s financial statements are authentic or not. The reason auditors are effective in their work is the fact that they are impartial, as they do not report to the person under the audit nor do the auditors pay to depend on the outcome. In essence, auditors tend to take responsibility for the audit results when checking for the financial reports accuracy and transparency (Zager, Malis, and Novak, 2016). As a result, it is in the financial interest of the auditors to give accurate feedback, as they may be liable for prosecution if they give inaccurate financial reporting feedback. For this reason, auditors must give a professional opinion when it comes to establishing whether there is embezzlement, accounting fraud, pilferage, theft, reimbursement abuse or inventory leakage.
From this comparison on the responsibilities of both the management and the auditors, it is clear that the auditors have a greater burden when it comes to the financial report. For one the auditor must scrutinize all of the aspects of the financial statements to verify whether they are correct or not. Furthermore, auditors must ensure that they report the actual status of the financial reports since a failure to do so may lead to legal liabilities from the third parties. As it is, third parties such as investor and stakeholders rely on audited financial reports to make investment decisions. As such, the auditors have a heavier burden of ascertaining the accuracy of the financial reports and statements.
Analyzing the sanctions available under SOX, and recommending the key action(s) that the PCAOB should take in order to hold management or the audit firm accountable for the accounting irregularities
The Sarbanes –Oxley Act (SOX) exists to ensure the reliability of financial reporting as well as the quality of audit outcomes. The Act ended self-regulation in auditing by creating the Public Company Accounting Oversight Board (PCAOB). Moreover, this act aimed at giving auditors more independence with the aim of enhancing the reliability and accuracy of financial reporting. Under the Sarbanes-Oxley Act, PCAOB may use several sanctions to deal with a company that has engaged in a financial accounting scandal such as Toshiba. PCAOB may require Toshiba to disclose off-balance sheet transactions for both the annual and quarterly financial reports §401 (Ernst &Young, 2012). Furthermore, Toshiba would be required to reconcile its pro forma information with GAAP by ensuring that it does not omit any information which would impede financial disclosures under §401. Additionally PCAOB may require Toshiba to give information on whether the senior officers have adopted a code of ethics to regulate the financial behaviors under (§406). These provisions apply to Toshiba considering that the top management was involved in manipulating the financial reports to appear profitable to attract investors and shareholders. The PCAOB may sanction the auditing firm by suspending its operations for a particular period for its failure to supervise the company under scrutiny as provided for in §105 (Ernst &Young, 2012).
References
Ernst & Young.(2012). The Sarbanes-Oxley Act at 10: Enhancing the Reliability of Financial Reporting and Audit Quality . Retrieved on 10 February 2019 from https://www.ey.com/Publication/vwLUAssets/The_Sarbanes-Oxley_Act_at_10_’’’’’’’-_Enhancing_the_reliability_of_financial_reporting_and_audit_quality/%24FILE/JJ0003.pdf
Hass, S., Burnaby, P., & Nkashima, M. (2018). Toshiba Corporation—How Could So Much Be So Wrong? Journal of Forensic and Investigative Accounting, 10(2), 267-280.
Public Company Accounting Oversight Board. (2018). Auditing Standards of the Public Company Accounting Oversight Board as of December 15, 2017. Retrieved on 10 February 2019 from https://pcaobus.org/Standards/Auditing/Documents/PCAOB_Auditing_Standards_as_of_December_15_2017.pdf
Zager, L., Malis, S. S., & Novak, A. (2016). The Role and Responsibility of Auditors in Prevention and Detection of Fraudulent Financial Reporting. P rocedia Economics and Finance, 39(2016): 693-700.
