This matter concerns an audit of Jersey Johnnie’s Surfboards Inc., and allegations concerning accounting improprieties and concerns regarding accurate financial reporting. Internal investigation has been commenced, and outside legal counsel has been engaged to review the matter.
1. In response to the foregoing, company management, the Board of Directors, or the Audit Committee of the Board of Directors should take the following action in response to allegations of possible fraud or illegal acts in terms of detection and response: maintain and foster whistle-blower methods, such as the anonymous hotline already in place; continue internal and external auditing and monitoring functions; conduct immediate analysis of forensic date; conduct internal investigations; develop specific protocols for internal investigations, accountability and enforcement, and disclosure; and take any and all necessary remedial action (Fraud Risk Management-KPMG, n.d.).
2. The audit engagement team should take the following action in response to allegations of possible fraud or illegal acts: identification and assessment of the potential for material misstatements in the financial statements due to fraud; research, analyze and obtain evidence concerning the fraud risk. These steps can be taken by first establishing ‘professional skepticism’ regarding the sufficiency of the financial reporting; engaging in dialogue with management, followed by conversations with those in charge of governance; identifying unusual or unexpected relationships in the subject transactions, and identifying the basis for the fraud risk (AU-C Section 240-AICPA, n.d).
3. In response to the allegations, the outside legal counsel hired by the Audit Committee conducted an investigation concerning the allegations of possible fraud or illegal acts and provided a draft report. The scope of this report is not sufficient to support the preliminary conclusions reached by counsel. The person in charge of signing purchase orders, the General Manager, was not interviewed, and was not privy to the approval of the Sinaloa agreement because he was on vacation. There exists a very real possibility that this individual may have an entirely different opinion on the matter. On the whole, the outside counsel must do its best to try and identify, perhaps with the help of the Audit Committee or external audit team, the key players involved in this transaction. It is absolutely not sufficient to rely upon interviews with personnel that have been identified solely by management or others who may have a potential interest in squelching any adverse findings. (Loewenson, n.d; Fraud Risk Management-KPMG, n.d)
4. Because the investigative scope is insufficient, the following additional procedures or inquiries should made, including without limitation, any and all communications related to the CFO concerning this transaction. The CFO has been alleged to be a driving force in this transaction, and it bears further investigation and due diligence. Moreover, the report should specify the interview methods and outcomes of conversations with the related parties (Loewenson, n.d). If possible determining the identity of the whistleblower would be helpful, as would interviewing the operator who took the call. There also need to be adequate assurances that there is no nexus or relationship between outside counsel and any of the governance or management personnel, as that could have a seriously negative impact on the independent nature of review. Id.
5. In this instance, those in charge of governance or management arguably have not given sufficient and/or appropriate interventions given the above-mentioned circumstances. In response, the audit engagement team should take into account certain considerations with respect to the implications of possible fraud or illegal acts when conducting the audit. First and foremost, in the absence of reasonable assurances from management concerning the propriety of accounting practice, audit teams should maintain skepticism regarding the information provided (AU-C Section 240-AICPA (n.d). Despite their best efforts, the reality is that fraud may not be detected, and the audit team must make public statements to this effect. Id.
- AU-C Section 240 Consideration of Fraud in a Financial Statement Audit Source: SAS No. 122; SAS No. 128. (n.d.) American Institute of Certified Public Accountants (AICPA). http://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-C-00240.pdf.
- “Fraud Risk Management Developing a Strategy for Prevention, Detection, and Response” (n.d). KPMG Forensic, Advisory Services. Retrieved from: http://www.kpmg.com/CN/en/IssuesAndInsights/ArticlesPublications/Documents/Fraud-Risk-Management-O-200610.pdf
- Loewenson, C.H., Ethics of Internal Investigations.” Morrison & Foerster LLP. Retrieved from: http://www.mofo.com/~/media/Files/Resources/Publications/2008/06/Ethics%20of%20Internal%20Investigations/Files/Ethics%20of%20Internal%20Investigations/FileAttachment/Loewenson_Ethics_of_Internal_Investigation.pdf