Recommendations of the Cohen and Treadway Commissions, Term Paper Example

The Cohen commission on review of the functions and responsibilities of independent auditing made a number of recommendations on a number of facets in auditing. These facets were largely deemed as potential weaknesses within the auditing profession, facilitated by the general lack of monitoring mechanisms to govern industry behaviour.

The committee made a recommendation to develop a broad mechanism for guiding financial statement evaluation by auditors. One of the most important is the need for guidance in the absence of accounting principles. In the absence of accounting principles, auditors are generally expected to follow analogy of previous accounting principle employed on similar situations. However, analogy should not be completely relied upon and guidance should be sought in the case in non-existent accounting principle on a given situation (Commission on Auditors’ Responsibilities, 1977). A principle of accounting, unlike common low, requires more than precedent for it to be generally accepted by the industry. Auditors usually have a preference to their perceived ideal accounting principles in a given situation. This leads to selection of auditors based on their acceptance and/or rejection of given principles. This may potentially lead to a deterioration to the quality of auditing by eliminating the need for judgement.

The commission also highly recommended the elimination of the use of the statement “subject to” when financial statements are subject to any uncertainties. The auditor is also required to make their own independent opinions when the management’s evaluation of a given uncertainty deviates from the adequate reflection of the significance of the uncertainty the financial outcomes. Eliminating the use of the phrase helps develop further research and comprehension of the effects of uncertainties on the company’s financial performance and position (Commission on Auditors’ Responsibilities, 1978). The uncertainties that are recorded in the notes sections should be restricted to only those that are generated from occurred events and/or conditions whose outcomes cannot be defined. Uncertainties reported in the note section should also depict the circumstances around the uncertainty.

The committee made a number of recommendation regarding the standard of care for fraud. One of the key recommendations was the establishment of an effective independent investigation program that regularly and randomly inspects the relationships between auditors and their clients. A proper audit requires specific financial and business-related understanding and skills so as to fully understand all risks involved. Thus all auditors are required to develop a comprehensive understand of the respective client’s industry before conducting an audit.

The commission further made recommendation on the need to develop a network for public accounting firms to exchange information on the advances in the execution and exposure of fraud. The commission promoted the idea of AICPA regularly disseminating this type of information.

The auditor’s responsibilities were also found to be largely undefined. One of the most important suggestions made was the detection of illegal and questionable acts and their reporting. Auditor’s have to comprehend the implications of fraudulent activities within a firm as they may have significant legal implications (Commission on Auditors’ Responsibilities, 1977). When fraudulent activity has been detected, the auditor is expected to obtain an appropriate response from the required level of authority as required by the code.

One of the most interesting and practical recommendations was the involvement of lawyers in the auditing process. Auditors should not be allowed too provide assurances on legal aspects of operations, especially when fraudulent activity is detected. There is also the need to create a full-time auditing standards-setting board. However, the process of setting standards should be subject to the participation of individuals within the profession, as well as those outside the profession. This allow for the development of accounting standards that are generally accepted by a majority of interest groups in auditing reports.

Recommendations of the Treadway Commission

The Treadway Commission conducted a study on the financial reporting system in the United States and made numerous observations and findings, particularly relating to the issue of fraud and reporting standards.

The commission made recommendation on the responsibility of the public company as far as financial reporting is concerned. Owing to the fact that any company is susceptible to a certain degree of fraudulent activity, it is essential that the top management of companies address the issue of fraudulent activity set the tone to create an appropriate environment for accurate financial reporting. This could be achieved through a three-step framework in which; (1) factors that may lead to potential fraudulent financial reporting are identified, (2) the risks of fraudulent financial reporting associated with these factors are assessed, and (3) internal controls are designed and implemented to provide assurance of detection and prevention of fraudulent activity. Furthermore, it was recommended that public companies cultivate and implement a corporate code of conduct in written format. (National Commission on Fraudulent Financial Reporting (U.S.), 1987)

The commission also made recommendations on the two vital functions; (1) the accounting function, and (2) the internal audit function. The commission recommended that public companies have to uphold all accounting functions that are developed to ensure all financial reporting obligations are observed (National Commission on Fraudulent Financial Reporting (U.S.), 1987). The internal audit function was also highlighted as an important facet of business operations and such a department should exist and be properly staffed, relative to the company’s size and operations. The internal audit function should also remain devoid of all subjectivity that may arise from conflicts of interested between the senior management and internal audit personnel. Furthermore, internal auditors are expected to comprehend the magnitude of the implications of their audit findings.

One of the most interesting recommendations made by the Tradeway Commission is the requirement of public companies to formulate an audit committee that is independent of the company’s directors. This requirement was recommended to be enforced by the SEC. furthermore, each public company is expected to develop a charter that defines the duties and responsibilities of the audit committee.

Recommendations made regarding guidance and internal control entailed the involvement of the commission’s sponsoring organizations to develop increased integrated guidance on the internal control measures within companies. The committee went further to recommend that the ASB revise the standards to include the duty and responsibility of the public accountant. This included taking affirmative in auditing and assessment of financial reports while designing tests to give assurance that fraud can be detected and the degree to which it can be detected.

The commission highlighted the need for public accountants to regularly review auditing procedures. This is why it recommended that such an endeavor be realized on a regular basis to ensure the continuous and progressive improvement of the auditing standards. Independent public accountants would also be required to conduct quarterly review of financial statements from all public companies.

The commission also highlighted the importance of communication the auditor’s role. In its recommendations, the ASB should revise the assurance offered by the auditor’s standards report. This is because this report does not provide absolute assurances, only reasonable ones.

