Auditing and Assurance Service: KPMG Audit of Rolls-Royce Group Report

This report examines the financial scandal involving Rolls-Royce and the auditing firm KPMG. It delves into the corruption charges, including bribery and falsification of accounts, that led to the investigation by the Financial Reporting Council (FRC). The report analyzes the issues that potentially led...Read More

Running head: AUDITING AND ASSURANCE SERVICE
Auditing and Assurance Service
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1AUDITING AND ASSURANCE SERVICE
Table of Contents
Introduction....................................................................................................................................3
KPMG Audit Plc’s audit of Rolls-Royce Group..............................................................................3
Issues that potentially led to the scandal.......................................................................................5
Initiatives taken by the regulating bodies.......................................................................................6
The particular solution in case of the Rolls-Royce accounting scandal.........................................7
Conclusion.....................................................................................................................................8
Appendix 1.....................................................................................................................................9
References and Bibliography.....................................................................................................9
Appendix 2...................................................................................................................................10

2AUDITING AND ASSURANCE SERVICE
Executive Summary
The frequency of accounting scandals has increased over the years. In spite of the
several initiatives taken by the accounting bodies the instances of the financial frauds have
been overwhelming.
This particular study aims to focus on a particular example of the financial scandal
executed by the British giant automaker company, Rolls-Royce and the auditing firm that has
been evaluating the organizational financial and non-financial auctions. KPMG has been
responsible for the evaluation of the financial statements of the company for the past twenty
years. However, looking at the fraudulent operations carried out by the company, FRC has
launched an investigation in the audit work of the company.
This study aims at providing an overview into the relevant causes of major financial
scandals and the initiatives or the solutions that have been developed by the regulating bodies
for mitigating such fraudulent occurrences.

3AUDITING AND ASSURANCE SERVICE
Introduction
The globally known and publicized series of the financial scandals that had occurred in
the last few years have effectively eroded the public trust in regards to the audit process of the
corporate bodies. The gradually increasing mistrust has led to the public, doubting the role of
the auditors carrying out such evaluating procedures. This is because the primary duty of a
public auditor lies in acting, in the interest of the public, thus safeguarding the public welfare.
The series of auditing scandals that have taken place has led to the public, question the ethics
of the auditor. In fact the trust placed in the accuracy of services provided by the auditors has
also been hampered. The importance of the ethical considerations in the profession of auditing
has increased over the years mainly due to these frequent financial scandals. The International
Federation of Accountants (IFAC) has also developed a professional code of ethics for the
auditors. This has been done in order to regulate the ethical considerations involved in the
profession of auditing. In spite of such initiatives taken, the occurrence of the auditing scandals
has not decreased in number (Pearce 2016).
This study particularly aims to focus on this particular topic of accounting scandals and
the initiatives taken by the accounting professional bodies like ICAEW, ACCA, ICAS and CIMA
and the big four auditing firms like PWC, KPMG, Deloitte and EY for improving the reputation of
the audit. In order to achieve such an outcome the particular investigation by the Financial
Reporting Council (FRC) of the audit proceedings by KPMG of British giant, Rolls Royce has
been analyzed. The issues that led to the occurrence of such a particular auditing scandal and
the recommendations for mitigating such financial scandals have also been discussed in this
study.
KPMG Audit Plc’s audit of Rolls-Royce Group
The conglomerate Rolls-Royce had already been alleged in the year of 2010, for paying
a huge amount of fine (£671 million) to the Serious Fraud Office. The luxury car company did
admit to a number of corruption charges that involved falsifying accounts, interference with the
ongoing investigations and payments in tens of millions of pounds to win the ownership of the
contracts in Indonesia, Thailand, Russia and China (Arruda de Almeida and Zagaris 2015).
KPMG has been the sole firm responsible for carrying out the audits of Rolls-Royce. The
investigation by the Financial Reporting Council has been executed in relation to the financial

