NEW CENTURY FINANCIAL - KPMG was fined a $1 billion lawsuit in 2009 by the trustee of bankrupt of New Century. The New Century shareholders accused KPMG of assisting cover up accounting and financial errors at New Century that led to its collapse.
The rise in the audit failure and the lawsuits facing the auditing firms had become a significant concern internationally. Many businesses are facing lawsuits as a result of misconduct during the auditing process. Negligence by the audit staff is one of the primary causes of the rise in the number of litigations facing auditing firms. When conducting an audit process, the auditor is required to apply due diligence and care in carrying out the process. The audit staff should be able to discover any errors in the books of the account and report in in its final audit report ( Hung Chan, & Wu, 2011) . Any misappropriation or misstatement in the financial statements must be detected and reported. However, when the auditor who must present the accurate report about the financial statements becomes negligent in the course of duty and fails to unearth any misappropriation, the individual audit firm is responsible for the loss incurred by the client. An auditor is trusted by the shareholders to give an accurate report, failure to which the audit firm can be sued for any loss as a result of its report.
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An auditor is expected to be independent while carrying out the verification process. The independence of the auditor is necessary for ensuring that the report given by the auditor is accurate, reliable and verifiable. When the freedom of the auditor is compromised, and the auditor provides inaccurate report, the individual audit firm is responsible for any loss or damage incurred by the client. The client can sue the audit firm for failing carry out the duty as expected by the auditing act.
Partnering with the management to seal a fraud conducted can also lead to litigation. The auditor is always required to remain neutral and perform his duty without being compromised. An auditor partner with the management to hide a fraud that has been conducted can put a firm into lawsuits. The auditor is expected to act in the best interest of the client and should not partner with the management in hiding a fraud.
Litigation has various effects on the auditing firm. It can cause financial damage to the audit firm. Where a company is sued in the court for failing to carry out its duty as required, there are always fines and penalties that the business is ordered to pay. The penalties are huge and can cause severe financial problems to a firm. Litigation can also damage the reputation and the name of the audit firm. Damage to the name can make the company lose clients because every client will want a company without integrity issues. Due to the considerable amount of fines and penalties, litigation can force a firm into bankruptcy.
The critical ethical internal control that led to litigation was lack of transparency. Ethics calls for transparency in dealing with a client. Lack of transparency can make an auditing firm fail to raise a red flag for any errors discovered in the financial statements. Honesty is another ethical issue that led to litigation of the company. The audit firm was not honest while making its audit report and the business had relied upon that report; the audit firm is liable for any damage.
The primary ethical standards of accounting organization’s leadership include integrity, credibility, and competence. Leaders are required to have the highest level of integrity. They should be honest and truthful in everything that they do. The leadership of the organization failed to show integrity thus leading to litigation. The leadership should show competence by performing duties according to the set rules and regulations. The management never demonstrated competence in its actions leading to the lawsuit. The management of the organization also lacked credibility. A credible leader must communicate all information fairly and objectively.
KMPG, an auditing firm assisted the management of the New Century in hiding an error in the financial statement that led to a loss to the organization. The management of the new century manipulated the financial statements to give false information. According to the professional code of conduct of accountants, an auditor should be independent and conduct his duty with due diligence and care. The code bares accountants from being compromised to act in favor of an individual or an organization. Any accountant or auditor who goes against the professional code of conduct is liable for the loss as a result of their misconduct. The action taken against this firm was, therefore, an appropriate action as per the professional code of conduct.
In preventing fraud in the financial statements, there should be a strong internal control system where most of the activities are automated. Automation will help reduce malicious fraud by the accountants. Separation of duties should also be used to control fraud ( DE Fond, 2010). A person receiving cash should be different from the one who writes the receipt. A practice certificate should be taken away from any auditor who is found to engage in malpractices either by negligence or intentional. Doing this will make auditors more careful and apply due diligence in the performance of their duty. All accountants and auditors must follow the prescribed professional code of conduct.
References
DE Fond, M. L. (2010). How should the auditors be audited? Comparing the PCAOB inspections with the AICPA peer reviews. Journal of Accounting and Economics , 49 (1), 104-108.
Hung Chan, K., & Wu, D. (2011). Aggregate quasi rents and auditor independence: Evidence from audit firm mergers in China. Contemporary Accounting Research , 28 (1), 175-213.
