 In this presentation, we will discuss government regulation, particularly pertaining to large publicly traded companies and accounting firms. Support accounting instruction by clicking the link below, giving you a free month membership to all of the content on our website, broken out by category, further broken out by course. Each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files, and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it, terms which audit them. The level of government regulation is really important because it's something that can change and it can change dramatically based on certain events that happen within an economy. So note that there's got to be some balance between the amount of regulation we have and reducing the regulation because as we know, government regulation is going to be increasing on the price and the cost. And the question is, as the price goes up for more regulation, are the benefits that we get from it worth the cost that we are paying? And oftentimes we don't think in that way when we think about government type of regulations. We know that audits in and of themselves is in a form of regulation because the government is saying publicly traded firms need to have an audit. The CPA firms themselves, the accounting firms that are auditing the publicly traded firms are not necessarily part of government, they're private CPA firms. They are subject to regulations within their profession in being CPA firms and being accounting firms. But the government regulations, of course, are required the publicly traded company to have an audit and therefore they have that type of regulation. Also, of course, the CPA firms themselves are regulated in some format within the industry and possibly through government regulations as well. So what we need to do then is find the balance. What balance are we looking for with the amount of regulation that we have and the cost that we have for that regulation? Now why would we want more regulation? Why do we have the audit in the first place? Why is the government involved in the audits? Well, what we're looking for in terms of the audit as we've discussed in prior presentations is that we want to increase the level of trust. Especially in the U.S., we have so much money that's actually coming in from other places, other places that have a larger potential for growth because they're not as industrialized and therefore have a larger potential for growth and they're a larger potential for return on investments. But people tend to come to the U.S., put their money into the U.S. not because of really the potential for growth or to get rich really quickly, but more because they do not have the same type of potential through lack of trust of losing the money that they invest in the corporate stocks that they put in within the U.S. And part of that is due to the transparency that has been built through regulation, through things like audits, so that when people put money into, say, the exchanges for a U.S. type publicly traded company, they have assurance. They feel some assurance. They feel trust that the money that they're putting in is being reflected by the financial statements that are being reported. And therefore they feel much more secure oftentimes investing in something like a publicly traded U.S. company possibly than other places in the world, even though, again, the potential return of other places that are not yet industrialized, but that could be industrialized, is much greater. We have a lot more potential for growth in something that is starting at a lower level than in something like a U.S. firm, which is already industrialized in some format. So then the question is, well, is there too much? Can we go too far? Obviously, at some point, if we increase regulations too high and we look for absolute assurance in some way, then it's going to be spending way too much money with regards to the cost of it. Because as we look at the cost of audits for publicly traded companies, they are very high. They are very expensive. And if we start to limit some other types of things that the CPA firm can do, that's going to take a toll on the economy. So the question is, is the added regulation we're putting in place going to pay for itself in terms of the added trust? What does trust do? It facilitates more transactions, more transactions which will stimulate the economy forward. So that's going to be the question. And notice we typically think of things that way when what happens is usually some kind of event happens, and we start to think that we need to, the pendulum swings all the way over and we need to then put in more regulations or less regulations. And often it might be the case that we say we're going to reduce regulations or we're not going to enforce regulations for a long period of time. Everything's going fine possibly. Then some event happens which shakes people's trust possibly. And then the pendulum swings all the way back over and we don't really consider cost benefit. We just say, we have to make sure this never happens again because this is the type of thing that happens with the government regulations. So you'll note over time, government regulations with regards to auditing CPA firms and other types of things will tend to swing. And as they swing, the swings aren't always the most modest type of swing. We don't typically often see the middle ground. We often see swings that are going to be a bit extreme possibly. For example, there's a large amount of accounting scandals that happened in the 1990s in 2000. And those include things like Enron. Arthur Anderson was the CPA firm for Enron that you would think would have handled or caught some of those problems, but they were one of the big, the large firms at the time and didn't, which was a problem. Tyco, WorldCom, Lehman Brothers, we won't go into the details of these scandals, but note that the number of these scandals and the size of these scandals were enough that people looking at it are saying, hey, I am losing trust, right? And we started to get concerned in terms of the trust of the type of publicly traded companies we have, because we know that in the US, the trust within the publicly traded companies that the financial statements are reported accurately, that when people invest in the financial statements, they're investing in something that is supported by the financial statements that are materially sound. That is something that draws in a lot of money, not only from US people, but outside the US. It's worth a lot. So the