Audit Committees and Auditor Independence

Jake Holman, Gin Gar Bo, Mike Burns, Robert Pagano

Merry-Go-Round Case

1.Although this is not an audit case the accusations against E&Y can be viewed from the lense of the Generally Accepted Auditing Standards (GAAS). The five standards they violated were adequate technical training and proficiency, adequate planning and supervision, due professional care, sufficient understanding of the internal controls, and independence. The most blatant stray from these standards in this case would be E&Y’s disregard of the adequate technical training and proficiency standard. They put inexperienced members on the case such as recent college grads, and one partner that had little experience in the retail industry and very little in the United States. This would be a clear violation of this standard has this been an audit. Furthermore, E&Y did not have adequate planning and supervision. Their leader of their team left on an eight-day vacation at very important time in the engagement. Also, the aforementioned point about the inexperienced partner is a clear violation of this standard as well. E&Y also did not adhere to the standard of having sufficient understanding of internal controls. Not only does this standard refer to internal controls, it refers to the entity’s industry. The advice they gave clearly shows they did not understand the entity and environment. They made a plan for the company to have $11 million a year in savings meanwhile they were set to lose $200 million the following year. This was clearly not the best advice given their situation and E&Y should have known it was not beneficial for the company. E&Y’s independence was also in question in this case. They had a close relationship with Rouse Co., one of MGR’s primary landlords. Also, the law firm that recommended to MGR to use E&Y, Swidler, had been in business with E&Y on at least 12 occasions. E&Y did not disclose any of this information to MGR and therefore violated the independence standard. From a GAAS perspective, they also violated the standard of duty of due professional care. There was most definitely a breach of the standards because E&Y did not take due professional care as clearly shown with the above violations. This may be the most important violation because it gives Merry Go Round a strong case for damages they are seeking due to E&Y’s negligent actions.

2.The requirements of professional standards for CPAs who consult apply to all the services performed by the members and the general standards are promulgated within the profession to address issues that could result if avoided. It can be argued that having professional standards for CPAs who consult could lead to both ways for any firm. One of the advantages for having the professional standards could result in a gain of public confidence and trust while also providing authoritative guidance when making decisions on independence matters. Consultants could also benefit from this due to more guidance which allows them to perform effectively.   

  Professional Standards require (for public accounting firms) to establish rules when accepting new clients. This exists because having such standards could minimize the risks of material misstatements. Therefore, if there are no professional standards, auditors could increase such risks. Another disadvantage is that the CPAs who consult have to follow the general standards which are established to include knowing clients interest, communicating and understanding the clients. While they could be good, they could also limit the CPAs effort with regarding to gathering relevant data and that could limit what they are doing and prevent from performing effectively. Hiring CPAs who consult could also cost more than non-CPAs who consult.

3.Yes, E&Y acted unethically. They could have disclosed the relationships to MGR. They had a close relationship with Rouse Co., one of MGR’s primary landlords. Swidler and Berlin, the law firm that recommended E&Y to MGR and E&Y had previously participated in 12 different business arrangements. Furthermore, is it appropriate to say that the advice from E&Y affected their relationship with the landlord? Did the relationship have an affect on why the cost-cutting suggestion did not go any farther?  This would affect the role of independence when performing consulting work.

The relationship with Rouse could have potentially caused E&Y to suggest that the stores which Rouse owned should be closed, in fear of losing business for Rouse. The relationship with Swidler could have made E&Y feel like they could not lose business with Swidler so this may have resulted in the easy going attitude towards the engagement. The regulations are put in place to reduce the probability of this conflict of interest shown in this case.

4. The variation in the non-audit restrictions are attributed to the regulations based on the company, whether or not it is a private or public company. The two types of companies can be drastically different, resulting in different regulations. The large publicly-traded companies require more heavily regulated rules compared to private companies. These differences led to the separation of control where the SEC and PCAOB are responsible for public companies regulations while the AICPA are responsible for private companies. PCAOB’s non-auditing restrictions include but are not limited to: bookkeeping services, internal audit assistance, investment advisory or management services, tax compliance services, information system design and business risk consulting. Due to public companies and the significant responsibility pertaining to crucial accurate information required for stockholders, the SEC and PCAOB have stricter regulations. The more actions performed by a company directly imposes the inclination of a compromised independence as there might have a greater probability to result in a conflict of interest regardless if private or public. Under the SEC, an audit committee to pre-approve all audit and non-audit services, where as a private company does not need this particular approval. A general rule under AICPA prohibits anyone associated with the services from appearing as a member of a client’s management, including making operational or financial decisions. Another additional requirement presented on behalf of public companies states the client must agree to assume certain responsibilities with the services sought after. This compliments the above requirement to strongly enforce independence, making sure all management decisions are performed by the client not by the auditing firm. Prior to performing non-audit services, there is an established document is recommended to establish specific engagements and responsibilities associated with them. Along with these requirements, CPA’s both in private and public sector, must follow the Code of Professional Conduct with respect to independence, general standards, integrity and objectivity.

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