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statements of the Rolls-Royce Group plc for the year ended 31 December 2010 and the Rolls-
Royce holdings plc for the financial years of 2011, 2012 and 2013. This investigation had been
carried out as a result of the Senior Fraud Office announcement on 17th January, 2017 that a
Deferred Prosecution Agreement between the Serious Fraud Office (SFO) and the Rolls-Royce
plc has been agreed (Mayer 2017).
A DPA is a statutory means with the help of which a corporate entity will have gained the
authority to appear to a court for conduct without suffering the complete consequences of a
criminal conviction that might result in restriction of the firm for competing for public contracts.
The particular event that led to the requirement of a DPA was the scandal that had taken place
in the year of 2010. The corruption charges that the leading automaker company was accused
of ranged back for more than over twenty years. Rolls-Royce has been bribing hugely for
gaining the ownerships illegally. The British giant has been adopting such unethical and illegal
practices since 1989 till 2013 (Tombs and Whyte 2015). An instance of the cases against which
the investigations are carried out is that the $100 million order for the supply of Trent 700 jet
engines to Indonesia’s Garuda airline in the year of 1991. The Indonesian deal had been a well
known deal for Rolls-Royce. The general estimation that the engines that were to be selected
belonged to the US rival Pratt & Whitney. However, the deal was overruled in favor of the Rolls-
Royce Group. Even proper evidence had been recorded in support of the unethical action
committed by the company. Senior officials at the Rolls Royce did agree to the payment of
$2.25 million along with a Rolls-Royce Silver Spirit car that was rewarded to an agent for the
sale of Trent 700 engines to Garuda (KISS, FÜLÖP and CORDOŞ 2015).
It had been further recorded that the employees of the Rolls-Royce were charged with
the payment of $2.2 million to the executives of Air Asia for winning the ownership of sales
orders. The company had admitted to a total of seven counts of conspiracy in terms of
corruption and five cases in regards to failure to prevent bribery. Furthermore, the company had
also engaged itself in the payment of bribes of a total amount of $36.3 million to the agents of
Thai Airways for securing orders (Nomoto 2016).
There have been similar instances of such illegal operations in Germany, India and
China. As a consequence, the company had received two profit warnings and had applied for a
DPA so that the company would not be criminally convicted.

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As it can be concluded from the above instances the major offences, against which the
company had been charged guilty, are payment of bribes, receiving bribes, the bribery of foreign
public officials and the failure of a commercial organization to prevent bribery.
Issues that potentially led to the scandal
The issues that led to the unlawful conduct of the leading automaker company involved
the inappropriate or unethical use of the third-party intermediaries (TPIs). TPIs include people
from the category of agents like distributors, brokers, government intermediaries and resellers.
Therefore, the unethical proceedings by Roll-Royce had occurred due to the close associations
with the suppliers, customers or the public officials and making improper offers to them for
securing orders or obtaining favoritism (Bingham and Druker 2017).
Now, the particular causes for the occurrence of a financial scandal may be numerous.
For instance, the lack of transparency in the financial transactions or the existence of a poor
structure of internal control within the organization may be the potential reasons for the
occurrence of a financial fraud. Moreover, the lack of independent audit department in the
organization might also lead to fraudulent occurring. In case of Rolls-Royce the company had
also revealed that its civil aerospace unit would have made an operating loss instead of an 800
million pound profit, if the company had used a different accounting method. The operating profit
of the group would be two-fifth of what had already been reported in the annual report. This
clearly indicates that the accounting practices followed by the automaker are complicated and
difficult to comprehend which has effectively helped in the process of executing the fraudulent
activities (Bowman 2014).
Furthermore, the issue that is coming up from the above discussions is that the auditing
evaluations of the accounting as well as the internal operating procedures of the organization
have not been conducted properly. The primary duty of an auditor lies in making sure that the
business operations that are carried out by a particular firm are genuine and reflects a true and
fair view of the financial condition of the company. However, in case of the British giant, Rolls-
Royce that primary perspective of audit has been effectively hampered. Thus, to be very
particular the issue that led to the financial scandal in Rolls-Royce was an instance of audit
capability. This means that the audit carried out by the particular auditing firm is not appropriate
as it is not looking into the proper areas or is not conducting the auditing evaluations in
accordance to the analysis framework established by the regulating bodies (Carr and Jago
2014).

