Analysis of Material Misstatement in Financial Statements

Desklib provides past papers and solved assignments for students. This project analyzes material misstatements and their impact.

Audit, Assurance, and Compliance
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Executive Summary
This project focuses on the effect a material misstatement on the key stakeholders provided
misstatement is not identified, adjusted or properly disclosed in the financial statement.
Different types of risks associated with each stakeholder have also been explained. In
addition to this importance of whistleblowing in relation to auditors have also been
considered. Enron Scandal and lesson learned by the auditor have also been explained.
Along with this audit quality has also been explained.
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Table of Contents
Executive Summary..................................................................................................................2
Introduction............................................................................................................................. 4
1) Key stakeholder analysis & how stakeholders are affected if material misstatement.....5
2) The concept of independence & whistleblowing in relation to auditor...........................7
3) What Lessons can auditor learns from the Enron scandal: -............................................9
4) Audit Quality.................................................................................................................. 12
Conclusion.............................................................................................................................. 16
References..............................................................................................................................17
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Introduction
This project is divided into four parts. The first part of the project focuses on how a material
misstatement in financial statement affects the users of the financial statement. The effect
has been properly analysed and discussed. The second part of this project deals with
concepts of independence and whistleblowing in relation to auditors. Their effects on the
public are also considered in this part. The third part of this project gives an insight into
Enron scandal and what lessons auditor has learned from this scandal. Last part of this
project focuses on different aspects which are related to quality of the audit.
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1) Key stakeholder analysis & how stakeholders are affected if material misstatement.
Financial statement plays an important role in an organization. Financial statement shows a
true & fair picture of the organization. After looking financials of any company investor can
easily understand where the company stands. Whether a company is a growing company,
business plans, strategies etc. Financial statements include both position statement and
statement of profit and loss account. The main objective of these statements is to provide
an overall fair view. Investors are able to make appropriate decisions making whether to
invest or trust in the company or not.
The financial statement can be used by different -2 users for different purposes. Top level
management of the organization can use financial statements for making strategies in order
to achieve objectives of the business. Shareholders are able to decide whether to hold
shares or to sell them. It is very easy for investors in decision making to check it is
appropriate or not to invest in the company.
Material misstatement in financial statement plays a major role in breaching the trust of
stakeholders. This is also because of the reason of company dis-reputation. In the case
where the financial statement of the company materially misstated, then this will adversely
or negatively affect goodwill of the company in the market. The market price of the share
also decreases.
Misstatement may arise due to fraud & error. If financial statements of a company are
materially misstated due to fraud, then in such case it is difficult to find out misstatements
because top management is involved. In that case, these statements will not show the
correct picture of the organisation. The company is in losses but top management
manipulates profit & loss account & balance sheet in such a way that present better position
of the company is being presented. Financial institutions also suffer losses. The
creditworthiness of the company also decreases.
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In case material misstatement is not properly identified, adjusted or disclosed in a financial
statement then, this will show the company's capabilities to survive in the long run. It affects
the fundamental principle of accounting i.e. going concern assumption. The growth of the
company also affected because investors in the company do not take any interest to invest
in the company. Top management of the company for achieving their personal goals &
objectives manipulates financial statements. Management uses company assets for personal
purposes; this will make a bad impression in the mind of stakeholders.
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2) The concept of independence & whistleblowing in relation to auditor
Independence simply means auditing work is conducted in an unbiased manner. Auditors
are required to perform their rights & duties in an independent manner. Auditor's
independence includes both external auditors as well as an internal auditor. Independence
requires while auditors perform their duties they follow professional skepticism concept.
Professional scepticism simply means auditors remains alerts for probable misstatements,
which can happen during the course of the audit. The main objective of auditor's
independence is that it serves reliable information which is used to take credit decisions &
investments approvals. In capital markets it is required auditing is conducted cost efficiently.
Independence requires auditors of the company should follow integrity & objective
approach. Auditors of the company performed their work without any influence of top-level
management.
In the case where auditor finds any irregularities in the operations of the company, the audit
needs to report to the management. Before independence, auditors need to be qualified
enough to conduct audit work professionally. Auditors required asking management
whether internal control system is properly implemented or not. In case there is no effective
internal control system then this will affect the independence of the auditor.
Whistleblowing is a term which is used in the case where a wrong activity is carried out
during the operations of the organisation. Where operations of the company are carried out
wrongly then in such case auditors are required to report top level management. It is an act
or a thing to show to the public or organization that working done by organization is
immoral or illegal. This is the duty of the auditor to report management everything which is
happened wrongly in the company.
The auditor needs to apply whistleblowing approach to stop wrong practices within the
organization. In the case where an employee discovers any immoral & unethical practices at
workplace then there are a lot of questions in the mind of employees in regards to that
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information. This term relates to the decision taken by the employee to disclose the
information to the higher level authority.
Whistleblowing term is used to define auditors to teach how they take decisions with
potentially damaging information. There are both the probabilities good and bad.
Whistleblowing helps to end all unethical practices which are carried out within the
organization. The actions of whistle-blowers are importantly benefited for the society as a
whole.
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3) What Lessons can auditor learns from the Enron scandal: -
Enron scandal was considered one of the biggest corporate scandals in the world. Investors
in the company suffered huge losses. When the scandal was come up before the public the
market price of the share goes down drastically. In the year 1990, Enron Company was
considered as one of the biggest innovative company in natural gas, communication &
electricity sector. Enron has a specialty in the field of the natural gas sector. In the year
2000, the company financial position is very strong. Enron makes huge profits. The market
price of the share also is on a hike. Enron is considered a well-reputed company in the
whole world. Investors trust easily because financials shows positive & growth trend.
