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Ibid., p. 38.
James A. Joseph, “Reaffirming Our Public Accountability,” Foundation News 33, No. 4 (July/August
1992), pp. 44“45.
Schering-Plough, 1992 Annual Report, p. 4
Corporate Contributions 365

Exhibit 12.2 Conflicts-of-Interest Programa

Description (Estimated)

Review and discussa with the business ethics One day, presentation,
and compliance officer such matters as: and group discussion

• Company™s conflicts-of-interest policies and
prevention and detection procedures in view
of the Sarbanes-Oxley Act (Sections 206, 303,
304, 305, 306, 307, 402, 403, 406, 501, 802,
806), SEC rules, and SROs listing standards
• Results of special investigations into
conflicts-of-interest situations, corrective
action taken, SEC disclosure (Form 8-K),
and press releases, if appropriate
• Audit findings of directors, officers, and
employees compliance with the company™s
code of conduct, including the code of
ethics for senior financial officers and
internal auditors
• Recommended improvements in
management controls to mitigate non-
compliance with the above activities and
related party transactions, including the
issuance of both internal or external audit
reports as well as the board of directors
policy statement
• Changes in the conflicts-of-interest
policies and practices in view of company
acquisitions, divestitures, and joint
• Compliance with loan covenants and
funding of pension plans
• Certification of periodic compliance with
the conflicts-of-interest policy statements
by appropriate employees
• Provisions for continuous surveillance and

In the absence of a business ethnics and compliance officer, the chief audit executive may present
and discuss the program with the audit committee.
366 Reviewing Certain General Business Practices

Exhibit 12.3 Lessons from the Enron Effect

• The audit committee should be informed about the financial and operational aspects of
the company and, therefore, should receive sufficient and timely information. If the
audit committee meeting is scheduled to coincide with the regular full board meetings,
then the committee must receive written information well in advance of the meetings.
• To be vigilant, the audit committee should ask probing questions about the propriety
of the company™s financial reporting process and the quality of its internal controls.
This task requires the committee to keep abreast of financial reporting developments
affecting the company.
• To be an effective independent overseer, the audit committee must be positioned
between senior management and the external auditors. This organizational structure
allows the audit committee to question management™s judgments about financial
reporting matters and to suggest improvements in the internal control systems. The
committee™s charter defines its mission, duties, and responsibilities; plans its annual
agenda; and documents its findings and conclusions.
• Failure on the part of the audit committee to review and evaluate the financial
statements and related accounting policies in accordance with generally accepted
accounting principles is clearly malfeasance.
• One of the conclusions from the Report of the Special Investigation Committee of
the Board of directors of Enron Corporation (Powers Report) was:
“The Board, and in particular the Audit and Compliance Committee, has the
duty of ultimate oversight over the Company™s financial reporting. While the
primary responsibility for financial reporting abuses discussed in the Report
lies with management, the participating members of the Committee believe
those abuses could and should have been prevented or detected at an earlier
time had the Board been more aggressive and vigilant” (p. 24).
For example, red flags that fraudulent financial reporting may be occurring
(and the appropriate action item) include:
• Overoptimistic news release with respect to earnings. Action item: Analyze
annual and interim earnings trends to avoid increased opportunities for managing
• Industry accounting practices in contrast to unusual revenue recognition policies
to increase earnings. Action item: Access significant accounting policies that
are industry-specific from a finncial reporting data base and review this
information with both internal and external auditors.
• Rapid growth of the organization. Action item: Investigate reasons for rapid
expansion in relationship to both top-line and bottom-line double digit annual
growth rates as well as significant increases in year-to-year changes relative to
past performance.
• Significant changes in accounting practices and estimates by management with
an excessive interest in earnings. Action item: Compare these changes with
industry norms and determine the reason for them.
• Conflict-of-interest and significant contracts that affect financial statements.
Frequent related-party transactions and failure to enforce the corporate code of
conduct. Action item: Determine management™s intent to disclose such
Sources and Suggested Readings 367

