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WR Grace & Co Audit Essay

W. R. Grace & Co. (The Company) is a company that makes some of the materials that are used in the production of products ranging from medicine to gasoline. The Company was audited by an accounting firm (The Firm) that is recognized as one of the Big Four Accounting firms in the world. The Firm found that the company was participating in a practice known as “profit management”. Profit management occurs when a company defers some of its revenues from the current period, and keeps it in a separate account to use in the future to inflate earnings.

Profit management occurred at The Company because executives were afraid that the increase in earnings would not last, and that if earnings fluctuated greatly over periods shareholders may have become weary. What The Company was doing was not only illegal, but unethical. The Company, The Firm and Mr. Eatough are all somewhat responsible for the problem not being resolved. According to the Generally Accepted Accounting Principles (GAAP) the financial statements of a company are supposed to accurately reflect its economic position.

GAAP also states the revenues have to be reported when earned, and since The Company had already earned the revenue they were obligated to report this. By deferring the earned revenue to a separate account The Company misled their shareholders about the economic position of The Company. The Firm that audited The Company was under a professional obligation to complete their work under the Code of Ethics as written by The Institute of Internal Auditors (IIA). There are certainly many ethical issues that arise within this case, the most pressing of which are integrity and competency.

Integrity establishes trust, and provides a basis for reliance on judgment. Competency, however, requires services to be conducted in accordance with the International Standards for the Professional Practice of Internal Audit (Standards). Trust and reliance are a result of work being done with honest diligence and conformance to laws. The Company compromised its integrity by putting forth false financial statements, whereas The Firm compromised its integrity by signing off on the fraudulent financial statements. If The Firm had persisted in fixing the problem before signing the financial statements it would have done its job properly.

The Standards provide a basis for evaluating the performance of the internal audit function. The Standards are further divided into attribute, performance and implementation standards. Attribute standards involve many aspects of the internal audit function, of which independence and objectivity, and proficiency and due professional care are the most relevant in this situation. Performance standards describe the nature of internal audit services, and provide criteria against which the performance of auditors can be assessed.

Managing the internal activity and communicating results are the performance standards that are important in this case. Objectivity is the ability to make unbiased decisions that reflect the reality of a situation. The Firm was able to be completely objective when doing the audit since it did not have a personal stake in the result. Mr. Eatough, however, was unable to be completely objective since he felt the need to protect his job.

Mr. Eatough’s fear resulted in a report that was not effectively communicative of the situation at hand. If Mr. Eatough had the opportunity to report his findings to a board that did not have the power to fire him, he would have been able to write his report objectively. Standard 1220 forms part of proficiency and due professional care. This Standard says that an auditor has to perform their work with the same level of effort and care that another auditor would, given the same situation. The Firm did not comply with this standard since, given the opportunity, another firm may have been more persistent about rectifying the problem before signing the financial statements.

Managing the internal audit activity is the responsibility of the Chief Audit Executive (CAE). Mr. Eatough was the CAE in this case, therefore it was his responsibility to oversee the quality of The Firm’s work and to report the outcomes to the board. Mr. Eatough did not effectively manage the internal audit activity since the outcome of The Firm’s work did not conform with the IIA’s Code of Ethics or the Standards. The Company should initially have appointed a board to which Mr. Eatough could have written his report.

He would have been able to draw the board’s attention to the fact that The Company executives were partaking in an unethical activity. Mr. Eatough’s report referred to the profit managing activity as a “deliberate deferral of reported income” when he should have called it fraud. Standard 2410 requires that results are communicated in such a way as to minimize the risk of misinterpretation. Since Mr. Eatough did not call the “profit management” fraud, he left the report open to misinterpretation. Ultimately, Mr. Eatough should write a report that clearly outlines what is happening at The Company.

The report should be given to the board of directors who can then make a more informed decision based on the information given. If nothing is done, Mr. Eatough should report his findings to the Securities and Exchange Commission (SEC) who will take further action. Mr. Eatough should ensure that The Company is periodically assessed once every five years by a qualified organization, as well as look to various Position Papers when he is unsure about the correct procedures that should be implemented in given situations.

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