Satyam Computer Services Limited Financial Statements Case Questions I have a case and I want to solve the questions and based on your understanding of the

Satyam Computer Services Limited Financial Statements Case Questions I have a case and I want to solve the questions and based on your understanding of the questions I want to write the introduction and conclusion, which is about six or seven pages C A S E
Mark S. Beasley · Frank A. Buckless · Steven M. Glover · Douglas F. Prawitt
L EA R N ING OB JE C T IVE S
After completing and discussing this case you should be able to
[1]
[2]
[3]
Understand common procedures used to audit
cash, including proper confirmation procedures.
Identify audit documentation requirements,
especially once an audit is complete.
Recognize consequences that can be imposed on
an audit firm subsequent to a PCAOB
enforcement action.
[4]
[5]
Understand the SEC’s oversight authority for
companies that trade shares on U.S. stock
exchanges as American Depositary Shares
(ADS).
Recognize how membership in a network of
firms might impact a member accounting firm.
INTRODUCTION1
“It was like riding a tiger, not knowing how to get off without being eaten,” according to Satyam
Computer Services Limited (Satyam) former Chairman, B. Ramalinga Raju, soon after massive
fraud involving the company’s financial statements was revealed. For over five years, Raju was at the
top of a massive fraud scheme orchestrated by senior executives at the Hyderabad, India information
technology services company that falsely inflated its cash and cash-related balances by over $1
billion. In an amazing fraud scheme that went undetected by the company’s external auditors, senior
executives directed the creation of over 6,000 false invoices and manufactured numerous false bank
statements to create over $1 billion in fictitious cash balances and other interest bearing deposits.
Just before the fraud was revealed in January 2009, Satyam’s shares traded on the New
York Stock Exchange (NYSE) at a price of $9.35. When trading resumed the next day, those shares
dropped nearly 85 percent to close at $1.46. Institutional investors who owned those shares realized
losses of over $450 million.
The audit of cash is often viewed as a fairly simple and straightforward set of procedures.
Frequently, responsibility for verification of cash balances is assigned to newer, experienced
members of the audit engagement team because of the relative low risk nature of cash related
assertions and the objective versus subjective types of audit evidence typically examined. So, when
the fraud was revealed, many were left wondering how such a massive fraud involving overstatement
of cash balances went undetected by auditors for several years.
1
The information in this case is based on the SEC Litigation Release No. 21915/Accounting and Auditing Enforcement Release No. 3258, U.S.
Securities and Exchange Commission v. Satyam Computer Services Limited d/b/a Mahindra Satyam, Civil Action No. 1:11-CV-00672 (D.D.C.),
and PCAOB Release No. 105-2011-002, Order Instituting Disciplinary Proceedings, Making Findings, and Imposing Sanctions, In the Matter of
Price Waterhouse, Bangalore, Lovelock & Lewes, Price Waterhouse & Co., Bangalore, Price Waterhouse, Calcutta, and Price Waterhouse & Co.,
Calcutta (April 5, 2011).
The case was prepared by Mark S. Beasley, Ph.D. and Frank A. Buckless, Ph.D. of North Carolina State University and Steven M. Glover, Ph.D. and
Douglas F. Prawitt, Ph.D. of Brigham Young University, as a basis for class discussion. It is not intended to illustrate either effective or ineffective
handling of an administrative situation.
©
143
SATYAM COMPUTER SERVICES LIMITED
Satyam was a large information technology services company with principal executive offices in
Hyderabad, India. At the time of the fraud, the company employed over 50,000 individuals worldwide
and maintained offices around the globe, including several in the United States. Company shares
traded on the Bombay Stock Exchange, the National Stock Exchange of India, and 65 million of
its American Depositary Shares (ADS) traded on the New York Stock Exchange. The ADS shares
represented between 11 and 20 percent of the company’s total shares outstanding. As an ADS
registrant, the company filed its financial statements with the United States Securities and Exchange
Commission (SEC).
The main line of business for Satyam was information technology services that it provides
to a variety of customers worldwide. The company prepared and submitted invoices for the services
performed to its customers and recorded those invoices in its invoice management system. Data
from that system was then exported into Satyam’s financial accounting system, which management
used to prepare the financial statements for its March 31 fiscal year ends.
FALSIFICATION OF REVENUES AND CASH
On January 7, 2009, Satyam submitted a Form 6-K to the SEC that included a letter prepared by
then-Satyam Chairman Raju admitting that the company had been engaged in a billion dollar
financial fraud involving the overstatement of more than $1 billion in cash and bank balances when
the actual amounts were $66 million. The overstatement of cash was tied to a fraud scheme senior
management had used to overstate company revenues over the past five fiscal years ending in 20042008.
During that period, senior management falsified the company’s reported revenues by creating
false invoices for services never performed and for customers who never existed. To orchestrate the
falsification of invoices, senior management provided certain employees with “super-user” login
identification and password access to the invoice management system. The “super-user” login
allowed the inclusion of false invoices to overstate revenues while also enabling the concealment of
those invoices from lower-level members of management who might recognize the invoices as fake.
