The American Institute of CPAs (AICPA) recently released a draft of a revised audit standard on Consideration of Fraud in a Financial Statement Audit. If adopted, this updated standard will replace the current standard with the same name, (Statement on Auditing Standards No. 82). The proposed update provides auditors with additional guidance designed to improve the likelihood that audits will detect material misstatements of financial statements due to fraud.

Several additional audit steps would be required under the proposed standard, including the following:

· Audit teams will need to discuss among themselves their thoughts about how and where the entity’s financial statements might be susceptible to material misstatement due to fraud. The expectation is that this will help to increase their focus on professional skepticism.

· Auditors will be required to make certain specific inquiries of management, audit committees and internal auditors about the risks of fraud. Management will also be asked about its knowledge of fraud or allegations of fraud and the steps taken to mitigate fraud risks, including communications to employees about business practices and ethics.

· Auditors will generally be required to make certain substantive tests on audits of public entities in response to a risk of management override that cannot be addressed through reliance on traditional controls. An example of this type of test is the review of nonstandard journal entries. The proposed standard also provides circumstances under which these tests might not be needed on audits of nonpublic entities.

The proposal is part of a broader AICPA program to address the growing concerns about fraudulent financial reporting. It responds to recommendations made by a Panel on Audit Effectiveness appointed by the Public Oversight Board at the suggestion of the Securities and Exchange Commission. It also takes into consideration the results of five academic projects sponsored by the AICPA and the guidance issued by the International Federation of Accountants (ISA 240) in the spring of 2001. Follow-on initiatives will focus on the prevention and deterrence of fraud as well as its detection.

Law-Makers Draft Toughest Accounting Reform Bill Yet

Differences of opinion between House Democrats and Republicans have resulted in the introduction of a second bill in the House Financial Services Committee. Known as the Comprehensive Investor Protection Act (CIPA), this new proposal is the toughest accounting reform bill yet. It was the result of close coordination with the Securities and Exchange Commission (SEC), and it is supported by the AFL-CIO, consumer groups, and former SEC Chief Accountant Lynn Turner.

Among other things, CIPA would:

· Create a Public Accountability Board with a 7-member majority selected from the public and the remaining 6 members drawn from groups representing institutional investors and pension funds.

· Empower the Board to conduct reviews of audits and audit firms, institute disciplinary actions and set standards for quality control of audits, auditor independence, and ethics.

· Impose tougher legal penalties on auditors by restoring joint and several liability in certain circumstances and restoring the aiding and abetting liability for accountants and outside professionals.

· Require the SEC to review more filings more systematically based on a risk-rating system that uses analytics (such as price-earnings ratios) to determine the frequency of reviews.

· Restrict auditors from providing a list of specified non-audit services and require audit committee approval of any non-audit services not listed in the bill, such as tax services.

· Require a 4-year rotation of auditors, with the possibility of one 4-year extension, if approved by the Public Accounting Regulatory Board.

· Require audit committees to meet quarterly with auditors and have an opportunity to do so outside the presence of management.

· Require a 2-year cooling off period for certain former auditor employees before they could work for an audit client.

· Prohibit directors from providing consulting services to the companies on whose boards they sit.

· Double the resources for SEC’s Division of Enforcement, Corporation Finance, and Office of the Chief Accountant.

· Set restrictions on security analysts to prevent conflicts of interest.

In introducing the bill, Representative John LaFalce said, the reforms are not "cosmetic" and do not "paper over the problem." Georgetown University law professor Donald Langevoort told Reuters, "If it were just the little guy who got trounced [by the Enron collapse], we would simply get cosmetic changes. But this has hurt more than the little guy."

Financial Executives Revise Ethics, Support CARTA

In testimony to the House Financial Services Committee on March 20, 2002, Phil Livingston, president and chief executive officer of Financial Executives International (FEI), said FEI lends its support to H.R. 3763, the Corporate and Auditing Accountability, Responsibility and Transparency Act of 2002 (CARTA).

Mr. Livingston also suggested the proposed legislation be amended to:

· Require that all senior financial officers of public companies adhere to a code of ethics similar to FEI's newly revised code.