contracts as well as how the firm addresses conflict-of-interest situations and
monitors compliance with the code. If necessary, conduct or authorize a special
investigation and retain independent councel and other professionals.
• Unexplained significant fluctuations in account balances. Action item: Focus on
analytical review procedures and discuss the findings with both internal and
external auditors.
• Breakdowns in the system of internal control. Action item: Obtain assurance
from both the internal and external auditors that management has evaluated the
weaknesses and recommendations in the management letter and that corrective
action has been taken.
• Scope restrictions placed by management on both the internal and external
auditors. Action item: Give assurance to the auditors that they have unrestricted
and free access to the audit committee.
Audit committee members should be highly attuned to the potential of
fraudulent financial reporting. Failure on the part of the audit committee to
question management™s representations may be the basis for audit committee
malfeasance, since the audit committee and the board may be held liable for
failure to know what they were responsible for recognizing.

Source: This discussion is adapted from an article by Louis Braiotta, Jr., “Lessons from the Enron
Effect,” at www.smartpros.com (March 2002).

The American Assembly, The Ethics of Corporate Conduct. Pamphlet 52 (New York: Co-
lumbia University, April 1977), pp. 1“11.
Beresford, Dennis R., and James D. Bond, “Foreign Corrupt Practices Act”Its Implica-
tions to Financial Management.” Financial Executive 46, No. 8 (August 1978), pp. 26“32.
Braiotta, Louis, Jr., “Lessons from the Enron Effect.” March 2002, www.smartpros.com.
Boltz, Gerald E., Grover R. Heyler, David L. James, and Francis M. Wheat, “Corporate Di-
rectors™ Responsibilities.” Financial Executive 45, No. 1 (January 1977), pp. 12“21.
The Business Roundtable, Corporate Governance and American Competitiveness (New
York: The Business Roundtable, 1990).
Charles E. Simon and Company, “An Examination of Questionable Payments and Prac-
tices.” Journal of Accountancy 145, No.4 (May 1978), p.7.
Coffee, Betty S., and Jia Wang, “Board Composition and Corporate Philanthropy.” Journal
of Business Ethics 11, No. 10 (October 1992), pp. 771“778.
Coopers & Lybrand, “Executive Perquisites Study Release: An Overview of the Findings.”
Executive Briefing (May 1992).
Department of Justice, “Foreign Corrupt Practices Act Option Procedure.” Code of Federal
Regulations, Sec. 28, Part 77, 1978.
Foreign Corrupt Practices Act, Title I of Public Law No. 95-213, December 19, 1977.
368 Reviewing Certain General Business Practices

