Audit, Assurance and Compliance: Tyco International and PWC Case (Group Assignment)
Executive Summary:
This assignment discussed one of the most significant settlement case related to the audit. This case discussed the audit of Tyco International by PWC. Due to the negligence of the audit team, shareholders were at the receiving end for bearing market value loss of approx. 100 billion US dollars. Auditors were not able to identify the flaws in the financial statement due to which partial and incomplete information was being transferred to shareholders and stakeholders. PWC was summoned by the legal courts, and PWC decided to settle this case out of court due to extreme public pressures. Due to this blunder, the reputation of PWC was severely damaged. This blunder could have been avoided if the top-level management had enhanced control over the financial statements of the company to make sure that all accounting principles and audit standards are being followed properly. PWC was required to pay $225 million to shareholders for negligence on their part, and Tyco International agreed to pay $3 billion to shareholders due to their mistakes. CFO and top-level management were accused of voluntary mistakes which negatively influenced the decision making of the shareholders. CFO of Tyco International has been punished for 22 years due to his voluntary negligence in this complete case as he was the prime person responsible for the formulation of the financial statements. It is recommended to auditors not formulate strong relations with clients instead keep everything professional and within auditing standards to avoid any issues. Case results identified that PWC was not able to conduct the audit of Tyco International according to Generally Accepted Accounting Principles. Identification of material misstatement should have been the most significant priority of PWC during the audit of Tyco International.
1-Introduction:
This assignment is related to the analysis of legal lawsuit filed by the shareholders of Tyco International on the top level management of Tyco International and auditor of Tyco International PWC. The breakup of Tyco International was responsible for generating a significant market value loss of approximately $100 billion. Chief financial officer of the company was charged with 22 different rounds of conspiracy, securities-related fraud and falsifying the records of the company. At the end of the case, Tyco International agreed to settle the case by paying $3 billion to shareholders, and PWC agreed to settle the case out of court by paying $225 million to shareholders. It was a wise decision by the PWC considering the significance of this case and the amount of negligence and mistake committed by the auditors and top-level management in this case (ACCA Global 2016).
The Tyco audit failure case is considered to be one of the most significant settlements related cases related to big 4 audit firms. After this case, scrutiny related to the independence of the auditor relationship with client significantly increased, and auditors were required to enhance their focus on internal control system implemented in the client’s organization to understand the environment of the client.
2-Brief description of the key events and the factual issues behind the case:
PWC agreed to give a significant amount of 225 million dollars in settlement to shareholders of the Tyco International regarding massive accounting fraud committed by the auditor of Tyco International, which is PWC. This is considered to be one of the most significant and biggest settlement amount paid by one of the big 4 audit firms. According to this case, Tyco International also agreed to pay a significant amount of $2.9 billion to settle their legal case in which the top level leadership and management were accused of implementing accounting fraud to overstate the income of the company by approximately $5.8 billion (Thanos 2015).
Auditor of Tyco International was not able to identify this significant accounting fraud due to which they were also involved in the legal case by the shareholders of the company. This settlement came into action after 4 years of legal action from both sides. Finance Chief Officer of Tyco International was also charged in 2005 for diplomatic fraud of the accounting techniques to state the income of the company, and they are currently serving a prison term of 25 years due to this fraud case (Guerrera 2018).
According to the settlement details, this amount of $225 million will be shared among the existing shareholders of the Tyco International who acquired the shares between December 1999 and June 2002. PWC will be using their cash resources to pay the settlement to the shareholders of the company. This victory is considered to be one of the biggest and significant victories for investors and shareholders around the globe. Experts related to corporate governance suggested that the settlement related to this case was very small because the loss to investors and shareholders due to this accounting fraud was as high as approximately $10 billion. Due to this case, PWC stopped being the auditor of Tyco International from 2003. One of the most significant reasons behind this settlement was to maintain the relationship with other Tyco companies, which include Tyco electronics, Healthcare Company, Tyco International, and Covidien (Thanos 2015).
3-Which parties were deemed responsible, and why?
According to the case analysis, it can be observed that the top level management and the objectives of Tyco International were on a mistake because the formulation of financial statements is the primary responsibility of the management of the company. It was the primary responsibility of the management of Tyco International to make sure that accounting policies were being implemented properly. Another significant mistake, in this case, was from the side of the auditor of the company (BBC 2019). Auditor of the company was PWC during the time of the fraud. Shareholders suggested that top-level management of Tyco International and PWC are responsible for manipulating the financial statements of Tyco International. Later on, it was proved that top-level management of Tyco International was intentionally involved in overstating the income of the company by approximately $6 billion to positively influence the stakeholders and shareholders of the company. This is considered to be one of the most significant negligence by the PWC audit firm as they were not able to identify this accounting fraud from 1999 till 2002 (McLaughlin & Babington 2018).
