ABSTRACT. Keywords: Auditor responsibilities; fraud; expectations gap; audit procedures; risk; materiality; audit quality.

Transcription

1 How A Forensic Auditor Unraveled Fraud Allegation Contained In A Published Audit Report By - Auditing The Auditor During Course Litigation - An Actual Case Earl Hopewell, CPA; MBA; CFE ehopewell@yahoo.com Northeastern Illinois University, Chicago, IL & Sidney Askew, CPA; MBA saskew@bmcc.cuny.edu City University of New York Borough of Manhattan Community College ABSTRACT Prosecutors and police raided the school district s central offices seizing all financial records and documents tangentially related to fraud allegations in an audit report that was released weeks earlier to the media. In the words of the arrested school superintendent, our offices were eviscerated and we were treated like criminals. Cook County States Attorney s Financial Integrity Investigative Unit arrived at the Illinois school district s central offices displaying subpoenas, badges and guns. All district office staff and personnel were gathered into a one large conference room by numerous armed law officials displaying badges while holding everyone under the watchful eyes for six hours while over 100 boxes of financial and personnel records were loaded into cargo vans. Over the next 5 years, certain school district employees and board members were paraded before grand juries contemplating criminal indictments, based in part, on a published audit report from a state agency. This factual case examines how a forensic accountant, designated as an expert witness, systematically employed generally accepted professional standards to vindicate school executives from fraud allegations flowing directly from a generally accepted governmental audit standard (GAGAS) audit report, signed by a state employee as a certified public accountant with the role and title of chief auditor of a state agency. This case offers both educators and practitioners empirical evidence how audit and accounting practices and standards can be employed by the forensic auditor and expert witness during the course of litigation whether benefiting the plaintiff or defendant. More important, educators and practitioners see how audit reports increasingly become prima-facie evidence for criminal prosecution by prosecutors Consequently, this case shows there is a role for the forensic auditor, acting as expert witness, to help minimize the criminalization of accounting through faulty auditing, in this way this actual case example becomes a case of first impression for the forensic field. Keywords: Auditor responsibilities; fraud; expectations gap; audit procedures; risk; materiality; audit quality.

2 TABLE OF CONTENTS INTRODUCTION AND BACKGROUND OBJECTIVES AND SCOPE CONCLUSIONS BASES FOR CONCLUSIONS FOOTNOTES

3 INTRODUCTION AND BACKGROUND Public school districts are required by law to have their fiscal operations and annual financial statements audited annually. Financial audits(1) cover the use of funds derived from local tax levies, state grants, and/or federal grants. Having been issued a good(2) audit opinion on its annual financial statements by its external independent certified public accountants(3) and the Illinois State Board of Education ( ISBOE ) auditors(3) for , West Harvey Dixmoor Public School District 147 ( WHD No.147 ) received a bad(2) audit report, dated July 18, 2006, that stated your district had overstated the grant expenditures by $2,243,539, for fiscal years 2003, 2004 and 2005, as signed by Robert Wolfe, Certified Public Accountant, and issued under official ISBOE stationary from the External Assurance Division. Prior to this date only good(2) opinions had been given to WHD No.147 from its external independent auditors and ISBOE. The ISBOE audit for was an OMB Office of Management and Budget Circular A-133 audit conducted in accordance with Generally Accepted Government Auditing Standards (GAGAS) as required by the United States General Accounting Office ( GOA ) by the Comptroller General of the United States. Financial audits performed on state and local entities(4) are required to be conducted in accordance with GAGAS by certified public accountants who work for either government organizations or for profit private corporations, partnerships or individuals. GAGAS are the minimum standards used to evaluate an audit performance.

4 THE MINIMUM STANDARDS OF GAGAS AND GAAS Earl Hopewell, both a certified fraud examiner ( CFE ) and licensed certified public accountant ( CPA ) in several states including Illinois, Michigan and Wisconsin, and is a member of Forensic Professionals, LLC., was retained in this matter of West Harvey Dixmoor School District No. 147 v. Illinois State Board of Education, for and by counsel, to ascertain whether ISBOE s External Assurance Division and its audit team followed generally accepted governmental auditing standards ( GAGAS ) and generally accepted auditing standards ( GAAS ) in performing various audits of the district and issuing audit opinions of the district. Materials produced in this litigation and made available to Hopewell include but not limited to ISBOE s External Assurance Division audit team work papers and the following: 1. ISBOE s External Assurance Division s July 18, 2006 Audit Report, 2. Various Selectively Produced ISBOE s Audit Team s, 3. Various Selectively Produced ISBOE s Audit Team Exit Conference Notes of February 14, 2006 and March 9, 2006, 4. Various Selectively Produced ISBOE s Gurrie, CPAs Management Letters Sent to ISBOE by Gurrie As Required by State Law, 5. Numerous Detailed Statement of Fund Accounts (DSFA) Reports by WHD No.147, 6. WHD No. 147 Chart of Accounts, 7. WHD No. 147 Financial Statements for 2003, 2004, 2005 and The materials not produced or made available to this expert to date are as follows:

5 1. ISBOE s External Assurance Division s audit team work papers for WHD No audit, 2. ISBOE s External Assurance Division s audit team work papers for WHD No audit, 3. ISBOE s External Assurance Division s audit team work papers for WHD No audit, 4. ISBOE s External Assurance Division s audit team work papers for WHD No audit, 5. ISBOE s External Assurance Division s audit team work papers for WHD No audit, 6. ISBOE s External Assurance Division s External Peer Review report for the past 5 years, 7. ISBOE s External Assurance Division s External Peer Review management letter for the past 5 years resulting from the external peer review. CONCLUSIONS LESSONS LEARNED FROM THE CASE