Freeman, Harry L., “Corporate Strategic Philanthropy.” Vital Speeches 58, No. 8 (February
1, 1992), pp. 246“250.
Gerson, James S., J. Robert Mooney, Donald F. Moran, and Robert K. Waters, “Oversight
of the Financial Reporting Process”Part I.” CPA Journal 59, No. 7 (July 1989), pp. 22“28.
Greene, James, “Assuring Ethical Conduct Abroad.” The Conference Board Information
Bulletin No. 2 (November 1976), pp. 1“18.
Gustavson, Sandra G., and Jere W. Morehead. “Complying with the Amended Foreign
Corrupt Practices Act.” Risk Management 37, No. 4 (April 1990), pp. 76“82.
Hanson, Walter E., “A Blueprint for Ethical Conduct.” Statement in “Quotes,” Journal of
Accountancy 145, No. 6 (June 1978), pp. 80“84.
Harris, James F., and Anne Klepper, Corporate Philanthropic Public Service Activities
(New York: The Conference Board, 1976).
Harriss, C. Lowell, “Corporate Giving: Rationale and Issues.” Two Essays on Corporate
Philanthropy and Economic Education (Los Angeles, Calif.: International Institute for Eco-
nomic Research, October 1978), pp. 1“13.
Hills, Roderick M., “Views on How Corporations Should Behave.” Financial Executive 44,
No. 11 (November 1976), pp. 32“34.
Joseph, James A., “Reaffirming Our Public Accountability.” Foundation News 33, No. 4
(July/August 1992), pp. 44“45.
Levy, Ferdinand K., and Gloria M. Shatto, “A Common Sense Approach to Corporate Con-
tributions.” Financial Executive 46, No. 9 (September 1978), pp. 36“40.
Marsh, Hugh L., “The Foreign Corrupt Practices Act: A Corporate Plan for Compliance.”
Internal Auditor 36, No. 2 (April 1979), pp. 72“76.
McGrahan, Kathleen T., “SEC Disclosure Regulation and Management Perquisites.” Ac-
counting Review 63, No. 1 (January 1988), pp. 23“41.
National Commission on Fraudulent Financial Reporting, Report of the National Commis-
sion on Fraudulent Financial Reporting (Washington, DC: NCFFR, 1987).
The Omnibus Trade and Competitiveness Act, Title V of Public Law No. 100-418. August
23, 1988.
Organization of Economic Cooperation and Development, Convention on Combating
Bribery of Foreign Public Officials in International Business Transactions (Paris: OECD,
Piturro, Marlene C., “Just Say . . . Maybe,” World Trade 5, No. 5 (June 1992), pp. 86“91.
Roberts, Judith L., “Revision of the Foreign Corrupt Practices Act by the 1988 Omnibus
Trade Bill: Will It Reduce the Compliance Burdens and Anticompetitive Impact?” Brigham
Young University Law Review, No. 2 (1989), pp. 491“506.
Robinson, Herbert, and J. Karl Fishbach, “Commercial Bribery”The Corporation as Vic-
tim.” Financial Executive 47, No. 4 (April 1979), pp. 16“19 and 50“51.
Schering-Plough, 1992 Annual Report.
Schwartz, R. A. Corporate Philanthropic Contributions. Pamphlet 72 (New York: New
York University, June 1968), pp. 479“497.
Securities and Exchange Commission, “Report of the Securities and Exchange Commission
on Questionable and Illegal Corporate Payments and Practices” (Washington, DC: SEC,
May 12, 1976).
Securities and Exchange Commission, “Executive Compensation Disclosure.” Federal Reg-
ister 57, No. 204 (October 21, 1992), pp. 48126“48159.
Sources and Suggested Readings 369

Securities and Exchange Commission, Annual Reports (Washington, DC: U.S. Govern-
ment Printing Office, 2001, 2002).
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Taylor, John C. III, “Preventing Improper Payments Through Internal Controls.” The Con-
ference Board Record 13, No. 8 (August 1976), pp. 17“19.
Therrien, Lois, “Corporate Generosity Is Greatly Depreciated.” Business Week (November
2, 1992), pp. 118“120.
Triton Energy Corporation, 1992 Annual Report.
“Triton Energy Corp.: Justice Department Probing for Possible Law Violations” Wall Street
Journal, (May 20, 1993), sec. A, p. 7, col. 3.
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No. 21 (May 25, 1992), pp. 12“15.
Part Four
The Reporting
Function and the
Audit Committee
Chapter 13
Independent Auditors™

The independent auditors™ report is the expression of their professional opinion on
the financial statements. As discussed in Chapter 2, although the financial state-
ments are management™s responsibility, the independent auditors have a responsi-
bility to attest to the fairness of management™s representations in the statements
through their audit report.
The purpose of this chapter is to familiarize the audit committee with the dif-
ferent types of audit opinions as well as other audit reports regarding matters such
as interim financial information and special reports.1 An understanding of the
audit opinions and other audit reports provides an important opportunity for each
audit committee member to obtain additional insight into the nature and impor-
tance of the independent auditors™ reporting responsibility.

As discussed in Chapters 2 and 5, the independent auditors or accountants report
their objective opinion on the fairness of the representations in the financial state-
ments. Such an expression of their opinion is required in accordance with gener-
ally accepted auditing standards as promulgated by the Auditing Standards Board
(previously Auditing Standards Executive Committee of the AICPA). Moreover, it
was indicated that corporate management has full responsibility for the fairness of
the representations in the financial statements. Such a distinction concerning the
responsibility for the financial statements is particularly important because if the
independent auditors do not concur with the fairness of management™s represen-
tations, then they are required to inform the users of the financial statements of
their exceptions. In particular, the fourth auditing standard of reporting is restated
for additional emphasis.

Attestation engagements with respect to other information, such as reports on internal control and
compliance with specified laws and regulations, were discussed in Chapter 5.



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