The Securities And Exchange Commission Regulates Public

The Securities And Exchange Commission Sec Regulates Public Companie

The Securities and Exchange Commission (SEC) regulates public companies. The SEC has found that some of these companies have violated GAAP by using creative accounting practices to mislead investors and creditors regarding the health of their company. Use the Internet or Strayer Library to research a recent accounting scandal within the last five years where the SEC accused public companies of accounting irregularities. Write a 3–4 page paper in which you: Analyze the audit report that the CPA firm issued. Ascertain the legal liability to third parties who relied on financial statements under both common and federal securities laws. Justify your response. Speculate on which statement of generally acceptable auditing standards (GAAS) that the company violated in performing the audit. Compare the responsibility of both management and the auditor for financial reporting, and give your opinion as to which party should have the greater burden. Defend your position. Analyze the sanctions available under SOX and recommend the key action(s) that the PCAOB should take in order to hold management or the audit firm accountable for the accounting irregularities. Provide a rationale for your response. Use the Strayer Library to locate at least two (2) quality academic resources in this assignment. Note: Wikipedia and other similar websites do not qualify as academic resources.

Paper For Above instruction

In recent years, several high-profile accounting scandals have come to light, highlighting failures in corporate governance, audit practices, and regulatory oversight. One notable example within the last five years is the case of Luckin Coffee Inc., a Chinese coffee chain that falsely inflated its revenue figures to appear financially healthier to investors. The SEC uncovered these irregularities following an internal investigation, leading to significant legal actions against the company and its auditors. This paper critically analyzes the audit report issued by the CPA firm, examines the legal liabilities to third parties, identifies violated auditing standards, discusses responsibilities of management versus auditors, evaluates sanctions under SOX, and provides recommendations for PCAOB actions to enhance accountability.

Analysis of the Audit Report

The audit report issued for Luckin Coffee by its external CPA firm was initially presented as an unqualified opinion, suggesting that financial statements fairly represented the company’s financial position. However, subsequent investigations revealed that management manipulated revenue figures through fictitious transactions, which the auditors failed to detect or report. The auditor's report lacked mention of any material weaknesses or irregularities, raising questions about the adequacy of audit procedures. Given the scope of the fraud, the audit report should have disclosed concerns over internal controls or issued a qualified or adverse opinion if necessary, but it did not, indicating a significant lapse in audit diligence.

Furthermore, the CPA firm’s failure to detect or report the irregularities directly impacted the reliability of the financial statements relied upon by investors, creditors, and regulatory authorities. The scope of audit procedures, including substantive testing and internal control assessments, appears insufficient given the complexity and scale of the fraud. Properly issued, the audit report should have flagged the risk of material misstatement, especially when red flags such as rapid revenue growth without corresponding cash flows emerged.

Legal Liability to Third Parties

Under both common law and federal securities laws, the CPA firm and the company's management can be held liable for damages suffered by third parties who relied on the falsified financial statements. The Securities Act of 1933 and the Securities Exchange Act of 1934 establish liability for misleading disclosures that influence investment decisions. Specifically, third-party investors who bought Luckin Coffee securities based on the audited financial statements could seek damages for securities fraud under Section 10(b) and SEC Rule 10b-5. The CPA firm, as an independent auditor, could also be held liable for negligence or fraud if it failed to conduct an adequate audit or knowingly issued a false report.

Violation of Generally Accepted Auditing Standards (GAAS)

It is evident that the CPA firm likely violated several GAAS, especially standards related to planning and supervision (AU-C Section 300), audit evidence (AU-C Section 330), and internal control testing (AU-C Section 315). The failure to identify or report the revenue manipulation suggests inadequate substantive procedures, insufficient skepticism, and possibly a rush to approve the audit report without thoroughly evaluating internal controls. A violation of these standards undermines the credibility of the audit and compromises its intended purpose of providing reasonable assurance about financial statement accuracy.

Responsibilities of Management and Auditors

Management bears the primary responsibility for the accuracy of financial statements, including designing internal controls, implementing ethical standards, and ensuring compliance with GAAP. Auditors, on the other hand, serve to provide an independent check, offering reasonable assurance through evidence collection and testing procedures. While management's responsibility is ongoing and pervasive, auditors’ responsibility is delimited by the scope of their audit and the standards governing their work.

In balancing these responsibilities, management should bear the greater burden because they possess the most control over the financial reporting process. Nonetheless, auditors also have an ethical obligation to exercise professional skepticism and rigorously test for biases or manipulations. In this case, the failure to detect the fraud indicates that auditors might have underestimated risks or lacked sufficient due diligence, which should be rectified through stricter standards and oversight.

Sanctions Under SOX and PCAOB Recommendations

The Sarbanes-Oxley Act (SOX) provides robust sanctions for violations, including criminal penalties such as fines and imprisonment for executives and auditors who knowingly certify or overlook fraudulent financial statements. Additionally, the PCAOB has authority to discipline audit firms, revoke licenses, or impose fines. In light of the Luckin Coffee scandal, PCAOB should prioritize increased inspections focusing on revenue recognition and internal control evaluations, impose stricter penalties on firms found negligent or complicit, and enhance standards for audit evidence gathering.

Further, the PCAOB should promote continuous professional education emphasizing red flags of fraud, enhance cooperation with international regulators, and strengthen its investigative and enforcement capabilities. These actions would serve as deterrents and ensure higher standards for audit quality and accountability.

Conclusion

Accountability in financial reporting is a shared responsibility among management, auditors, and regulators. The Luckin Coffee scandal exemplifies the catastrophic consequences of lax oversight and inadequate audits. Strengthening audit standards, enforcing sanctions, and fostering a culture of ethical rigor are essential steps toward restoring trust in financial markets. The PCAOB’s role remains critical in holding parties accountable and ensuring that audit firms uphold the highest standards of professional conduct to prevent future occurrences of such irregularities.

References

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• Ferguson, B., & Stokes, D. (2020). Corporate governance and accountability in public companies. Accounting Review, 95(2), 85-105.
• Public Company Accounting Oversight Board (PCAOB). (2022). Annual Reports and Standards. https://pcaobus.org
• Securities and Exchange Commission (SEC). (2021). Case against Luckin Coffee for financial misconduct. SEC.gov.
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