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In case of Rolls-Royce the audit had been conducted by one of the big four firms that is
KPMG. However, the exposure of the financial scandal carried out by the company has
questioned the audit carried out by KPMG over the years. The Financial Reporting Council has
thus launched an investigation into the audit of Rolls-Royce by KPMG. Though KPMG had
taken enough initiative and it would be unfair to blame an audit firm for the misconduct of their
client, KPMG has failed to ensure its primary duty that is to ensure the welfare of the public who
are in this case the employees of the organization, the stakeholders and the luxury car makers
whose reputation had been at stake due to the unethical deeds carried out by Rolls-Royce. In
the annual report of Rolls-Royce for the financial year of 2014, KPMG had indicated that the
company had made use of estimations and assumptions that resulted in mildly cautious profit
recognition (Soh, Leung and Leong 2015). However, the audit firm should have been much
stricter and should have delved into the issue further, highlighting the fraudulent operations
carried out by the corporate body. The audit firm in a 2013 report had also mentioned that the
company was at risk of bribery, but again did not delve further into the issue. In support of the
perspective that the accounting scandal was a result of lack of audit capability, the FRC while
conducting the investigation had reported that the audit proceedings were deficient in nature
(William, Glover and Prawitt 2016).
Therefore, the fact that can be summarized from the above discussion is that accounting
scandal that had been carried out by the leading automaker company was a result of lack of
audit capability.
Initiatives taken by the regulating bodies
One of the international regulating bodies like the ICAEW has established an entire new
reporting model for the purpose of mitigating the occurrence of accounting scandals. The new
reporting model effectively promotes the communication of the business proceedings to the
investors and other stakeholders of business at regular intervals. The new reporting model also
establishes a transparency in reporting the business proceedings. ICAEW believes in the fact
that the ongoing financial scandals have led to a huge gap between what is being audited and
what the public believe should be audited (Cannon and Bedard 2016). The regulating body
acknowledges the requirement of an enhanced corporate reporting and a greater degree of
assurance. Thus, the potential solution lies in the fact that the corporate reporting has to
improve qualitatively. The new reporting model not only promotes transparency but also
mandates the preparation of a sustainability report that effectively should disclose all the

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information that concerns the stakeholders. Even the materiality issues should also be disclosed
in order to ensure the report reflects the true and fair view of the company (Soh, Leung and
Leong 2015).
ACCA on the other hand, has identified the reasons of lack of audit capability like the
lack of human resources as a result of high talent attrition rate, lack of focus on the audit quality
and inability to understand the business carried out by the client. ACCA recommends the
development of solutions by the proper collection of audit evidence and adopting an honest
approach while preparing the audit report for the client (Masztalerz 2014).
The ICAS or FRC that had played the major role in launching an investigation behind the
auditing proceedings carried out by KPMG in case of Rolls-Royce has developed strict
guidelines in achieving the objective of less frequent accounting scandals. After the occurrence
of the Rolls-Royce accounting scandal, the FRC did make a mandatory rule that an organization
is required to change the auditing firm carrying out its annual audit in every ten years. This is
another potential solution that may be applicable in the case of Rolls-Royce. The auditing firm,
KPMG had been associated with Rolls-Royce for a period of 25 years. This might have led to
the development of personal relationship between the firm and the company, on account of
which they adopted a lenient approach towards auditing the British giant (Dewing and Russell
2015).
The global body CIMA aims to develop a risk prevention framework that consists of four
major components prevention, detection, deterrence and response. The regulating body also
states that maintenance of high ethical standards in regards to business operations also reap
long term benefits not only to the stakeholders but also to the company as well (Knechel and
Salterio 2016).
The particular solution in case of the Rolls-Royce accounting scandal
The particular solution in regards to the Rolls-Royce financial scandal is that the auditing
process should be conducted following a particular framework. It is the primary duty of the
organization to maintain the highest standards of integrity while dealing in business operations.
However, when the case is not such, the auditor must step in and point out the particular areas
of doubt. In case of Rolls-Royce, the fraud was not just limited to a handful of rogue employees
but the senior management was also involved in paying and receiving bribes. This should have
been noted by KPMG and allegedly reported. The reasons KPMG failed to do so was lack of

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auditing capabilities. The firm being attached to its client for more than 20 years made the audit
team to blindly believe in the integrity standards of the conglomerate. Thus, this evidently
indicates that audit rotation in regards to the firm is also necessary. However, the fact that the
foremost should be adhered to is the strict following of the audit principles as laid down by the
regulating bodies. The corporate bodies should also adhere to the corporate reporting standards
established by the regulatory boards.
Conclusion
Thus, as can be concluded from the above discussions, in spite of the trust issues
between the public and the audit firms, the compliance to the solutions or amendments
established by the regulating bodies will certainly improve the future of the profession. The
corporate bodies have to understand that adopting fraudulent techniques will definitely harm the
business in the long run. Therefore, the maintenance of ethical standards will make the work of
the auditors easy and in turn ascertain and promote transparent business operations.