6 FOOTNOTES (1) Financial audits are primarily concerned with providing reasonable assurance about whether financial statements are presented fairly in all material respects in conformity with generally accepted accounting principles (GAAP), or with a comprehensive basis of accounting other than GAAP. Other objectives of financial audits, which provide for different levels of assurance and entail various scopes of work including auditing compliance with regulations relating to federal award expenditures and other governmental financial assistance in conjunction with or as a byproduct of a financial statement audit. GAGAS, Chapter 2. (2) Layman consider a good opinion an audit opinion that does not raise any substantive issue; this is generally called an unqualified audit report. Anything other than an unqualified audit report is considered a bad report from a layman s view. (3) AICPA Professional Standard and GAO s GAGAS standards interchangeably use the terms auditors, accountants, CPAs without any specific meanings. (4) Also see related exhibits following this page. (5) AICPA Professional Standards states that whether an act is, in fact, illegal is a determination that is normally beyond the accountant s professional competence. The accountant s training, experience, and understanding of the client and its industry may provide a basis for recognition that some acts coming to his attention may be illegal. However, the determination as to whether a particular act is illegal would generally be based on the advice of an informed expert qualified to practice law such as the petitioner s or respondent s legal counsel or the final determination by a court of law (AU ). (6) Hopewell proffers examples from his over 15 years of teaching the auditing course along with numerous other accounting courses at various colleges and universities: Auditing, 5 th Edition by Guy, Alderman and Winters, Dryden Press, 1999, P.15., and Auditing, 5 th Edition, Taylor and Glezen, John Wiley & Sons, Inc.1991, P.27., and Principles of Auditing, 16 th Edition, McGraw-Hill, 2008, P.12. (7) Registered Certified Public Accountant is a new titled required by the Illinois Public Accounting Act that allows one to use the initials CPA without acting as a duly Public Accountant. (8) See Financial Accounting, Warren Reeve, Thompson South-Western, 9th Edition, 2007, P.162, Accounting Cycle Steps (Also See Exhibit 10 in this expert report). (9) AICPA Professional Standard No. AU , states misstatements arising from fraudulent financial reporting or omissions are intentional misstatements or omissions of amounts meant to deceive the users of the financials. (10) AICPA Professional Standard No. AU Section states that although fraud is a broad legal concept, the accountant s interest specifically relates fraudulent acts that cause a material misstatement of financials. (11) AICPA Professional Standard No. AU Section 110, Responsibility and Functions of the Independent Accountant, states that the accountant has a responsibility to determine whether financials are free of material misstatement, whether caused by error or fraud He does not purport to act in the capacity of a lawyer and may appropriately rely upon the advice of attorneys in all matters of law For those illegal acts that are defined as having a direct and material misstatement effect on the determination of amounts in financials resulting from such illegal acts is defined by AU Section 317, Illegal Acts by Clients, the accountant s responsibility is to detect misstatements resulting from such illegal acts is the same as that for error or fraud The accountant s responsibility is confined to the expression of his or her opinion on financials Because of the nature of audit evidence and the characteristics of fraud, the accountant is able to obtain reasonable assurance that material misstatements are detected. (12) AICPA Professional Standard No. AU 150, Generally Accepted Auditing Standards, states that materiality is inherent in the work of the accountant. (13) AICPA Professional Standard No. AU Section 210, Training and Proficiency of the Accountant, states that the accountant holds himself out as one who is proficient in accounting and auditing of financials.his or her formal education and professional experience complement one another He is retained to audit and/or report upon the financials of a business because through his training, experience, and expertise, he has become skilled in accounting and auditing and has the acquired ability to consider objectively and exercise independent judgment with respect to the information recorded in books of account or otherwise disclosed by his procedures. (14) AICPA Professional Standard No. 329, Analytical Procedures, states that analytical procedures are an important process that consist of evaluation of financial information made by a study of plausible relationships among both financial and nonfinancial data ranging from simple comparisons to the use of complex models involving many relationships and elements of data. A basic premise underlying the application of analytical procedures is that plausible relationships among data may reasonably be expected to exist and continue in the absence of known conditions to the contrary. The accountant should evaluate significant unexpected differences. In those cases when an explanation for the difference cannot be obtained, the accountant should ordinarily be corroborated with other evidential matter. The accountant should obtain sufficient evidence and perform other procedures to satisfy himself as to whether the difference is a likely misstatement. The

7 difference if further unexplained may indicate an increase risk of material misstatement (See AICPA Professional Standard AU 316, Consideration of Fraud In A Financial Statement). (15) AICPA Professional Standard No.AU 411, The Meaning of Generally Accepted Accounting Principles, states that generally accepted accounting principles is a technical term that encompasses the conventions, rules, procedures and practices and also broad guidelines that define accepted accounting practices at a particular time. Those items provide a standard by which to measure financial presentations. Without this framework, there is no way to judge the presentation of financial position, results of operations, and cash flows in financials. (16) AICPA Professional Standards states that whether an act is, in fact, illegal is a determination that is normally beyond the accountant s professional competence. The accountant s training, experience, and understanding of the client and its industry may provide a basis for recognition that some client acts coming to his attention may be illegal. However, the determination as to whether a particular act is illegal would generally be based on the advice of an informed expert qualified to practice law such as the petitioner s or respondent s legal counsel or the final determination by a court of law (AU ). (17) AICPA Professional Standards states that illegal acts vary in relation to the financial statement. Generally, the further removed an illegal act is from the events and transactions reflected in the financial statements, the less likely the accountant is to become aware of the possible illegality.