fact that we had a lot of these different type of scandal situations and they weren't being caught or regulated within our current structure led us to say, hey, we need to, we need to do something. Now I'm not saying that the pendulum swung too much. I don't want to get into a debate on whether or not it was it was an overreaction or not. But clearly there was a severe reaction related to this and probably then some some type of pullback after after that point in time as well. So what was the reaction to this in the 1990s and 2000 government regulations, including the Sarbanes Oxley Public Company Accounting Reform and Investor Protection Act, often called Sarbanes Oxley. So Sarbanes Oxley Public Company Accounting Reform and Investment Protection Act. It was passed in 2002 regulation of audit profession. So it actually regulated the audit profession as well because you'll recall in part one of the things that that happened if these are publicly traded companies, the CPA firms, the large CPA firms that have basically kind of a monopoly over these over the large companies, there's a very few amount of firms and oligopoly let's say over the largest companies are being audited by a very small set of firms and that became something of concern. So then the question is, well, we have to basically make sure that these large CPA firms aren't being compromised. They're not somehow, you know, colluding with in some way or working with these large companies to possibly deceive given the fact that the dollar amounts are so large. So that would that would became more of a concern and created the Public Company Accounting Oversight Board. So this was a huge change. Now we have the Public Company Accounting Oversight Board which was created by the regulation of Sarbanes Oxley as a response to many of the large scandals from the large companies that you would think would have been caught or hoped to be caught within a standard required audit process. And then there's also Dodd-Frank Wall Street Reform and Consumer Protection Act. This one's a little bit more specific in scope to industries and many of its application. It passed in 2010. So let's take a look now at the Auditor's Responsibilities. Auditor's Responsibilities provide reasonable assurance that the financial statements are materially free of misstatement, whether caused by error, fraud or illegal acts. So notice that's what's supposed to happen here. We want reasonable assurance. Now we're not saying that there's gonna be complete assurance. There's gonna be audit risk. It could quite be possible that there's gonna be some material misstatement that is there, not quite possible, but there's gonna be some risk involved in it. Also note that the auditor is not looking necessarily for fraud. Most of the things that led to these added regulations are due to fraud. And our goal as auditors isn't necessarily, we're not saying, hey, we're gonna catch all fraud and we're not saying we're gonna catch all mistakes or anything like that. We're saying we're looking for the material misstatements whether caused by fraud or mistakes. So our goal is to look for those material misstatements. Now, of course, the frauds that we looked at or the problems with these large scandals that led to the increase in regulation are areas that looked material and therefore should have been something that you would think that the audit would pick up on. Reasonable assurance is not absolute assurance, however, that the material misstatements are detected. So we're never gonna say absolute assurance. But again, if you looked at the things that happened in terms of those large scandals during the time period of the 1990s and 2000, you would think that given the number of them and the size and scope of them that they were, of course, things that we would expect to be caught and that's of course what resulted in the increase in regulation. As we think of this increase in regulation, especially with regard to the CPA firms or the accounting firms that are doing the audit, we do wanna keep in mind the responsibilities involved including who is responsible for the financial statements. Remember that the management is primarily responsible for maintaining effective internal control and for ensuring the fairness of the financial statements. So we always wanna keep these two things involved in our head. We have the corporations, the large corporations that are controlled by the managers, they're run by the managers who are voted on by the hired by the board of directors who are voted on by the owners or the stockholders. And then we've got the CPA firms hired by the company in essence, but supposedly independent or should be independent in character through the separate regulations that they have that are responsible for reviewing as to whether management has maintained the proper internal controls or given opinion on the internal controls as well as the fairness of the financial statements. So you have these two basic two different sides that we have to always keep in mind with regards to the audit process and the regulation of it. Now, one of the primary concerns with these large scandals that happens is when management itself is no longer trustworthy. And this doesn't, you would think most of the time management is fairly trustworthy because if you're talking about a large company they have to be somewhat transparent within their operations and they wanna be possibly overly transparent oftentimes. But if you're in a situation where the top level management of a publicly traded company is seeking to be fraudulent is seeking to deceive in that case it becomes a little bit more difficult in some cases depending on the type of fraud to detect because the internal controls that are put in place the checks and balances that are gonna be put in place don't typically apply or can be subverted or worked around with regards to the top level management. So the internal control in other words oftentimes separate the duties who's in charge of what but the person that's in charge of separating the duties is top level management. So if the fraud is happening at the top level management as it did with some of these cases then the internal controls themselves are a bit more problematic. They may not catch the problem. That's of course one of the problems in place and that's one of the things that are concerning or one of the concerns currently being thought of and being thought of with regards to these regulations is what happens when the problem is within the top management.