[Solved] 2. Evaluate the deficiencies in internal controls and corporate governance at Navistar. Do you believe external audi

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[Solved] 2. Evaluate the deficiencies in internal controls and corporate governance at Navistar. Do you believe external auditors should be expected to discover fraud when a company, such as Navistar, is so poorly run that its personnel did not have the necessary training and expertise, its internal controls were deficient, and it relied too heavily on Deloitte to determine GAAP compliance? Explain.

In this paper of Tax, you are required to present a report being the Tax Manager, you are supposed to Evaluate the deficiencies in internal controls and corporate governance at Navistar. And explain how external auditors should be expected to discover fraud when a company, such as Navistar, is so poorly run that its personnel did not have the necessary training and expertise, its internal controls were deficient and it relied too heavily on Deloitte to determine GAAP compliance. Also, use the Six Pillars of Character and ethical reasoning to assess the ethical values and decisions made by Navistar and Deloitte in the case.

Case 4-6 Tax Shelters

You are a tax manager and work for CPA firm that that performs audits, advisory services, and tax planning for

wealthy clients in a large Midwestern city. You just joined the tax department after five years as a tax auditor for

the county government. During the first six months in tax, you found out that the firm is aggressively promoting

tax shelter products to top management officials of audit clients. Basically the company developed a product and

then looked for someone in management to sell it to, rather than the more conventional method whereby an officer

might approach the firm asking it to identify ways to shelter income.

The way these products work is the firm would offer an opinion letter to the taxpayer to provide cover in case the

What would you 4. do if you were Billy? Consider the following:

How can you get it done effectively and efficiently?

What do you need to say and to whom?

What can you expect the pushback to be and how might you counteract any reasons and rationalizations?

Do you think the client’s accounting approach to the market valuation of the inventory was acceptable under

GAAP? Include in your discussion a brief explanation of why fair value measurements are difficult.

1.

Evaluate the professional judgment used by Kang and the firm in assessing the client’s accounting and

reaching its own decision to accept it.

2.

Would independence be impaired if the firm were offered, and accepted, the consulting arrangements?

Consider whether any threats to independence would exist and, if so, how they might be reduced to an

acceptable level.

3.

4. What would you do at this point if you were Joe Kang and why?

IRS questioned the reasonableness of the transaction. The opinion would say that the firm “reasonably relied on a

262 Chapter 4 Ethics and Professional Judgment in Accounting

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person who is qualified to know,” and that would support the contention that the opinion was not motivated out of

any intention to play the audit lottery. It also would protect the taxpayer against penalties in the event the firm is

not correct and does not prevail in a tax case.

As time goes on, it becomes clear that the culture of the tax department is shifting from client service to

maximization of tax revenues. It is the most lucrative type of service for all big firms and the competition in the

industry is fierce in this area of practice. You become concerned, however, when you discover the firm did not

register the tax shelter products, as required under the law.

One day you are approached by the tax partner you report to and asked to participate in one of the tax shelter

transactions, with the end result being you would recommend to the tax partner whether he should sign off before

presenting the product to the client. You feel uncomfortable with the request based on what you have learned

about these products. You make an excuse about needing to complete three engagements that are winding down,

and buy some time.

The first thing you do is look for completed tax shelter arrangements with clients that had been reviewed and

approved by the tax quality control engagement partner. What you find makes you more suspicious about the

products. Several are marked “restricted” on the cover page without any further details. You then call a friend who

is a manager in the audit department and set up a time to meet and discuss your concerns.

What you learn only heightens your concerns. Your friend confided there is a culture in the tax department where

business rationality sometimes displaces professional norms, a process accelerated by a conformist culture. Your

friend also confided that the audit managers and partners are jealous of their tax peers because the tax managers

and partners earn almost twice what the auditors earn because of the higher level of client revenues. It was clear

your friend harbors ill feelings about the whole situation.

The following week the tax partner comes back and presents you with another tax shelter opportunity for the firm

and all but demands that you oversee it. He implies in a roundabout way that your participation is a rite of passage

to partnership in the firm. You manage to stall and put off the final decision a few days.

Questions

1. of the tax shelter transactions, including your concerns about the practices.

2. Who are the stakeholders in this case, and what are your professional responsibilities?

3. What are the options available to you in this matter?

4. What would you do and why?

Case 4-10 Navistar International

In a bizarre twist to a bizarre story, on October 22, 2013, Deloitte agreed to pay a $2 million penalty to

settle civil charges—brought by the Public Company Accounting Oversight Board (PCAOB)—that the

firm violated federal audit rules by allowing its former partner to continue participating in the firm’s

public company audit practice, even though he had been suspended over other rule violations. The

former partner, Christopher Anderson, settled with the PCAOB in 2008 by agreeing to a $25,000 fine

and a one-year suspension for violating rules during a 2003 audit of the financial statements for a unit of

Navistar International Corp. According to the charges, “Deloitte permitted the former partner to conduct

work precluded by the Board’s order and put investors at risk.”

After he settled the case and agreed to a one-year suspension, the PCAOB said Deloitte placed

Anderson into another position that still allowed him to be involved in the preparation of audit opinions.

Allowing a suspended auditor to continue working in that capacity is a violation of PCAOB rules,

unless the SEC gives the firm permission. During the suspension, Anderson rendered advice on assignments involving three other Deloitte clients, according to the PCAOB. Deloitte said that it had taken “several significant actions to restrict the deployment” of Anderson. “However, we recognize

more could have been done at that time to monitor compliance with the restrictions we put in place.”

