Question

Audit Accounting

Topic: ADVANCED DRAINAGE SYSTEMS, INC. and MARK B. STURGEON, CPA,

Question: Explain how the auditors could have prevented the AAER

Answer 1

The full form of AAER is Accounting and Auditing Enforcement Releases which is audited by SEC. The accounting profession has diverse protocols, procedures, rules, and regulations in addition to the relevant financial laws codified in state or federal statutes. The author suggests that best practices most applicable to deter, detect, expose, or correct violations represented in the SEC accounting and auditing enforcement cases can be described in five general principles:

Clearly define the external audit mission, objectives and framework, and evaluate any internal audit practices relevant to those objectives.

"Preventing false and misleading disclosures" is a logical external audit objective. In the example below, the "deficient underwriting and loan monitoring controls" were the direct cause of the "false and misleading disclosures." Thus, revealing and fixing those deficient controls would have prevented those false and misleading disclosures and would have prevented or ameliorated a bank's false and misleading disclosures of past-due loans and loan losses in 2009 and 2010.

The bank had deficient underwriting and loan monitoring controls and failed to take appropriate action on many of its matured loans.

Internal audit practices recommended in the bullets below would have ensured that controls are in place for monitoring the specified items and that these controls are audited monthly, and that disclosures of past-due loans comply with the standards.

• Ensure that controls for monitoring underwriting, loans, completions, and payoffs-at-maturity are in place and audited monthly, including the continuation, sale, or lease of the construction projects underlying those loans.
• Ensure that disclosures of past-due loans comply with GAAP and Regulation.

Make sure the client relationship is strong and open to full communication and that everything that should be communicated is in fact communicated.

Deficient internal controls caused some information to be misrepresented and some to be simply omitted: Not everything that should have been communicated actually was, leading to errors and fraud resulting in high fines and cease-and-desist actions.

The internal control failures in this case show the need (as in the first and fourth bullets below) for explicit affirmative actions and protections to force detection and disclosures relating to valuations, interpart transactions, and all significant compensation.

Similarly, as in the second and third bullets below, explicit disclosure controls and procedures are needed to communicate and reveal changes to relevant realities in market conditions, valuations, or appraisals.

• Ensure that internal controls force detection and disclosures relating to valuations, related-party transactions such as loans and guarantees, and all significant compensation to or among executives or directors.
• Devise and maintain sufficient disclosure controls and procedures to meaningfully evaluate whether changes in market conditions or other factors require changes to valuation disclosures.
• Disclose appraisal or other valuation methodology as applied to assets and meaningful estimates of underlying or realizable value.
• Disclose all regular and supplemental compensation to and among officers, directors, and advisers, and ensure that these facts do not contradict affirmative disclosures to the public, to partners, or to other stakeholders.