In the year 2001, Enron faces difficulties. This is the year in which Enron scandal in published
in public. This is a sudden collapse situation for Enron. Enron is not in a situation to pay their
debts. Assets of the company are not sufficient enough to pay debts. Hence Enron declared
bankruptcy.
Top management of Enron including CFO’s, CEO’s, and Managers indulge themselves in
unethical practices. Financial statement of the company did not present a correct view.
Financial statements are materially misstated. Top management of Enron manipulates these
statements; assets are recorded at very high values. Liabilities of the company like trade
payables, loans & advances are shows at reduced prices. Financial statements of Enron
show better financial position but in actual Enron suffered huge losses. Top management of
the company engaged in wrong trade practices to attract investors, stakeholders & lenders.
The internal control system of Enron is not capable enough to detect misstatements.
Internal auditors of the Enron are also not independent enough to perform their work
efficiently.
Arthur Anderson is a top leading auditing firm. Arthur Anderson has many clients in the
corporate world. Enron is one of the biggest reputed audit firms. Arthur Anderson is not
able to detect material misstatements in the financial statements of Enron. It can also be
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considered as one of the biggest reason for Enron collapse. Auditing firm Arthur Anderson
does not perform their rights & duties properly. They are not competent enough to perform
their rights & responsibilities the main reason behind is that they are completely influenced
by top management of Enron. For the reason of bad practice approach of Enron & due to
conflict of interest situation of Arthur, Anderson company is not managed their work
efficiently. As per auditing principles, Arthur Anderson is only responsible to conduct an
audit as per applicable regulatory framework. It is the responsibility of top management of
Enron to prepare a financial statement. Auditor has no rights to prepare a financial
statement.
Following are the lessons that can be learned by an auditor from Enron scandal -
Overall independence - This is the basic need in an auditing system. Auditors are required
to be independent when they usually perform their duties. In the case where auditors of the
company are influenced by top-level management than in such case, auditors are not able
to do things as per their own mind. Auditors are depended upon top management. The
functions which are usually be done by the board, performed by auditors in an unbiased
manner. In the case of the Enron scandal, it is to be seen that auditors of the company i.e.
Arthur Anderson are totally dependent upon top management of Enron & this will result in
company failure.
Confidentiality & integrity – In auditing the fundamental principle is that information of the
client needs to remain confidential. It is a professional behaviour that can be maintained by
auditors throughout the audit. In the case of Arthur Anderson, they disclose confidential
information of their client & this will become the big failure for Enron. Integrity simply
means auditors of the company remains honest & trustworthy towards their effort. This is a
compliance requirement for auditors to become integral & confidential.
Act on behalf of stakeholders of the company – From the Enron scandal, it is to be learned
by the auditor that the company will work to achieve the overall objectives of the
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stakeholders of the company. Stakeholders of the company include all i.e. shareholders,
investors, financiers, employees, management etc. Enron uses assets of the company for
their personal purposes. This will affect stakeholders trust. Using company asset for their
personal purpose is not a good practice. Auditors of the company need to oversee that
whether company do their work in accordance with to achieve the overall objectives of
stakeholders.
Auditing with the alert mind – Auditors of the company needs to perform audit work by
applying professional scepticism technique. Professional scepticism simply means that
auditor of the company remains alert for future probable threats. Auditors of the company
do not rely upon top management easily. They are required to gather additional evidence to
validate their work. Evidence obtained by auditor himself is more reliable in comparison to
evidence provided by management. In comparison to photocopies actual documents are
more reliable hence auditor needs to gather evidence at his own.
Evaluation of financial statement – Preparing financial statements of the organisation is the
responsibility of the management. This is not the duty of auditors to prepare a financial
statement, the auditor is only responsible to conduct an audit as per auditing standards. The
auditor is required to give an opinion over true & fair view of these statements of the
company.
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4) Audit Quality
Audit Quality is considered one of the most important aspects of the audit. Maintaining high
standards of audit quality builds confidence in the profession of Audit. Not only this, high
quality of audit helps the organisation in building confidence in the clients to invest in the
company. Audit Quality helps in creating faith, confidence, and credibility in respect of all
the records of the company. Auditing Standards also plays a very important role in
maintaining Audit Quality.
Audit Quality helps in creating an environment which focuses on maximising the fact that
different audits are performed on a consistent basis taking into account Quality as the base.
A Quality audit can be achieved by the engagement team if-
 Appropriate values have been exhibited.
 Appropriate ethics and positive attitude has been kept
 Knowledge, skill and experience of the audit team
 Time is taken to perform the respective audit.
 Internal Controls of the organisation.
A quality audit can be achieved if there are proper support and interaction among different
participants of the engagement team. Auditors should properly follow relevant auditing
standards and maintain standards on quality control so as to ensure that an effective audit
is being carried on. Proper communication with the management, different stakeholders,
TCWG acts as the pillars for a good quality audit.
Before starting the audit, the auditor should make a brief study of the background of the
company. An overall framework including a focus on an audit of financial statements, past
audit reports, complexities noted during the course of audit also helps in maintaining the
quality of the audit. All these factors apply to all the entities irrespective of their size and
nature. In brief audit quality can be regarded as a systematic and continuous examination of
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