Facts

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Research Memo

Fromcompany’s background and the letter addressed to the board ofdirectors by the Chairman of CompuConnection, Bennie Ripoff, thefollowing facts were availed

CompuConnectionis big Information Technology Service Company founded in India. Thecompany has over 50,000 employees and its operations have expandedworldwide, and it has nine offices in the United States. According tothe reports of the financial year ended 31st March 2010, the companyhad 1.176 billion of the total shares outstanding. The company is thetherefore, a registered corporation in the NYSE.

Theletter attached to the financial reports with SEC on Form 6-K of thequarterly and the Form 20-K of the annual report revealed that therewere material misstatements in the financial statements. Thestatement did not therefore, represented a true and fair view of thefirm. It is a requirement by the generally accepted auditingstandards that the financial statements must show a true and fairview of the company (Alvin, Elder &amp Beasley, 2010). However, thefinancial reports of the CompuConnection Company prepared for thefinancial year 2007/2008 have proven to fail totally to adhere to theauditing standards. Various fraudulent acts and materialmisstatements have been identified in the particular year. My mainconcern is the loss that my client underwent due to the fraudfore-mentioned and more specifically the violations of auditstandards by CompuConnection’s engagement team.

Sincethe year, 2003 through 2008, the management of the CompuConnetionsCompany have been intentionally and knowingly falsifying thefinancial reports of the company. The firm also issued some specificemployees with login details and password to allow them in havingaccess to the invoice management system. In according to my opinionthis was either done with an attempt of creating opportunities ofcommitting fraud. The act, therefore, accelerated the risk for fraud.It was also found that more than 6,600 false invoices were createdwithin that period of the year 2003 to 2008. This aggregates to anaverage of the 100 to 200 of fake invoices per month. This is amaterial misstatement in the financial statements as the companyfound that $1.1 billion in quarter 2 of the year 2009 was falserevenue. In the first two quarters of the year 2009, the companyreported hundreds of millions of dollars while in the real sense thefirm had made a net loss. The management prepared a false bankstatement to hind the loss. The bank balances were inflated to showexcess back balance than it was in the real sense. Also, the cash andcash equivalent were inflated to an extent of approximately 50% ofthe total assets of the CompuConnections.

Issues

  1. The greatest question raised in this report is that “where were the auditors during all this period of the fraud?” The financial statements of the company are audited by one of the most famous audit firms in India known as Lovit or Leavit (LoL). LoL is a registered audit firm with PCAOB’s however, the auditor seems to have violated the rules and standards governing their profession in various ways. The firm undertakes all the field work during the audit of the CompuConnection. However, when the fraud was announced by the chairman of CompuConnection, the PCAOB’s inspection division delegated the role of reviewing the audit documentation to DicewaterCamp (DwC). DwC is not independent from Lovit &amp Leacit Firm as they even shared most of the resources including the office area and even the telephone numbers. The inspection report raised the following major issues the first one was that the engagement team failed to make a direct contact with the six banks used by the CompuConnection. The team, therefore, did not confirm the actual bank balances as they were expected to. It was found that the engagement team solely relied on the company’s reported balances. PCAOB’s requires that the auditor should seek all the appropriate document to support the balances and any transactions.

  2. The second issue raised by PCAOB team was that the engagement team received few responses from the account receivable confirmation. That is, only a few debtors gave feedback to confirm their owing to the company. This therefore, meant a hindrance in ascertaining the actual balances of the debtors and also in assessing of they were fairly recorded in the balance sheet.

  3. After the audit work, the investigations showed that the engagement team had not included some of the documents in their previous working papers. This is against the provision of AICPA that requires auditors to present all the supporting documents together with their working papers.

Discussionand analysis

FASBASC 230-10-45-4 provides that the opening and the closing cash andcash equivalent balances should be in line with the totals shown onthe balance sheet. In this case, CompuConnection violated thisprovision by inflating the cash and bank balances. The amountreported on the balance sheet of the company as at 2008 was not inline with the actual cash balances at the bank and also in hand. Thegap in the balance sheet has arisen due to the inflated profitsduring the financial year. The various reported amount differed fromthose recorded in the source documents and other books ofsubsidiaries that revealed the actual financial data. Due to thesevariations between the reported and the actual operating profits hasresulted to the company trying to carry additional resourcesincluding assets in order to justify its high operations. The companyhas tried all the means to fill the gap including arrangedacquisition with Maytas.