· Require that the proposed public accountability board include representatives of professional organizations, such as FEI.

· Require that stock exchanges insist that members of audit committees have an understanding of generally accepted accounting principles and other matters that can only have been gained through experience as a financial executive or auditor.

· Restrict companies' ability to hire senior personnel from their external auditors.

· Establish a committee to study the Financial Accounting Standards Board and issue recommendations for reform in three months.

· Require that audit committees disclose the nature and extent of their continuing professional education and require that public companies provide a report of their key corporate governance policies.

· Require that shareholders approve all stock option plans.

The Securities and Exchange Commission has filed suit against the founder and five other former top officers of Waste Management Inc. for massive fraud. The complaint charges the defendants with inflating profits to meet earnings targets.

The officers named in the complaint include the following:

· The CEO, who set earnings targets, fostered a culture of fraudulent accounting, personally directed certain of the accounting changes to make the targeted earnings, and was the spokesperson who announced the company's phony numbers.

· The CFO, who ordered the destruction of damaging evidence, misled the company's audit committee and internal accountants, and withheld information from the outside auditors.

· The corporate controller, who devised many "one-off" accounting manipulations to deliver the targeted earnings and carefully crafted the deceptive disclosures.

· The general counsel, who blessed the company's fraudulent disclosures.

In brief, the complaint says the company's revenues were not growing fast enough to meet its earnings targets, so the defendants instead resorted to improperly eliminating and deferring current period expenses. Specific tactics:

· Avoiding depreciation expenses on their garbage trucks by both assigning unsupported and inflated salvage values and extending their useful lives.

· Assigning arbitrary salvage values to other assets that previously had no salvage value.

· Failing to record expenses for decreases in the value of landfills as they were filled with waste.

· Refusing to record expenses necessary to write off the costs of unsuccessful and abandoned landfill development projects.

· Establishing inflated environmental reserves (liabilities) in connection with acquisitions so that the excess reserves could be used to avoid recording unrelated operating expenses.

· Improperly capitalizing a variety of expenses, and failing to establish sufficient reserves (liabilities) to pay for income taxes and other expenses.

The SEC says Andersen, the company’s auditor, identified the improper accounting practices, quantified much of the impact, and annually presented company management with a set of "Proposed Adjusting Journal Entries." Instead of making the adjustments, management signed off on a "Summary of Action Steps" that the SEC says included steps designed to write off the accumulated errors and to change the underlying accounting practices in future periods.

In a related story, the Illinois Department of Professional Regulation has filed complaints against four Andersen partners in connection with their role in auditing Waste Management Inc. The complaint includes a recommendation asking that their licenses be revoked or suspended. Only one of the four partners is still with Andersen. A hearing is scheduled in Chicago on April 22.

CFOs are looking for ways to maintain earnings stability and secure a competitive advantage in the uncertain economic market and are finding it in an unlikely place - risk management - according to final results of a survey released today by CFO-Research.

According to the survey, conducted last fall and just released, companies are finding numerous benefits to strategic risk management, including;

· The ability to uncover new corporate opportunities

· Anticipating unexpected events and planning for their potential impact

· Limiting potential surprises

· Creating efficiencies

· Better capital allocation

· Lowered cost of risk transfer.

Risk management has traditionally focused on analyzing risk on activities or events on a case-by-case basis. But strategic risk management "should focus on the critical risks that could impact the company's business strategy," said Aon Insurance risk strategies spokesperson, managing director, Randy Nornes. Aon was one of the sponsors of the survey. "With the skittish state of financial markets today, companies can ill afford to simply respond to surprises. Leading companies are using risk assessment, risk modeling and planning to anticipate and exploit risk," he said.

CFOs point out that while they more readily embrace the notion of using strategic risk management as a tool in helping to guide the business, the human and financial resources available to capitalize on this tool are thin. With increased attention on the role of audit committees to scrutinize a company's financial direction, CFOs hope that management's response will be favorable towards funding the resources necessary to take full advantage of what strategic risk management has to offer.

"Strategic Risk Management: New Disciplines, New Opportunities" is available as a free download at http://www.aon.com/about/publications/issues/2002_aon_cfo_report.asp from the Aon Web site.