The Accountant's Responsibility to Detect Illegal Activity During an Audit

While I'm stuck on the topic of AU 317, I would like to relate the requirements of this pronouncement to a current political event in the news recently (http://www.aicpa.org/).

For those unfamiliar with the American Institute of Certified Public Accountant's pronouncement AU 317 entitled "Illegal Acts by Clients" following is a link:

http://www.aicpa.org/download/members/div/auditstd/AU-00317.PDF.

Following also is a link to a current news article relative to the alleged acts of bribery by a U.S. Congressman (http://allafrica.com/):

http://allafrica.com/stories/200605220098.html.

The news article published on the website allafrica.com sheds light on U.S. Rep. William Jefferson, (D), La., being video taped accepting $100,000 from an F.B.I. informant. The article went on to describe a scheme whereby Congressman Jefferson allegedly accepted bribes from a communications company to get his children a "cut" of a government contract in Africa. The bribe money was then supposed to be forwarded to a high level African official to ensure both Jefferson's family and business colleagues received the contract of their desire. The article then goes on to mention businessman, Vernon Jackson, from Louisville, KY, who plead guilty to federal charges of bribery. He admittedly forwarded $400,000 to Jefferson in order to procure telecommunications contracts in Africa. This implicates the lawmaker and leaves him right in the middle (http://allafrica.com/).

Lets examine how an event like the bribery scandal, which we hear no shortage of in the news media today, might relate to an audit. Returning to the American Institute of Certified Public Accountant's pronouncement AU 317 section .09 specifically states (http://www.aicpa.org/):

.09 In applying audit procedures and evaluating the results of those procedures, the auditor may encounter specific information that may raise a question concerning possible illegal acts, such as the following:

*Unauthorized transactions, improperly recorded transactions, or transactions not recorded in a timely manner in order to maintain accountability for assets

*Investigation by a governmental agency, an enforcement proceeding, or payment of unusual fines or penalties

*Violations of laws or regulations cited in reports of examinations by regulatory agencies that have been made available to the auditor

*Large payments for unspecified services to consultants, affiliates, or employees

*Sales commissions or agents' fees that appear excessive in relation to those normally paid by the client or to the services actually received

*Unusually large payments in cash , purchase of bank cashiers' checks in large amounts payable to bearer, transfers to numbered bank accounts, or similar transactions

*Unexplained payments made to government officials or employees

*Failure to file tax returns or pay government duties or similar fees that are common to the entity's industry or the nature of its business

If we relate AU 317.09 to Congressman Jefferson's situation, or more appropriately through an auditor's eyes, the books of Mr. Jackson's Kentucky telecommunications business we can see that there definitely would have been activity as described by the pronouncement for an auditor to uncover (http://www.aicpa.org/). Why then are not more scandals and illegal acts similar to those perpetrated by Mr. Jackson uncovered by the accounting profession?

The answer, I would presume, lies in the individual judgment of the independent auditor. The pronouncements for the accounting profession are very specific that the independent auditor should consider not only the materiality of irregularities or illegal acts but also the impact of these on the financial statements taken as a whole. Thus, we have to be very careful to limit our scope to the financial statements. In my opinion, it is not the job of the accounting profession to become corporate police. However, within the realm of our professional pronouncements, we cannot forget our obligation to take the ethical high ground when it comes to the broader spectrum of the impact illegal acts and irregularities within the context of the financial statements may have. Just ask any Enron shareholder. As an auditor, you must always remember, within the context of the Congressman Jefferson debacle, your work may impact the next election.

Always--

Kevin P. Felty

Sources--

AICPA. Illegal Acts by Clients. Retrieved May 27, 2006, from http://www.aicpa.org/download/members/div/auditstd/AU-00317.PDF

Jolayemi, M. (2006, May 22). Nigeria: U.S. Congressman Jefferson Collects Bribe in Vice President Atiku's Name. AllAfrica.com. Retrieved May 27, 2006, from http://allafrica.com/stories/200605220098.html

Illegal Acts by Clients During an Audit

I thought I would begin my posts and make my debut as a blogger with a currently red-hot topic. Following is a link to the website of the AICPA (http://www.aicpa.org/):

http://www.aicpa.org/download/members/div/auditstd/AU-00317.PDF.
It is the Generally Accepted Auditing Standard entitled, "Illegal Acts by Clients."
Anyone wanting to participate in this discussion should read it thoroughly.

AU 317 describes the independent auditor's responsibility relative to illegal acts by a client (http://www.aicpa.org/). I thought it would be fun to discuss how this might relate to the common practice among many public companies today of employing illegal immigrants in the United States. We know by reading the pronouncements for the Accounting Profession that much is left up to the professional judgment of the independent auditor.

Imagine a scenario whereby an independent auditor, particularly aged in years like myself, new to the profession is sent by his young Harvard graduate boss in want of flaunting his status as audit manager and flexing some Ivy League intellectual muscles to audit the inventory of a client that is a public company. Upon arriving at the client's place of business the auditor notices a large number of employees of Hispanic origin many whom do not speak English performing much of the manual labor and assembly-line work. It enters the auditor's mind that many of these employees may be and appear to be illegal immigrants not authorized to work within the United States. Thus, being new to the Accounting Profession and admiring his young Harvard boss's intellect, he directs what was found to his audit manager. The young audit manager decides to take this issue related to the overall audit up with the client personally. When asked the question whether all employees have presented adequate documentation to demonstrate proof of eligibility to work within the United States or not, the client's management responds yes. However, management responded no to the question as to whether the authenticity of employees' documentation had been investigated. Also, a certain ranking member of management proceeded to expound upon the necessity of cheaper labor and the abundance of "illegals" whom were quality workers to continue to compete in business.

Using his Ivy League intellect and his auditor's judgment, the audit manager decides that based on the criteria from AU 317 and what he has seen the client has committed an illegal act(http://www.aicpa.org/). Therefore, he considers the effects on the financial statements as a whole. In his opinion, earnings are overstated because the rate of wages for those in the same economic region as the client that are not illegal workers would be higher if the supply within the labor market was not flooded with illegal workers. Also, the audit manager discussed with client management his judgment that the client needs to account for and document in the notes to the financial statements contingencies related to litigation and fines relative to the hiring of illegal immigrants.

If management did not comply with the auditor in this situation, the client would be subject to either a qualified or an adverse opinion. Also, the auditor may consider withdrawal from the engagement.

The preceding, you may find, is an interesting anecdote. However, it is my opinion that some auditors could and perhaps should and would interpret the business practice of hiring illegal immigrants in America as an illegal act within the realm of AU 317 (http://www.aicpa.org/). The room for debate would enter when the professional judgment of the independent auditor enters the picture. It would be this individual judgment that would decide how the business practice of employing illegals ultimately is handled in the independent auditors report.

Please, feel free to post your opinion on how the hiring of illegal workers might impact a company's financial statements, its audit or the climate of this issue within the Accounting Profession as a whole.

Always--

Kevin P. Felty

Sources--

AICPA. Illegal Acts by Clients. Retrieved May 26, 2006, from http://www.aicpa.org/download/members/div/auditstd/AU-00317.PDF