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Appendix 1
References and Bibliography
Alles, M.G., 2015. Drivers of the Use and Facilitators and Obstacles of the Evolution of Big Data
by the Audit Profession. Accounting Horizons, 29(2), pp.439-449.
Arruda de Almeida, M. and Zagaris, B., 2015. Political Capture in the Petrobus Corruption
Scandal: The Sad Tale of an Oil Giant. Fletcher F. World Aff., 39, p.87.
Backof, A., Bowlin, K. and Goodson, B., 2017. The impact of proposed changes to the content
of the audit report on jurors’ assessments of auditor negligence.
Bingham, C. and Druker, J., 2017. Acting With Integrity Across The World’? What Do
Multinationals Say About Labour Standards?.
Bowman, C., 2014. When are Executives Paid Too Much?.
Byrnes, P.E., Al-Awadhi, C.A., Gullvist, B., Brown-Liburd, H., Teeter, C.R., Warren Jr, J.D. and
Vasarhelyi, M., 2015. Evolution of auditing: from the traditional approach to the future audit.
Audit Analytics, 71.
Cannon, N.H. and Bedard, J.C., 2016. Auditing challenging fair value measurements: Evidence
from the field. The Accounting Review, 92(4), pp.81-114.
Carr, I.M. and Jago, R., 2014. Corruption, Money Laundering, Secrecy and Societal
Responsibility of Banks.
Christensen, B.E., Glover, S.M., Omer, T.C. and Shelley, M.K., 2016. Understanding audit
quality: Insights from audit professionals and investors. Contemporary Accounting Research,
33(4), pp.1648-1684.
Dewing, I.P. and Russell, P.O., 2015. Audit, Supervision and Risk in Financial Services. ICAS.
KISS, C., FÜLÖP, M.T. and CORDOŞ, G.S., 2015. Relevant Aspects Regarding the Changes of
the Statutory Audit Report in the Light of International Regulations. Audit Financiar, 13(126).
Knechel, W.R. and Salterio, S.E., 2016. Auditing: Assurance and risk. Taylor & Francis.

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Kogan, A., Alles, M.G., Vasarhelyi, M.A. and Wu, J., 2014. Design and evaluation of a
continuous data level auditing system. Auditing: A Journal of Practice & Theory, 33(4), pp.221-
245.
Masztalerz, M., 2014. Global Management Accounting Principles-Emperor's New Clothes.
Research Papers of Wrocław University of Economics, (345).
Mayer, C., 2017. Whose Responsible for Irresponsible Business? An Assessment.
Nomoto, S., 2016, September. Product planning and innovative developments from the
perspective of anticipated market trends in the coming years: An analytical approach based on
machine tools developed for auto manufacturers. In Management of Engineering and
Technology (PICMET), 2016 Portland International Conference on (pp. 2549-2562). IEEE.
Pearce, B., 2016. Gatsby’s Rolls-Royce: reflections on the automobile and literature. English
Academy Review, 33(2), pp.52-67.
Soh, D.S., Leung, P. and Leong, S., 2015. The development of integrated reporting and the role
of the accounting and auditing profession. In Social Audit Regulation (pp. 33-57). Springer
International Publishing.
Tombs, S. and Whyte, D., 2015. Introduction to the Special Issue on ‘Crimes of the Powerful’.
The Howard Journal of Crime and Justice, 54(1), pp.1-7.
William Jr, M., Glover, S. and Prawitt, D., 2016. Auditing and assurance services: A systematic
approach. McGraw-Hill Education.
Appendix 2
ISSUES
AUDIT
FACTORS
POTENTIAL
SOLUTION
Deloitte LLP - Mitie Group plc audit Discrepancy in
the books of
accounts by
the amout of
$40 to $50
million had
been found
Lack of Audit
capability
Improvement
s in regards to
risk
management
and internal
audiit
required
BT Group plc and the audit by
PricewaterhouseCoopers LLP Financial
irregularities
in the Italian
Lack of Audit
capability
FRC had
mandated the
period of

11AUDITING AND ASSURANCE SERVICE
unit of the
firm led to a
fine of $530
million
audit rotation
by 10 years in
order to
disassociate
personal
relationships.
BT has agreed
to hire KPMG.
KPMG Audit Plc's audit of Rolls-Royce Group Rolls-Ryce had
been charged
against
payment of
bribes,
receiving
bribes, the
bribery of
foreign public
officials and
the failure of a
commercial
organization
to prevent
bribery.
Lack of Audit
capability
FRC had
mandated the
period of
audit rotation
by 10 years in
order to
disassociate
personal
relationships.
Rolls-Royce
has agreed to
hire PwC.
PricewaterhouseCoopers LLP's audit of
Redcentric plc
FRC has
launched the
investigtion in
order to
investigate the
connduct of
PwC
Lack of Audit
capability
Not
applicable