In January 2013, Deloitte had settled a lawsuit alleging it committed fraud and negligence, forcing

Navistar to restate earnings between fiscal year 2002 and the first nine months of 2005. Deloitte was

dropped by Navistar in 2006, and the company was delisted by the New York Stock Exchange.

One (of the many) unusual aspects of this case was the claim by Navistar that Deloitte lied about its

competency to provide audit services. “Deloitte lied to Navistar and, on information and belief, to

Deloitte’s other audit clients, as to the competency of its audit and accounting services,” Navistar

alleged in its complaint. “Navistar feels compelled, more than five years later [2010], to sue Deloitte for,

fraud, fraudulent concealment, negligent misrepresentation, deceptive business practices, and breach of

fiduciary duty arising from the accounting advice, audit services and internal controls advice that

Deloitte provided to Navistar relating to Navistar’s financial statements from 2003 to 2005.”

Deloitte spokesman Jonathan Gandal expressed the firm’s position as follows:

“A preliminary review shows it to be an utterly false and reckless attempt to try to shift

responsibility for the wrongdoing of Navistar’s own management. Several members of Navistar’s

past or present management team were sanctioned by the SEC for the very matters alleged in the

complaint.”

Early in the fraud, Navistar denied wrongdoing and said the problem was with “complicated” rules

under SOX. Cynics reacted by saying it is hard to see how the law can be blamed for Navistar’s

accounting shortcomings, including management having secret side agreements with its suppliers who

received “rebates;” improperly booking income from tooling buyback agreements, while not booking

expenses related to the tooling; not booking adequate warranty reserves; or failing to record certain

project costs.

It is clear that Navistar employees committed fraud and actively took steps to avoid discovery by the

auditors. The auditors did not discover the fraud, according to Navistar, and in retrospect, the company

wanted to hold the auditors responsible for that failure. Deloitte maintained that in each case, the

fraudulent accounting scheme was nearly impossible to detect because the company failed to book items

or provide information about them to the auditors.

It took Navistar five years to sue Deloitte. That seems like an unusually long period of time and raises

suspicions whether the company waited until its own problems were resolved with the SEC. Perhaps

Navistar thought if it had sued Deloitte while the SEC investigated, it might be misconstrued by the

SEC as an admission of guilt.

Deloitte may have been guilty of failing to consider adequately the risks involved in the Navistar audit.

After SOX was passed in mid-2002, all the large audit firms did some major cleanup of their audit

clients and reassessed risk, an assessment that should have been done more carefully at the time of

accepting the client. Big Four auditors, in particular, wanted to shed risky clients to protect themselves from new liability. Interestingly, to accomplish that goal with Navistar, Deloitte brought in a former

Arthur Andersen partner to replace the engagement partner who might have become too close to

Navistar and its management, thereby adjusting to the client’s culture.

Whether because of his experience with Andersen’s failure, fear of personal liability, a “not on my

watch” attitude, or possibly a heads-up on interest by the SEC in some of Navistar’s accounting, this

new partner cleaned house. Many prior agreements between auditor and client and many assumptions

about what could or could not be gotten away with were thrown out.

One problem for Navistar was that it was too dependent on Deloitte hold its hand in all accounting

matters, even after the SOX prohibited that reliance. According to Navistar’s complaint, “Deloitte

provided Navistar with much more than audit services. Deloitte also acted as Navistar’s business consultant and accountant. For example, Navistar retained Deloitte to advise it on how to structure its

business transactions to obtain specific accounting treatment under GAAP . . . Deloitte advised and

directed Navistar in the accounting treatments Navistar employed for numerous complex accounting

issues apart from its audits of Navistar’s financial statements, functioning as a de facto adjunct to

Navistar’s accounting department. . . . Deloitte even had a role in selecting Navistar’s most senior

accounting personnel by directly interviewing applicants.

The audit committee’s role is detailed in the 2005 10-K filed in December 2007:

“The audit committee’s extensive investigation identified various accounting errors, instances of

intentional misconduct, and certain weaknesses in our internal controls. The audit committee’s

investigation found that we did not have the organizational accounting expertise during 2003

through 2005 to effectively determine whether our financial statements were accurate. The

investigation found that we did not have such expertise because we did not adequately support

and invest in accounting functions, did not sufficiently develop our own expertise in technical

accounting, and as a result, we relied more heavily than appropriate on our then outside auditor.

The investigation also found that during the financial restatement period, this environment of

weak financial controls and under-supported accounting functions allowed accounting errors to

occur, some of which arose from certain instances of intentional misconduct to improve the

financial results of specific business segments.

The complaint against Deloitte also references audit discrepancies cited in PCAOB inspections of

Deloitte. Navistar believed the discrepancies related to Deloitte’s audit of the company. However, the

names of companies in PCAOB inspections are not made publicly available due to confidentiality and

proprietary information concerns.

Questions

”

1. 1.      Use the Six Pillars of Character and ethical reasoning to assess the ethical values and decisions made by Navistar and Deloitte in the case.

1. 2.      Evaluate the deficiencies in internal controls and corporate governance at Navistar. Do you believe external auditors should be expected to discover fraud when a company, such as Navistar, is so poorly run that its personnel did not have the necessary training and expertise, its internal controls were deficient, and it relied too heavily on Deloitte to determine GAAP compliance? Explain.

1. 3.      Discuss the deficiencies in the work done by Deloitte for Navistar with respect to the AICPA Code of Professional Conduct.