Auditing Leslie Fay Case

Leslie Fay Company Case

Leslie Fay discovered in 1992 that the company's corporate controller with some other employees had committed a serious auditing fraud which showed inflated profits. When these irregularities were found, the company had already been knee-deep in debt as there were losses of around $81 million dollars. This led to the company filing bankruptcy to protect itself against creditors. This was indeed a serious issue and one may wonder if SOX, had it been designed then, would have been able to discover the irregularities much sooner.

Theoretically speaking, it appears that the answer would be in the affirmative. A company which is closely following SOX's mandatory auditing practices of having an internal control system and independent auditors checking the presence of those controls would be in a much better position than Leslie Fay because irregularities could be unearthed sooner. With internal controls such as random checking of transaction and running them through controls is an effective way of controlling irregularities especially the ones taking place on large scale like in the Leslie Fay case. It was found that none of the entries on the cost side were accurate and all had been doctored to show profits. Similarly with third party auditing, it would have been much easier to capture irregularities.

Having said that, we must not forget that this is all in theory and how SOX fares in practice can only be seen after implementation of the law. The reason we say this is because every company has a different culture and a different way of conducting business which in some cases may actually affect serious implementation of SOX. Secondly unethical behavior can occur at all levels and it's possible to assume that some people would still betray the many layers of auditing protection provided by SOX to doctor financial statements. Hence it is highly debatable if accounting irregularities could be found sooner with SOX.

Answer 2

If SOX is followed, there is no specific test name that can be specified in the case under consideration. However there are other audit tests available which could help in detection of fraud and irregularities. One such test is Model Audit Rule (MAR) test that allows firms to check for irregularities through an independent auditing committee. Even though this test applies specifically to insurance companies, it can be just as easily applied to other sectors. This test recommends choosing an independent auditing company which is selected by the auditing committee and would meet with the management to determine if the company's financial reporting has been on track.

Even compliance with the two important tests of SOX would help companies like Leslie Fay from suffering so massively due to one person's unethical behavior. These two tests are rather the two steps that must be followed in order to comply with SOX guidelines. For one companies need to have a system of internal controls and secondly, it must meet with independent auditors who are registered with the government to see if these internal controls are truly effective or not.