Employees in on the fraud generated between 100 to 200 fake invoices a month, which ultimately led
to the recording of over 6,600 false invoices in the invoice management system and the company’s
quarter and annual financial statements.
The chart below summarizes the impact of the falsification of the fictitious invoices for five
and one-half years ending in 2009:
144
© 2015 Pearson Education, Inc.
As can be seen in the table above, the fraud enabled the company to overstate its revenues on a
cumulative basis over the five plus years in excess of $1.1 billion, enabling the company to report net
profits in periods where net income was actually less than zero. To compensate for their recording
of false revenues, management buried the false entries in numerous cash accounts linked to bank
accounts at six banks. Senior management concealed the scheme by preparing false bank statements
to reflect cash deposits that it did not have in the company’s bank accounts. As shown below, cashrelated balances reported on the balance sheets at each fiscal year end were massively overstated.
In addition to overstating the cash balance, management also overstated its accounts
receivable balances.
THE AUDIT OF SATYAM’S FINANCIAL STATEMENTS
Price Waterhouse, Bangalore (PW Bangalore) based in Bangalore, Karnataka, India served as
Satyam’s independent auditor, signing the audit opinions on the financial statements of Satyam from
2000 through 2009. PW Bangalore was one of five India firms that worked closely together as part
of a larger network of accounting firms known as PW India. The other four firms linked with PW
Bangalore in the PW India network were: Lovelock & Lewes, Price Waterhouse & Co., Bangalore,
Price Waterhouse, Calcutta, and Price Waterhouse & Co., Calcutta.2 This network of firms shared
resources under a common leadership that included the sharing of engagement personnel, office
space, and telephone numbers.
While Lovelock & Lewes participated in the audits of Satyam’s financial statements for the
years ended 2005 through 2008, the remaining three firms in the network did not participate in any
of the audits. PW Bangalore was engaged to perform the audits of the financial statements and issued
unqualified audit opinions on the Satyam annual financial statements based on audits performed in
accordance with PCAOB auditing standards for each of the fiscal years 2005 through 2008.
AUDIT OF CASH AND RECEIVABLES
Because reported cash represented between 50 and 60 percent of total reported assets on the
balance sheets during the years 2004 through 2008, the audit engagement team sought to verify the
existence and accuracy of the recorded cash balances. As part of the audit team’s procedures, the
engagement team signed the auditor’s confirmation requests and gave the requests to employees of
Satyam, who were responsible for sending the confirmation requests to the banks.
Later, Satyam employees returned the alleged completed confirmation responses from
the six banks to the audit engagement team. These responses covered approximately 93 percent
of Satyam’s reported cash for each year end. At the same time, the engagement team separately
received confirmation responses directly from other branches of the same banks. Interestingly, the
bank-supplied confirmation responses reflected significantly smaller cash balances than Satyam
2
Despite having very similar names, each of these four firms are distinct firms. That is, Price Waterhouse, Calcutta, and Price Waterhouse and
Co., Calcutta are different firms.
© 2015 Pearson Education, Inc.
145
management asserted were held in fixed deposits at the same banks and significantly lower than the
amounts reported on the “confirmation responses” provided to the engagement team by Satyam
management. For example, in the 2008 audit, Satyam management provided a confirmation response
supposedly from the Mumbai branch of a bank that indicated the company held approximately $176
million of fixed deposits with the bank. At the same time, the auditors received directly from the
Hyderabad branch of the same bank a confirmation response indicating that Satyam had no fixed
assets with the bank. Unfortunately, the engagement team did not perform procedures to reconcile
these kinds of differences in responses.
The approach the auditors took in their audit of accounts receivable was similar to the
approach the auditors took in the audit of cash. For the 2006 and 2007 audits, the engagement team
relied on Satyam management to send confirmation requests for accounts receivable. Despite never
receiving any responses to these confirmation requests, the engagement team made no attempt to
follow-up on the non-responses with second confirmation requests.
At one point, the auditors did perform alternative procedures by verifying subsequent cash
receipts. However, they never ensured that the cash received after year end related to individual
invoices outstanding at year end. And, in some cases, the subsequent cash receipts testing was
performed as of a date that differed from the fiscal year end date.
These audit responses also failed to take into account deficiencies they noted in Satyam
controls. As part of the firm’s testing of IT controls in 2007 and 2008 required by Section 404 of
the Sarbanes-Oxley Act, the firm noted over 170 deficiencies in internal control, including eight
significant deficiencies that indicated a heightened risk related to accounts receivable. Unfortunately,
the audit firm failed to adjust its audit plan in response to these findings.
AUDIT DOCUMENTATION
To make matters worse, in November 2007, PW Bangalore and Lovelock & Lewes learned that the
2007 Satyam audit engagement would be inspected by the PCAOB in February 2008. PW Bangalore
issued its audit opinion on the March 31, 2007 financial statements on April 27, 2007. Between
November 2007 and the arrival of the inspectors in early 2008, members of the audit engagement
team created new documents that were added to the audit working papers; however, none of the
documents disclosed the dates the documents were added, the persons preparing the documents,
or the reasons for adding those documents.