For the sake of resolving this issue, the audit firm was needed to pay $225 million as compensation and settlement to the company shareholders. The amount was distributed among the shareholders who purchased the shares of the company during December 1999 and June 2002. The analysts believe that this settlement amount was still not enough to cover the significant loss incurred by this accounting fraud case. This amount was considered as peanuts compared to the actual loss made by the firms. In terms of corporate governance, the case was responsible for making a loss of nearly $10 Billion to the investors of the company. Therefore, the nature of the accounting fraud and the given settlement amount while in comparison, were not considered equal in terms of this case.
4-Investigate relevant issues in Auditing and Accounting raised by the case:
As far as the audit of Tyco International is concerned, there were different factors which work against the practice of auditing and Accounting Principles. According to Generally Accepted Accounting Principles, the business entity is separate from the personal entity, and they must not be interlinked with each other. In the case of Tyco International, Funds of the company were used for personal use by the top level executives which are against the basic principles of accounting. And another significant practice against Accounting Principles was overstating the income of the company. According to Generally Accepted Accounting Principles, income must not be overstated or liabilities must not be understated to provide the shareholders and stakeholders with correct and accurate information regarding the performance of the company so that they could make their effective and efficient investment related decisions (Guerrera 2018).
Due to an overstatement of the income, the investment decisions of most of the shareholders and stakeholders were positively influenced, but it was against the Generally Accepted Accounting Principles. And another significant mistake was that chief financial officer and chief executive officer of the company sold their shares on misleading the potential investors and shareholders of the company. It is important to understand that top-level executive and managers in any company should properly implement the concept of conflict of interest to avoid any kind of the misleading activities for the investors and related stakeholders (Thanos 2015).
There were several different audits related failures during the audit of Tyco International. Auditors were not able to maintain the concept of independency due to which the audit was compromised. Auditors were not able to assess the significant risk associated with the unauthorized loans; compensations and bonus that were provided to the top level executives of the company.
Auditors were not able to provide any kind of recommendation in the documented form regarding the internal control system implemented at Tyco International. Auditors of the company did not test further procedures, even after identifying significant risks associated with the internal control system of the organization. Auditors suggested that the financial statements of the company have been formulated according to the guidelines provided by Generally Accepted Accounting Principles, but in reality, the financial statements were not formulated according to the guidelines provided by GAAP (Gay & Simnett 2017).
5-The root cause of the issues:
One of the most significant causes identified was the overstatement of income by approximately $6 billion in the financial statements of Tyco International. This is an accounting fraud which was committed by the top level management of the company specifically by the chief financial officer and other executive members of the company. The chief financial officer admitted his introduction for accounting frauds, and he was sentenced to 25 years of jail in 2003 for this act. This suggests that this was not due to the mistake by the top level management nor it was due to the organizational culture prevailing at Tyco International instead it was due to the intentional fraud accounting practices implemented by the top-level management and executives of the company (ACCA Global 2016).
I believe that this fraud could not have been possible if the management of the company and the auditor of the company were willing to enhance control over their financial statements to make sure that all the accounting policies were being followed to formulate the financial statements of the company. It was due to the negligence of the audit form and the intentional accounting fraud implementation by the top executives and top management of Tyco International (Symonds 2019).
This case was resolved by the mutual settlement between the parties, and it can be considered as a good thing for the accounting firm because the reputation of accounting firm would have been severely and negatively influenced if this case would have gone to the trial. It was a necessary required step at that time to accept the settlement with the shareholders to resolve this scandal which was considered being one of the biggest and significant settlement scandals between the audit firm and shareholders of Client Company (Thanos 2015).
6-Influence of this case on the Audit firm’s reputation:
The industry is already under fire for most of the criticism claiming that auditors receive significant Consulting fees to give their professional audit opinion regarding the financial statements of the company and they formulate a close relationship with the companies with which they are associated for audit purpose. Some of the cases in the past have identified the relationship between audit firms and companies being audited. It is the primary responsibility of the auditor to make sure that there does not prevail in any kind of nonprofessional relationship between the client and the audit firm (McLaughlin & Babington 2018).
