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We discuss the internal auditor's role in detecting fraud and providing needed assurance services, providing guidelines for their efforts and a rationale for not outsourcing their services.
Fraud continues to plague society and hurt investors. According to Lee, Churyk, and Clinton, external auditors often use conventional audit procedures, whose efforts often come too late because the audit year is over, the books are closed, and the damage is done.1 Therefore, we discuss the internal auditor's role in detecting fraud and providing these needed assurance services, providing guidelines for their efforts and a rationale for not outsourcing their services.
Corporate scandals and internal audit
Major corporate scandals, including those at HealthSouth, WorldCom, Enron, Waste Management, and Toshiba, have cost financial users billions of dollars. In some instances (e.g., Enron), employees expressed concerns about the financial statements' integrity to top executives. In other cases (e.g., HealthSouth and Waste Management), management identified the fraud or became fraud whistleblowers. Following, we briefly describe several well-known financial frauds.
In 1998, a new CEO and management team reviewed Waste Management's financial records, finding that the company fraudulently managed financial reports to reach target earnings. Earnings management included improperly decreasing depreciation expense by assigning a longer time for length of depreciation, increasing or creating salvage values, and capitalizing other expenses. Involving six senior financial officers, the financial frauds ran from 1992-1997. One such officer justified the manipulation by stating that: "I was never told otherwise, either by our internal accountants or our outside auditors."2
In 2001, former Enron vice president and whistleblower Sherron Watkins used an anonymous memorandum to inform CEO Kenneth Lay of accounting irregularities. 3 Lay's inactions caused huge financial losses to Enron's financial statement users and led to the passage of the Sarbanes-Oxley Act of 2002 (SOX), where Congressional hearings highlighted the need for public companies to investigate financial integrity warnings from internal auditors and other key employees.
In 2002, following Enron, Cynthia Cooper, WorldCom's former vice president of internal auditing, uncovered a $3.8 billion fraud.4 WorldCom overstated revenue by creating fake journal entries and understated expenses by capitalizing costs incorrectly.5
HealthSouth executives had long committed many frauds, including manipulating merger and acquisition dates to create adjustments, inflating receivables, and booking thousands of false quarterly journal entries...