The commission recommended that SEC enforcement remedies should be increased to offer more severe penalties and the development of sanctions according to the magnitude of fraud specific with the case. Furthermore, criminal prosecution is recommended for cases in which the case for fraud is either legitimate or strong (West, 2003). However, this would also require the regulation of independent public accountants and public accounting firms to supplement such efforts. This could be achieved through requiring membership of all impendent public accountants and public accounting firms.

Auditing Standards Addressing the Cohen and Treadway Recommendations

Since the release of the Cohen report in 1974, a number of statements on auditing standards have been developed and effected, addressing the issues raised in the report, as well as the Treadway commission. While these statements have been adopted and accepted by most professional in the profession, a number of statements are contentious and continue to divide the industry.

The Auditor’s Responsibilities

The Cohen and Treadway commissions both highlighted the importance of defining the auditor’s roles and responsibilities. As a result a number of International Standards on Auditing address this issue.

ISA 210

This standard stipulates the precondition of an audit. This standard is meant to safeguard the independence and integrity of auditors and the auditing exercise. It details the responsibilities of the auditor regarding the agreement of terms with management before the commencement of an auditing endeavor. It also stipulates that those charged with governance may be required to enter into a formal agreement with the auditor before the commencement of an auditing exercise. This establish preconditions while ensuring a common understanding between management and the auditor. Both the Treadway and Cohen commissions highlighted the importance of independence of the auditors to ensure effective execution of their duties

ISA 240

This standard describes the auditor’s duties as far as fraud within an entity is concerned. The standards stipulates that it is the responsibility of an entities management to mitigate fraudulent activity. The auditor’s responsibility concerns fraudulent activity that have a significant bearing on the financial information reported by these companies. It stipulates that an auditor is adopt an attitude of professional skepticism in conducting an audit.

ISA 250

This standard describes the responsibility and duty of an auditor to take into consideration relevant and applicable laws and regulations in the course of conducting an audit. The auditor is expected to develop an understanding of the regulatory and legal framework that applied to the entity based on its nature and the nature of its activities. The auditor is expected to apply professional skepticism in evaluating the entity’s compliance to these regulations and laws, determining the material effect on financial statements. The auditor should develop a framework designed to anticipate and detect fraudulent activity to ensure effective and accurate auditing.

ISA 265

This standard describes the duty of an auditor as regards to conveying deficiencies identified in internal controls. Owing to the fact that internal controls is charged to those with governance and management, it is the duty of the auditor to report any discrepancies identified in the course of an auditing exercise to the appropriate individuals charged with management and governance within the company. However, this relies on the auditor’s judgment as to the measure applied to gauge the degree of significance of deficiencies. Furthermore, the content of communication considerably relies on a number of factors such as the complexity, nature and size of the company, as well as the nature of the deficiency detected. The auditor is required to execute written and documented communication.

ISA 330

This standard describes the auditor’s responsibilities in determining the overall response to any risks identified in financial statements. The standard acknowledges the auditor’s responsibility to formulate responses on two levels. First, there has to be responses developed at the financial statement level by altering the nature, timing, and/or extent of auditing procedures employed. Secondly, the auditor has to develop responses at the assertion level.

ISA 570

This standards describes the role and responsibility of the auditor in forming an opinion on the company’s capacity to continue as a going concern. It fundamentally ensures that the auditor appropriately and adequately expresses their opinion regarding the ability of a company to continue operations, relative to its financial condition.

ISA 700

This standards describes the role and responsibility of an auditor to form an independent opinion on the financial statements under audit. This standard dictates that an auditor’s core function and business is to give professional judgment on the fairness of financial statements as presented, i.e. in terms of form and content. This standard addresses the issue of the role of the auditor as raised in both the Treadway and Cohen Commissions.

Internal Controls

Internal controls were identified to be a considerable factor in the fairness of financial reporting. This process was identified to be highly reflective of policies adopted and effected by management. As such, internal control is an integral auditing tool. The following ISAs have been developed as a result;

ISA 315

This standard describes the duty of the auditor as regards a company’s internal controls. The standards asserts that the auditor is supposed to detect and evaluate risks associated with material misstatement by developing an understanding of the company, its environment and internal control measures employed. This ISA is embodied in the United States Sarbanes-Oxley Act of 2002 which requires independent auditors to verify the existence and effectiveness of internal controls. This certifies analysis on these internal controls as executed by management of the company in question.

References

Audit Commission. (2000). Statement of responsibilities of auditors and of audited bodies. Lodnon: Audit Commission.

Beasley, M. S., & Carcello, J. V. (2007). 2007 GAAS guide : a comprehensive restatement of standards for auditing, attestation, compilation, and review. Chicago: CCH Inc.

Commission on Auditors’ Responsibilities. (1977). Report of tentative conclusions. New York: The Commission.

Commission on Auditors’ Responsibilities. (1978). Report, conclusions, and recommendations. New York: The Commission.

Duska, R. F., & Duska, B. S. (2003). Accounting ethics. Malden: Blackwell Pub.

Godfrey, J. (2010). Accounting theory (7th ed.). Chichester: John Wiley and Sons.

Institute of Internal Auditors, & National Commission on Fraudulent Financial . (1994). The audit committee : a briefing on roles and responsibilities. Altamonte: Institute of Internal Auditors.

Minnesota Institute of Legal Education. (2002). Sarbanes-Oxley Act of 2002 : developing new corporate practices.Minneapolis: Minnesota Institute of Legal Education.

National Commission on Fraudulent Financial Reporting (U.S.). (1987). Report of the National Commission on Fraudulent Financial Reporting. Washington: The Commission.

West, B. P. (2003). Professionalism and accounting rules. New York: Routledge.