Financial reporting of the company’s performance is a statutory requirement of the Companies Act that regulates the performance of companies in most world economies. Corporations are required by the law to publish their performance at the end of every set predetermined fiscal period through diverse mediums. Financial reporting is necessitated by the need to regulate the stewardship role of the company management. Usually, the management of corporations is separated from the company’s ownership in that the firms’ managers are different from the owners. As such, the firm’s owners delegate the role of management to mangers who are trained professionals best suited to make rational decisions on behalf of the owners.
The corporations’ financial reports are vital to various stakeholders in the society who need to make rational decisions using the information released. Hence, the reliability and relevance of the reported information is crucial to the various interested parties. The stewardship function of the management is counterchecked in various ways but majorly through the auditing function. The auditor is an external independent party who acts on behalf of the shareholders, who are the owners of the firm, to ascertain as to the truthfulness and fairness of the presented information. As such, the auditor acts as the owners’ watchdog in regard to affirming that the management has applied the resourced entrusted to them optimally for maximum profitability.
The objective of the auditing function has changed over time. The traditional objective of auditing was to investigate as to whether the financial statements represent true and accurate view of the affairs and to investigate fraud and errors. Over the years, this objective has changed due to the increasing business transactions, change of business sizes and environments among other factors to the current objective of ascertaining a true and fair view of affairs by the financial statements. Various stakeholders are interested in the firms’ financial performance for various reasons. For instance, owners want to establish whether their wealth is growing in terms of increased share prices and high dividends. On the other hand, creditors want to establish whether the reporting firm can meet their claims.
Often, agency conflict arises in a business setting when various parties act contrary to what is expected of them. For instance, managers or employees of a company may engage in fraud to benefit themselves at the expense of the company owners. Though the objective of the auditing function has changed in the present day, fraud investigation is still justified in scenarios where there is suspicion of loss of substantial amounts of company funds by the management or employees. Fraud investigations are usually conducted through forensic audits by specialized companies or government agencies such as the Forensic International Inc or the police.
Fraudulent financial performance reporting portends grave consequences not only to the corporation but also reducing the public confidence on the security markets as they do not know which information is reliable. Various high caliber fraudulent cases often occur in economies putting a challenge to the credibility of auditors, analysts and regulators in financial reporting. The efficiency of a clean-up process is not in the amount of dirt collected but on the evidence of absence of dirt remaining. This axiom of thinking seems to be true when evaluated vis-à-vis the forensic report by the Forensic International Inc. (FII) named Town Red Fern Forensic Accounting Report of July 16 2005. This paper will critique the gaps in the above mentioned report suggesting some of the ways the report could be improved.
The Key Areas of Critique
Abuse of trust by Thomas
The report alleges that Thomas as the second most senior officer in the finance department abused the trust bestowed upon him by the firm. However, the report fails to state categorically the job description of finance department deputy. The report also mentions of the size of the Town Red fern firm in an ambiguous way by suggesting that it is a big company but fails to state the criteria used to classify it as a big company. The report should state the basis of viewing Town as a big company, say by the number of employees or the income generated per annum. The report does not also state the provisions bestowing powers to Thomas. By merely stating that he is the second most powerful person in the company is not enough. It would have been better to mention about the organization structure in order to justify the trust given him.
The report is equivocal in its description of the findings of the analysis done on the internal controls systems in October/November 2004. The report posits that the functions conducted by Thomas were “incompatible” with each other albeit offering loopholes for fraud. This statement is paradoxical on the understanding that “compatible” and aggregated functions conducted by one person are most likely to encourage fraud. Moreover, the evaluation on the internal control system was done in 2004 alone while the report covers a longer period.
Forensic International Inc.’s report when talking of how the fraud was detected, posits that the investigation was orchestrated by a tip-off from a disgruntled employee. The report uses the term “routine” internal control, suggesting that Town firm conducted regular internal controls. This insertion is contradictory in that it suggests that the company had a functional and regular internal audit practices.
External audit function
Forensic International Inc. in making their report concentrated on the weaknesses of the internal control systems while the external auditor Jones smith & Co laid much emphasis on extensive evaluation of the financial statements’ postings. Working together with the external auditor in some areas put the outcome of the report credibility to test.
The external auditor relied most on the assumption that the management presentations and disclosures were in good faith. More so, Jones Smith &Co failed to present working papers to the reporting firm (FII) when requested. Based on some substantial information, the external auditor was related to the accused party hence it was apparent that the credibility of the audit opinion was vulnerable to compromise. As such, (FII) should not have relied on any information from the external auditor.
Scope of investigation
In formulating the way to answer to the investigation questions, the Forensic International Inc (FII) sought to establish an understanding on the alleged fraud. This was in response to press reports in June 2004. The understanding of the internal control systems was inspired of the media claims hence the findings were more inclined to follow the press view other than investigating all the areas. The report posits that the differentiation of errors and frauds was a daunting task due to the scanty nature of the records available. In response to this challenge, (FII) ranked the procedures to be followed in the methodology based on their own understanding. The weakness with this approach is its subjectivity in that some of the procedures thought to be less yielding would end up producing better results than others highly ranked.
The scope of the study was also limited in regard to the duration of investigation. The interrogation of the internal control system was done in October/November 2004 only. For better inference, a longer period would have been more apt for this report. (FII) gives the reason of a change in the computer system in 2002. The report is limited in that it cannot show the frauds and errors that occurred before 2002.
The findings of the internal control system reflected that 60% of the 370 entries investigated reflected weak controls. The report states that the 84 cases found worthy of improvement were forwarded to Town management for remedy. However, the report would leave a reader eager to know the nature of those scenarios, making the report to be discriminative. The report is also inclined in the investigation of a single employee which could open loopholes for non detection of other fraud and error areas.
The investigation was commenced in response to press outcry hence the findings should have been made public for they were not done for Town Company. In summary, the appendix 1 on the scope of the study is not elaborate in terms of adequately defining the population universe. It does not specify which category of documents was analyzed. It is possible to evaluate a thousand documents but of less importance. As such, the report should have stated the criteria of the choice of the documents of investigated.
The report lists four unauthorized payments. However, the report does not give the reference from which an interested party may countercheck for confirmation. Likewise, the misappropriation of cash receipts does not have a cross reference for counterchecking, leaving the report as the only document of reference available. The unauthorized transactions reported represent only the documents evaluated.
The recommendations of the report were not availed to the public who would have benefited from them. The fraud and error investigations were not conducted at the request of Town Company but in response to the press outcry, hence the recommendations would have been useful to the public. The utilization of the materiality concept was subject to biasness. The setting up of the value above $5000 as the material figure for consideration shows that the reported fraud is not accurate implying that the figures in the press were bound to differ with the report findings materially.
The reliability of any financial reporting information is very crucial in the stock market and the general public. In the same tune, any investigative report should be as inclusive and comprehensive as possible in order to be beneficial to the various stakeholders. As alluded to earlier, the quality and efficiency of a report is in the amount of information omitted as opposed to the information disclosed. Though there are some areas that could have been performed better as indicated, the report by (FII) is to some great extent useful. However, the report still avails some room for improvement. With the improvement of the areas highlighted in this paper, the report on Town Company will become more useful to interested members of the society.