A competent auditor has done a conscientious job of auditing Hercules Corporation, but because of a clever fraud by management, a material fraud is included in the financial statements. The fraud, which is an overstatement of inventory, took place over several years, and it covered up the fact that the company's financial position was rapidly declining. The fraud was accidentally discovered in the latest audit by an unusually capable audit senior, and the SEC was immediately informed. Subsequent investigation indicated Hercules Corporation was actually near bankruptcy, and the value of the stock dropped from $35 per share to $1 in less than one month. Among the losing stockholders were pension funds, university endowment funds, retired couples, and widows. The individuals responsible for perpetrating the fraud were also bankrupt.

After making an extensive investigation of the audit performance in previous years, the SEC was satisfied that the auditor had done a high-quality audit and had followed generally accepted auditing standards in every respect. The commission concluded that it would be unreasonable to expect auditors to uncover this type of fraud.

Who should bear the loss of the fraudulent financial reporting? Include in your discussion a list of potential bearers of the loss, and state why you believe they should or should not bear the loss

 

Answer:

The group of persons that should bear the loss of the fraudulent reporting or the liability includes the governing board, the executive and management, the accountants and employees who had direct link with the fraud.

Step-by-step explanation

As stated in the above information, certain types of fraud are hard for auditors to detect. The primary responsibility of detecting and preventing fraud rests with the governing board and the management. The governing board in particular has a fiduciary duty towards the shareholders who elected them. As such, in situations whereby there's been fraud the board should be investigated to determine who among the board members was linked to the fraud.

The corporate leaders, the CEO and the executive leaders including the management, should also be held accountable. They are also responsible for detecting and preventing fraud. The failure in the company shows that they were aware things were bad and instead pushed for misstatements in order to present the position of the firm to be good while in the real case it was not. In issues of fraud, this is the primary party that also needs to be investigated and be held liable for the loss.

The accountants, internal CPAs, who are responsible for preparing the financial statements should also be held liable. This is the party that is directed to manipulate the financial records and as certified accountants they ought to overcome such issues by practicing independence. For taking part in the fraudulent financial reporting knowingly, the accountants should be held liable.

Any other employee linked to the fraud should be held liable. If any employee participated in aiding the fraud and had the knowledge of what was going on but failed to report they can be held liable for the loss. There are employees who are not accountants but they are involved in the recording of financial transactions or the processing of transactions. If an employee is aware but is negligent, they should be held liable.