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- A Chinese wall is most commonly employed in investment banks, between the corporate-advisory area and the brokering department in order to separate those giving corporate advice on takeovers from those advising clients about buying shares.
- The "wall" is thrown up to prevent leaks of corporate inside information, which could influence the advice given to clients making investments, and allow staff to take advantage of facts that are not yet known to the general public.
- PCAOB (Public Company Accounting Oversight Board)
- The PCAOB sets and enforces auditing, quality control, ethics, independence and other standards relating to audit reports.
- New rules for auditors
- Auditors must report specific information to the company's audit committee.
- New roles for audit committees
- Audit committee members must be on the company's board of directors and be independent of the company.
- New rules for management
- Requires the CEO and CFO to certify that financial statements and disclosures are firly presented.
- New internal control requirements (Section404)
- Management is responsible for establishing and maintaining an adequate internal control structure and appropriate control procedures.
- Increases responsibility and accountability of CEO's and directors:
- Section 302:Managers must evaluate the disclosure controls on a quaterly basis.
- Section 404:Mangers must document, test, and evaluate controls.
- Increases white-collar crime penalties.
- Auditors and consulting:
- seperate auditors and consulting functions.
Active and deliberate threats: Fraud/ Embezzlement/ Sabotage
Passive and unintentional threats: Accounting error/ Natual disasters/ Poor management desicion making.
:Adeliberate act or untruth intended to obtain unfair or unlawful gain.
- - Information-relate clime
- - Eg. overstate assets or revenue.
- - Samll companies usually happpened.
- 1. Misappropriation of assets.
- - Misues of company resources for personal gian.
- - Theft or embezzlement of assets.
- 2. raudulent financial reporting (83%)
- - Report ficticious revenue.
- - recognize future revenue now.
- - delay expenditure.
- - contractual benchmark (bonus, stock option)
Definition:A favorable interpretation of GAAP which result in a higher or lower net income.
Firms manage earnings when there are:
- 1. Stock market motivations
- - Incentive to MBE
- - Incentive to not report a loss
- - Incentive to show growth
- - Incentive to smooth earnings:Cookie Jar Reserves/ Move big earnings to years of loss.
- 2. Contractual obligations
- - Direct bonus to CEO for meeting net earnings targets.
- - Job security.
- 3. Debt-related issues
- - Debt convenant:requirement by bank to maintain certain level of income for a loan.
- - Creditors may recall of level not met. (loan)
The consequences of managing earnings are:
- 1. Personal benefits to managers
- - stock options
- - Job security
- - compensation and bonus
- 2. Corporate benefits
- - boots stock price to raise more capital.
- - Keep credit rating high, get a bond for cheaper price.
- - Stay with debt convenant:recall the loans.
- - Will rise share price.
Ways to manage earnings:
- Establishing Cookie Jar Reserves.
- Establish "restructuring expense": put some money aside for raining days. (auditor stop this 35% of the time)
- Recognize fictitious revenue. (auditor stop this 60% of the time)
Places where earnings are managed:
- Manage current income statement.
- Shift future income to current income.
Compare Fraud and Earnings Management:
- 1. Earning Management:
- - "Conservative" Accounting
- - "Neutral" Earnings
- - "Aggressive" Accounting
- 2. Fraud:
- - "Fraudulent" Accounting
The most frequent case of fraud
Employee Fraud (60%)
How and why fraud occurs?
1. Available opportunities: poor internal controls.
2. Situational Pressures: an employee is experiencing financial difficulties.
3. Personal Chariacteristics: personal morals of individual employees.
Auditor's Responsibility to Detect Fraud:
- 1. SAS 99:
- - Governing statement of auditors' responsibility
- 2. Auditors must..
- - understand fraud.
- - discuss the risk of fraud in F/S
- - adjust audit plan
- 3. Reasonable assurance
- - mission of auditors
- - F/S aren't materially misstated.
- - Not absolute assurance:when company gets sued, auditors get sued too.
- 4. Reporting fraud to upper management
- - No matter how small the fraud is, must be detected.
(Committee of Sponsoring Organizations)
Enterprise Risk Management
A private sector group consisting of:
- - AAA
- - AICPA
- - IMA
- - IIA
- - FEI
To provide guidance on evaluating internal control.
The ERM framework
Make sure high level goal
of the company are aligning with its mission
- Operations objectives:Deal with effectiveness and efficiency of operation.
- Reporting objectives: To ensure the integrity of external & internal reports for both financial and non-financial.
- Compliance objectives: To ensure compliance with legal and regulatory bodies.
Eight elements of risk and control components:
- 1. Internal Environment
- 2. Objective setting
- 3. Event Identification
- 4. Risk Assessment
- 5. Risk Response
- 6. Control Activities
- 7. Information & Communication
- 8. Monitoring