CardilloTravel Systems, Inc.
CardilloTravel system, Inc.
Cardillois a public company that operates in the travel sector. The companyhas been faced with two major issues. First, the company isundergoing serious financial crisis following an increase in the costof operation. Secondly, Cardillo is facing the risk of litigation andmultiple charges following the failure by the management to complywith the accounting standards and provisions of Securities andExchange Commission. This paper will address the rationale ofdifferent charges made against Cardillo executives by SEC, people whoviolated and whose who complied with AICPA, Code, actions of outsideauditors, adherence to internal controls, and the responsibility ofauditors in assessing management’s judgment.
Securitiesand Exchange Commission’s Rationale
Falserepresentation made to the outside auditors
Itwas right for the Securities and Exchange Commission to charger theexecutives of Cardillo. This is because the executives given theauditor misleading statements with the objective of concealing thedetails of transactions that had been revealed. For example, Rognlienlied to company’s independent auditor, Touche Ross that the $203,210 given to Cardollo by United Airlines would not be refundedunder any circumstances since there was secret deal between theexecutives of the two companies, but that was untrue. This was aviolation of accounting standards and requirements of the Securitiesand Exchange Commission.
Failingby company to maintain accurate financial records
Thereason given by SEC for charging the executives of Cardillo forfailing to keep accurate financial records is justifiable. Rognlienand Lawrence maintained that $ 203,210 given by United Airlines hadbeen recorded in the proper way. However, this was a violation of thedisclosure requirements of the accounting standards because the moneywas refundable in case Cardollo failed to meet conditions agreed withthe United Airlines, which means that the money could not berecognized and recorded as revenue until the time (1990) of theagreement was over (Byron, 2015).
Failureto file financial reports promptly with SEC
Allcompanies registered by SEC have the primary responsibility forfiling their financial records with the commission within the statedtime (SEC, 2013). These reports should be accurate and consistentwith the accounting standards. Raymond Riley had warned Lawrence andRognlien that the adverse judgment given by the auditor in the formof a “material event” should be reported to SEC via the 8-K form.Failure to make the report in time was a violation of the SEC rule10b-5 since it demonstrated the lack of commitment to give potentialinvestors information that is material to their investment decisions.
Violationof the provisions outlined in the federal securities laws on insidertrading
Itwas reasonable for SEC to charge the executives of Cardillo forinsider violating the laws on insider trading. Insider tradingoccurred when Rognlien sold 100,000 shares of the company in the openmarket. In sider trading occurs when an officer in the company usedinformation that has not been availed to the public to sell companyshares. In this case, Rognlien was aware that Cardillo wasexperiencing financial challenges, which might have motivated him tosell the shares before the information reached the potentialinvestors. This was violation of rules 10b5 of laws that govern stockexchange (SEC, 2013).
Peoplewho violated and those who complied with AICPA’s Code ofProfessional Conduct
Thereare three people who complied with the code of profession. First,actions of the controller named Russell Smith and two partners (RogerShlonsky and Helen Shepherd) of the accounting firms are consistentwith provisions on the responsibility of an independent auditor underthe AICPA code (AICPA, 2013). Smith refused to sign themisrepresented financial statement indicating that the Cardillo’sequity had reached $ 3 million, which was incorrect (Byron, 2015).Helen complied by making the necessary efforts to obtain the correctinformation regarding the transaction indicating the United Airlineswould give $ 203,000 to Cardillo, which would help her make anaccurate conclusion. This was consistent with the General AccountingStandard 201 as well as the objectivity rule number 102 (AICPA,2013). In addition, the decision made by Roger Shlonsky, a partner atKMG, to disagree with the executives about some misleadinginterpretations about unexplained transaction between United Airlinesand Cardillo was consistent with the code’s provision that requirescompanies to represent and disclose all material information.
WilliamKaye violated AICPA rules by failing to modify an entry on thetransaction on which United Airlines would give Cardillo $ 203,000.The auditor had warned that this transaction was suspicious andrequired more explanation, but Kaye refused to make the necessarymodifications to give a true representation of that transaction. Thiswas a departure from rule 102 of AICPA on integrity (AICPA, 2013).Cardillo’s executives were also aware of the misleading transactionbetween their company and the United Airlines, but did not order therelevant managers to make the necessary changes. This indicates thatCardillo’s executives also violated the AICPA rule 102 onintegrity.
ActionsTaken by the Cardillo`s Outside Auditors
Theexternal auditors of Cardollo did a better assessment of financialrecords, which helped in the identification of a misrepresentedtransaction between the company and the United Airlines. This helpedthe auditor identify that the audit risk as well as the engagementrisks were high for their client. Helen interviewed the executives ofCardillo, which helped determine the cause the extent of materialmisrepresentation in the company records. This was critical becauseit helped her develop a suitable list of expectations and advise theclient accordingly. After losing the client, Helen made a report ofmaterial misrepresentation in 8-kstatement, which was part of the SECrequirements (SEC, 2013). The second auditor, KMG made similarconclusions regarding the accuracy and compliance level of Cardillo’sfinancial records. Therefore, the two external auditors expressedtheir competencies by identifying the key weaknesses in the internalcontrols of Cardollo and making the necessary conclusions.
TheFive (5) Components of Internal Control
Thekey components of organization’s internal control include riskassessment, control activities, control environment, information andcommunication, and monitoring (Lougran, 2014). These controls werenot observed properly by Cardillo. The lack of proper observation ofcontrol environment is evidenced the lack of commitment on the partof the executive to maintain integrity and submit reports to therelevant authorities (such as SEC) in time (Byron, 2015). Forexample, Rognlien indicated that the organization did not have asuitable communication structure, which was the major reason for latesubmission of reports to SEC. In another example, William Kayeindicated the lack of adequate monitoring when he failed to correctthe suspicious transaction.
Doauditors have a Responsibility to Assess the Judgment of Management?
Externalauditors have a responsibility to assess management’s judgmentsince it may have material effects on the performance of theorganization. Decisions made by the management affect externalstakeholders (including investors and creditors) and externalauditors have the responsibility to protect and safeguard them falseor misleading financial statement. Members of the public and externalstakeholders attach a lot of value to statements made by theindependent auditor, which means that the auditor’s assessment onthe actions of the management is important. In addition, thestatements made by the independent auditor protect externalstakeholders from the subjectivity that is highly prevalent in thejudgments made by the management.
Themanagement of Cardollo has demonstrated the lack of respect for therules governing financial reporting and agencies (such as SEC) thatoversee the operations of the stock market. This subjected thecompany to significant financial risk and eventually to aninvoluntary receivership. Although the fall of Cardillo can beattributed an increase in the cost of operation, the charges madeagainst the company and its executives could have contributed towardsits financial problems. This happened because the management failedto heed to the instructions of external auditor.
AICPA(2013). Thecode of professional conduct and bylaws.New York, NY: AICPA.
Byron,L. (2015). Cardillo Travel Systems, Inc.
Lougran,M. (2014). How to identify the fife components of internal control.JohnWiley and Sons, Inc.Retrieved August 17, 2015, fromhttp://www.dummies.com/how-to/content/how-to-identify-the-five-components-of-internal-co.html
U.S.Securities and Exchange Commission (2013). Insider trading. SEC.Retrieved August 17, 2015, fromhttp://www.sec.gov/answers/insider.htm