Auditors and Regulatory Oversight
Hill International Accounting Scandal
According to Jaeger (2020), the SEC brought a case against Hill International after the regulatory body identified accounting errors in the company’s financial statements. The company’s former chief and senior accounting officers were accused of failing to maintain accurate books. The primary accusations were that the accounting officers in the company restated the company’s book of accounts for three consecutive years (2014, 2015, 2016, and the first quarter of 2017), leading to the reduction of the company’s net income by $30 million. The accountants covered $5 million in losses through foreign exchange obligations that were not recorded in 2014. SEC identified the error in 2017.
Legal Liability to Third Parties
The auditors that audited Hill International are legally liable to third parties for deliberately ignoring the accounting errors. Even if the company followed national reporting standards, the fact that the CPA firm knew that Hill International lied about some transactions makes them legally liable.
Besides, SOX provisions provide that an auditing firm owes third parties a duty of care. For this reason, the SEC requires all auditors to register with them. Auditors should include specific personal details of the accountants who work with the auditing company. The auditing firm should regularly update its information to ensure that third parties know who works in these firms. Third parties will decide whether they can rely on CPA firms’ information based on the accountability and transparency of those who work at the company (Chung et al., 2010). Based on these provisions, the CPA firm that ignored the accounting mistakes made by the company’s auditors is legally liable to third parties.
Generally Accepted Auditing Standards (GAAS) Violation
GAAS provisions are subdivided into three sections. Hill International violations during audit preparation cut across all three categories. The first category is referred to as general standards. One of the key provisions under GAAS provisions is that an auditor must maintain an independent mental attitude when auditing a company’s books of account (US AICPA, n.d.). However, Hill International’s key accounting personalities (the chief and senior accounting officers) failed to uphold the requirement. Instead, the two falsified entries over three years to protect the company’s reputation and create false confidence in third parties. Still, in the same category, the company’s auditors failed to practice professional care while preparing audit reports. Hill International subjected shareholders to significant losses due to the errors recorded by the two accountants.
Hill International’s accountants also violated some standards of fieldwork. One of the requirements under this section is that auditors need to understand an entity and its environment (US AICPA, n.d.). The two accountants deliberately ignored the risk of material misstatement while reporting.
The third GAAS section refers to the standards of reporting. One of the requirements under this section is that accountants need to state why reporting standards in the current period are not consistent with the preceding period (US AICPA, n.d.). Hill International’s accountants erred by using the same financial reports for three consecutive years.
The Responsibility of Management and the Auditor in Financial Reporting
According to the Public Company Accounting Oversight Board (2002), both the auditors and the company’s management share a role in the financial reporting function. Some of the management’s roles include establishing sound financial reporting policies and creating effective internal controls to ensure proper reporting. Although the management is explicitly responsible for reporting, conflicts of interest occur from time to time. The conflicts usually involve the agent (management) and the principal (shareholders), and they may lead to false reporting. For instance, if a manager’s financial bonuses are based on the firm’s performance, they may exaggerate financial performance to attain the benefits.
Auditors come in to resolve the principal-agent conflicts of interest. That is achieved by ensuring that the management issues truthful financial reports as per the GAAP and GAAS principles (Public Company Accounting Oversight Board, 2002). An auditor conducts the exercise as per the demands of the regulations to ensure a company’s financial reports are free from any material misstatements.
Based on the management and auditors’ roles in financial reporting, I think the management bears a greater burden. That is because the management largely controls internal reporting processes. Even when external auditors are involved, the management still has the upper hand. The external auditors’ incentives are not aligned with shareholder incentives but rather management incentives. Managers can incentivize auditors to fabricate financial reports to get performance benefits. Therefore, financial statements are largely a manager’s responsibility, while an auditor only shares their opinion.
Sarbanes–Oxley Act (SOX) of 2002 significantly impacted the management’s role in financial reporting. It requires managers to verify financial reports personally. A willful false certification of financial reports exposes managers to prosecution by the Public Company Accounting Oversight Board (PCAOB) and could face between 10-20 years in prison (Blokhin, 2019). Another disciplinary sanction available for PCAOB was to force the management of Hill International to give up profits and bonuses from the sale of the company’s stock.
Blokhin, A. (2019, June 27). The Impact of the Sarbanes-Oxley Act of 2002. Investopedia. https://www.investopedia.com/ask/answers/052815/what-impact-did-sarbanesoxley-act-have-corporate-governance-united-states.asp
Chung, J., Farrar, J., Puri, P., & Thorne, L. (2010). Auditor liability to third parties after Sarbanes-Oxley: An international comparison of regulatory and legal reforms. Journal of International Accounting, Auditing and Taxation, 19(1), 66–78. https://doi.org/10.1016/j.intaccaudtax.2009.12.005
Jaeger, J. (2020, January 21). SEC charges Hill International with accounting fraud. Compliance Week. https://www.complianceweek.com/accounting-and-auditing/sec-charges-hill-international-with-accounting-fraud/28328.article
Public Company Accounting Oversight Board. (2002). AU Section 110 – Responsibilities and Functions of the Independent Auditor. Default. https://pcaobus.org/oversight/standards/archived-standards/pre-reorganized-auditing-standards-interpretations/details/AU110
US AICPA. (n.d.). Generally Accepted Auditing Standards Generally Accepted Auditing Standards. Retrieved May 1, 2022, from https://us.aicpa.org/content/dam/aicpa/research/standards/auditattest/downloadabledocuments/au-00150.pdf
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The Securities and Exchange Commission (SEC) regulates public companies. The SEC has found that some of these companies have violated GAAP by using creative accounting practices to mislead investors and creditors regarding the health of their company.
Use the Internet or Strayer Library to research a recent accounting scandal within the last five years where the SEC accused public companies of accounting irregularities.
Write a 3–4 page paper in which you:
Analyze the audit report that the CPA firm issued. Ascertain the legal liability to third parties who relied on financial statements under both common and federal securities laws. Justify your response.
Speculate on which statement of generally accepted auditing standards (GAAS) that the company violated in performing the audit.
Compare the responsibility of both management and the auditor for financial reporting, and give your opinion as to which party should have the greater burden. Defend your position.
Analyze the sanctions available under SOX and recommend the key action or actions that the PCAOB should take in order to hold management or the audit firm accountable for the accounting irregularities. Provide a rationale for your response.
Use the Strayer Library to locate at least two quality academic resources in this assignment. Note: Wikipedia and other similar websites do not qualify as academic resources.
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