In the case of such a relationship, image, and reputation of audit firms are negatively influenced. According to the accounting and securities-related law expert, it is important to understand that accounting firms are not required to uncover the frauds committed by the management of the companies related to accounting practices. One of the most primary and significant responsibilities of the auditors is to make sure that the accounting related activities implemented by the management of the company are according to the Generally Accepted Accounting Principles, and they all have been formulated accurately in order to make sure that the information provided by the financial statements are accurate (McLaughlin & Babington 2018).
Unfortunately, it is one of the easiest jobs to criticize audit firms for not doing their job well. It is important to mention here that audit firms receive very less time to formulate their audit opinion by analyzing the financial statements of the company. They do not get enough time to analyze the complete financial statements of the company, so they analyze the financial statements by taking the samples instead of analyzing every transaction related to the financial statements. It is important to mention that most of the accounting related products are associated with the deception of not making the auditors responsible while showing that the primary culprit in accounting related frauds is the top level management of the involved companies or clients. (Thanos 2015).
7-Recommendations for improving audit procedures:
Different recommendations can be implemented to improve the audit procedures to avoid any similar such case in future audit procedures. It is important for the auditors to completely understand the environment of the client and fraud risk associated with the environment of the client. According to the code of professional conduct, it is important for the auditor to retain proper Independence from the client to provide true and fair audit opinion regarding the financial statements of the client.
Another significant recommendation to improve audit procedures is that the auditors must first understand the internal control system implemented in the organization. Different significant factors like executive compensation and loans should be analyzed, and related party transactions should also be analyzed. This will help to provide understanding regarding the internal control system implemented in the organization.
The auditor should also analyze the risk associated with material misstatement, should perform proper substantive procedures and test controls to improve the audit procedures. The auditor must analyze the significant amount of risk associated with management and should also verify the authorization related to the factors like compensation and loans. Minutes of the board of directors’ meetings and Annual General Meeting should also be properly analyzed, and the Memorandum of association should also be analyzed by the auditor. It is important that recommendations should be promptly communicated to the management, and the communicated recommendations should be properly documented to avoid any kind of discrepancy.
One of the most significant recommendations of the auditors is to increase their II analysis related to shares trading activity by the top level executives of the organization. It is important to understand that any activity related to the trading of the shares by the top level management of the company can influence the decision-making process of the potential investors and stakeholders of the company (Fraser & Lindsay, 2007). It is important to analyze the transactions related to such shares related activities by the top level executives and management of the company.
8-Conclusion:
It can be concluded after analyzing the case of Tyco International that PWC was not able to conduct the audit of Tyco International, according to the Generally Accepted auditing standards. Security Exchange Commission also claimed that the audit was not conducted by the Generally Accepted auditing standards. It can also be concluded that the audit reports formulated were improper, and they were not reflecting the actual position of the financial statements from 1999 till 2002. The auditor and was responsible for the formulation of improper audit reports. No legal actions were taken against the auditor, and he was only banned from practicing as a public accountant due to this significant mistake from his side.
9-References:
ACCA Global 2016, Auditor liability: ‘fair and reasonable’ punishment? viewed 18 May 2019, https://www.accaglobal.com/pk/en/student/exam-support-resources/professional-exams-study-resources/p7/technical-articles/auditor-liability.html
BBC 2019, Are auditors fit for purpose? viewed 18 May 2019, https://www.bbc.co.uk/programmes/m0002mg6
Fraser, J. & Lindsay, H., 2007. 20 Questions Directors Should Ask About Internal Audit. The Canadian Institute of Chartered Accountants.
Gay, G & Simnett, R 2017, Auditing and Assurance Services in Australia, 6th edition, McGraw-Hill Education Australia.
Guerrera, F 2018, PwC settles Tyco lawsuit for $225m, viewed 17 May 2019, https://www.ft.com/content/90c2350e-2c0f-11dc-b498-000b5df10621
McLaughlin, T & Babington, D 2018, Tyco scandal hits auditor, 17 April, viewed 17 May 2019, https://www.theglobeandmail.com/report-on-business/tyco-scandal-hits-auditor/article1026734/
Symonds, WC 2019, Commentary: Tyco: How Did They Miss a Scam So Big?, viewed 18 May 2019, https://www.bloomberg.com/news/articles/2002-09-29/commentary-tyco-how-did-they-miss-a-scam-so-big.
Thanos, LM 2015, ‘Tyco International Ltd. Case Study: The Implications of Unethical Behavior’, Academic Leadership Journal in Student Research, vol. 3, no. 7, pp. 1-6.