CHARGES AND SANCTIONS
Shortly after the fraud was revealed, the Government of India assumed control of the company and
dissolved the existing board of directors, replacing them with new government-nominated directors.
In February 2009, the Company Law Board of India authorized the new board of directors to seek
a strategic investor for Satyam. By May 2009, an Indian information technology company, Tech
Mahindra Limited, a subsidiary of Venturbay Consultants Private Limited, was selected. The new
board of directors had installed new senior management team, which included executives from Tech
Mahindra Limited, and announced its new brand identity as “Mahindra Satyam” by the end of June
2009. Additionally, Indian authorities filed criminal charges against several former officers.
In April 2011 the SEC announced that it had settled a civil action against the company and
that the company had agreed to pay a $10 million penalty. The SEC’s enforcement action also noted
that Satyam must require specific training of officers and employees concerning securities laws and
accounting principles and improve its internal audit function. In addition, the company agreed to
hire an independent consultant to evaluate the internal controls at Satyam.
As for the auditors, the PCAOB censured all five audit firms included in the PW India
network. The PCAOB also temporarily limited the activities and operations of PW India, including
a prohibition from accepting SEC issuer referred engagement work for new clients for a period of
six months. In addition, the PCAOB required PW India to engage an independent monitor, adopt
146
© 2015 Pearson Education, Inc.
and implement certain changes to the network of firm’s quality control, and provide additional
professional education and training to its personnel. Finally, the PCAOB imposed a civil monetary
penalty in the amount of $1.5 million on PW Bangalore and Lovelock & Lowes.
R EQ U I R E D
[1]
Research the difference between American Depositary Shares and American Depositary
Receipts. Then, visit the SEC’s website (www.sec.gov) to locate the final SEC rule Release No.
33-8879 issued on December 21, 2007 and research whether foreign issuers must file with the
SEC financial statements in conformity with generally accepted accounting principles (GAAP).
[2]
Research auditing standards and other guidance on effective internal control to answer the
following questions:
[3]
[a]
What are IT general controls and what type(s) of IT general controls were compromised in
the Satyam fraud?
[b]
What is meant by the term management override and how was that revealed in the Satyam
fraud?
Research PCAOB auditing standards (which can be found on the PCAOB’s website –
www.pcaob.org) related to the use of confirmations and document the specific requirements
related to maintaining control of the confirmation process.
[a]
Based on what you learn, provide an assessment of deficiencies in the confirmation approach
Satyam’s auditors took related to cash and accounts receivable.
[b]
Do auditing standards require the use of confirmations in the audits of cash balances and
accounts receivable balances?
[4]
The Satyam auditors attempted to confirm both cash and accounts receivable balances
with external parties. Which of the audit assertions for cash and accounts receivable would
confirmations be most relevant?
[5]
Research the PCAOB’s website (www.pcaob.org) to learn about the PCAOB’s inspection
process. How often are firms inspected by the PCAOB and to what extent are the inspection
findings available to the investing public?
[6]
Research PCAOB auditing standards (which can be found on the PCAOB’s website –
www.pcaob.org) related to the use of audit documentation and identify specific requirements
related to deadlines for including audit documentation in the engagement workpapers, such
as the documentation completion date. Also, identify requirements related to what must be
documented on the workpaper, including the date of preparation of audit documentation and
the identification of the preparers of the documentation. Based on your findings, provide your
assessment of how PW Bangalore violated these requirements.
[7]
Research the AICPA’s Code of Professional Conduct (which is available on the AICPA’s website
– www.aicpa.org) to research what it means to be in a “network” of firms. How might the actions
of one of the accounting firms in the network impact other members of the network?
[8]
Locate the PCAOB’s Settled Disciplinary Order against the auditors of the Satyam financial
statements, which can be found on the PCAOB’s website under the link for “Enforcement” (see
PCAOB Release No. 105-2011-002 dated April 5, 2011), and review the sanctions imposed on
the audit firms within the PW India network. You will see that the PCAOB censured all five
firms in the PW India network, even though three of those firms did not participate in the audit
of Satyam’s financial statements. Discuss why the PCAOB charged all five firms rather than only
charge PW Bangalore and Lovelock & Lewes?
© 2015 Pearson Education, Inc.
147
P R O F ES S I ON A L JU DG M E NT QU E ST ION S
It is recommended that you read the Professional Judgment Introduction found at the beginning of
this book prior to responding to the following questions.
[9]
One of the judgment shortcuts that can lead to bias in professional judgments is the “confirmation
tendency.” Briefly describe what is meant by confirmation tendency and where was that evident
in the auditor’s judgment process in the Satyam case?
[10] What
148
can professionals do to overcome the confirmation tendency?
© 2015 Pearson Education, Inc.

Purchase answer to see full
attachment