Paragraph7 in AC C25.105 also continues and emphasize that the reported cashand cash equivalents balances must be similar with the actualbalances. It is therefore, the role of the auditors to confirm thebank balances and the reported figures through bank reconciliationexercise. According to the investigation report of PCAOB’s, theengagement did not make a direct contact with the six banks ofCompuConnection.

CompuConnectionalso overstated the liabilities in its balance sheet. The Guidanceprovided in ASC 210-20-45-19 the company to represent the actualliabilities as they are. The Act goes ahead and describes that anincrease or decrease in the liabilities reported should be supportedby the source documents.

AU316.06 states that any intentional misstatement or omissions thatarise from fraudulent financial reporting of the financial statementsdisqualify the reports from being represented in any materialrespect. The Generally accepted accounting principle also emphasizesand say that manipulation of the financial statements should beavoided in all dimensions.

AU-C240 describes the responsibilities of an auditor in relation tofraud. The auditor should seek the evidence to support anytransaction recorded in the company’s financial statement. If theauditors had taken an initiative of investigating the invoices ofCompuConnection, they could have noticed the misstatement on therevenue and also the overstated operating profit.

Rule10b5 – 1 explains the issue of a situation whereby an insider maypurchase or sell securities under a material non-public information.The engagement team of CompuConnection violated this rule as theyaccepted the sale of securities regardless of the information of thecompany’s status at that period. The rule goes ahead and addressthe issue of noncompliance to the contract terms in a family ornon-business relationship in the second paragraph.

Theengagement team also failed to disclose the sale of securities as itis provided in the Section 13(b). It was found that the company madedid not made all the disclosures of the sold securities. It is alsoprovided in the 15 U.S.C §78mthat every firm should include all the issued securities in theiroutstanding shares. We can therefore conclude that the engagementteam violatedthe Exchange Act Section 13(a) and Rules 13a-1 and 13a-16 in theirassessment and presentation of the company’s financial statement.

Paragraph79 through 82 of AU 316.02 requires for the communication about fraudto the management. It was, therefore, expected that the misstatementsin the financial statements to be reported to the senior managementof ComuConnection before it was too late. AU-C 250.17 also requiresthe auditors to report any suspicious acts of fraud and any otherform of material misstatement in the financial statements of thecompany and any non-compliance with the professional standards.

Conclusion

Inaccordance with the generally accepted principles (GAAP), the companyshould not provide a piece of information that is misleading thepublic (IAS, 2015). In their financial reporting, CompuConnectionoffered a contradicting information to both its shareholders and thepotential investors. Immediately after the acquisition, the shareprice of the company’s shares drastically declined to about 50%that caused a great loss the Brunkenhoefer and other investors whohad recently invested in the company.

Accordingto ASC 605-10, revenue should be recognized when it is realized andtherefore, firm should not anticipate revenue. CompuConnection hadviolated the provision of this section and they ended up inoverstating the revenue recorded in their income statement. Themanagement delegated some employees with control of the invoicemanagement system which led to a creation higher opportunity forfraud. The engagement team of CompuConnection also failed in theirresponsibilities as stated by the PCAOB’s team and therefore, wecan conclude that the engagement team violatedthe Exchange Act Section 13(a) and Rules 13a-1 and 13a-16 in theirassessment and presentation of the company’s financial statement.

Thefraud triangle describes that individuals are motivated by three mainaspects to commit a fraudulent act, that is pressure, opportunityand the rationale (Alvin, Elder &amp Beasley, 2010). The companytriggered the increase of the risk to fraud by providing theemployees with login details to the invoice management system. Thecompany was also under pressure as it was facing financialdifficulties and even operating at net loss.

Onthe other hand, the audit firm of the CompuConnection Company shouldbe held liable as they acted against the professional standards. Inaccordance to the AU- 240 it is the role of the auditor to approve ifthe financial statement of a firm represents a true and fair view.The engagement team is required to seek all the appropriate evidenceto support the financial data reported by the firm. In this case, itis so unfortunate that the auditors had not reported the misstatementin their report.

Reference

AlvinA., Elder J. and Beasley S. (2010). Auditing and Assurance Services14thEdition. Upper Saddle River: London

AmericanInstitute of CPA. (2015). Clarified Statements on Auditing Standards.Retrieved 02 November 2015.From http://www.aicpa.org/research/standards/auditattest/pages/clarifiedsas.aspx

InternationalAccounting Standards (IAS). (2015). Retrieved August 12, 2015,from http://www.iasplus.com/en/standards/ias.

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