ID1-3: Explain the function of the audit committee, and describe why it is important that it consist of outside (non-management) directors.
An audit committee is a subcommittee made up of outside (non-management) directors. The audit committee functions by working with management to choose an outside auditor and monitors the audit to ensure that it is thorough, objective, and independent.
It is important that the audit committee be made up of outside (non-management) directors because it ensures that the auditor chosen and the audit performed is independent and truly impartial/objective. If management were to function as the audit committee, the company would be at risk to managers shopping around for auditors that produce favorable audit opinions, or also known as "Opinion shopping", which is also prohibited by the SEC.
ID1-7: Fortune magazine ran an article titled “New Ethics or No Ethics? Questionable Behavior Is Silicon Valley’s Next Big Thing,” which recounts stories of Internet companies that aggressively inflate their revenues, delay the recognition of expenses, and report sales that are not exactly sales. In many cases the actions of these companies, while aggressive, are not in direct violation of generally accepted accounting principles. Discuss why companies might engage in such behavior, and comment on the ethical implications.
Companies might engage in such behaviors because it is a clever method of effecting shareholder or creditor confidence without violating GAAP. If a company were publically traded and they inflated revenues or reported sales that weren't sales, it would signal to investors that based on their strong financial reporting, their stock would appear as a good investment to invest in, or from a creditor point of view, a good company to loan money to.
While stretching the truth with "creative accounting" may yield short term results, the ethical implications if exposed or revealed can spell disaster for a company. The company would be at risk of law suits from misleading the public. They could be in trouble with their creditor for not being honest with their financials. Their overall reputation and trust from the public becomes damaged for poor corporate governance and lack of moral integrity.
ID1-9: In a report to its clients on the implications of the Sarbanes–Oxley Act of 2002, KPMG states that the Act is intended to expand corporate governance, increase public confidence in financial reporting information, and strengthen our capital market systems. Describe the meaning of corporate governance and how it relates to financial accounting statements. Also, comment on how Sarbanes–Oxley can achieve the intentions stated in the KPMG report.
Corporate governance are mechanisms that encourage management to report in good faith to and act in the interest of the stockholders. Corporate governance is critical for achieving effective and proper financial reporting statements. Corporate governance does this by providing internal financial controls, ensuring that the company is in compliance with financial reporting regulations, legal liability, professional reputation, and ethics.
Sarbanes-Oxley can achieve the intentions stated in the KPMG report by requiring principal executives and financial officers to certify that the company financial reports have been reviewed by them and that they do not contain untrue statements or omit important information, and fairly present the company's financial condition and performance. In other words, it holds executives legally responsible for the financial reporting of their company. There are also other provisions within Sarbanes-Oxley that places additional responsibilities on management and the auditor to ensure that adequate internal controls are in place to
