Contemporary Auditing Knapp 9th Edition Solutions Manual

Contemporary Auditing Knapp 9th Edition Solutions

Manual

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 CASE 8.7

AUSTRALIAN WHEAT BOARD

Synopsis

The Australian government created the Australian Wheat Board in 1939 to help the nation’s
struggling wheat farmers. All wheat grown in Australia had to be sold to this government agency.
The resulting proceeds were then distributed on a pro rata basis to the nation’s wheat growers. In
1999, the Australian government converted the Australian Wheat Board into AWB Limited, a
company controlled by the country’s wheat growers. By this time, the domestic wheat market had
been deregulated, but AWB retained the exclusive right to export Australian wheat to other nations.
Thanks to AWB and its predecessor, Australia became the second largest wheat exporter in the
world, second only to the United States. Other large wheat exporters around the globe frequently
criticized the market structure that Australia had established for its wheat industry, insisting that the
so-called “single-desk” system gave Australian wheat producers an unfair advantage in the
intensively competitive international wheat market. These same critics suggested that AWB often
paid bribes and kickbacks to secure lucrative wheat contracts with developing countries.
Increasing concern over the integrity of international markets caused the OECD (Organization
of Economic Cooperation and Development) in 1996 to issue the Convention against Bribery Of
Foreign Public Officials in International Business Transactions. This convention was modeled after
the U.S. Foreign Corrupt Practices Act of 1977. OECD members, including Australia, quickly
adopted legislation to enact the key provisions of the OECD Convention, the principal provision
being to criminalize payments made to officials of foreign governments for the purpose of obtaining
or retaining international business relationships.
AWB’s management team ignored the new law that incorporated the OECD Convention and
continued to make illicit payments to officials of foreign governments to secure large wheat
contracts in the global marketplace. Most notably, AWB paid approximately $300 million to
Saddam Hussein’s regime to become Iraq’s largest wheat vendor under the U.N. Oil-for-Food
Program. In addition to concealing these payments from the U.N., AWB was forced to conceal the
illicit payments from its independent auditors, Ernst & Young. When two newly-hired executives
became aware that suspicious payments were being funneled to the Iraqi government, they hired a
consulting team from Arthur Andersen to investigate those payments. AWB’s management ignored
the report prepared by the Andersen consultants that questioned the propriety of the Iraqi payments.
A U.N. investigative team chaired by Paul Volcker discovered and reported the bribes paid by
AWB to Saddam Hussein’s regime. The highly publicized scandal embarrassed AWB’s
management and resulted in the company losing its exclusive right to export Australian wheat.
332 Case 8.7 Australian Wheat Board

Australian Wheat Board—Key Facts

1. In 1999, the Australian government converted the Australian Wheat Board into AWB Limited, a
company controlled by the nation’s wheat producers; similar to its predecessor, AWB had an
exclusive right to export Australian-grown wheat.

2. Wheat exporters in other countries maintained that AWB’s monopoly over Australia’s wheat
exports gave the company an unfair advantage in the global wheat market; these same critics also
suggested that AWB made illicit payments to secure large wheat contracts.

3. U.S. wheat exporters complained that the FCPA of 1977 placed them at a disadvantage to their
foreign competitors, such as AWB, since that law forbids illicit payments to obtain or retain
international business.

4. Increasing concern over the integrity of international markets caused the OECD to adopt the
Convention against the Bribery of Foreign Public Officials in International Business Transactions in
1996; the blueprint for this convention was the U.S.’s FCPA.

5. Australia quickly adopted the OECD Convention; the resulting legislation prohibited companies
from paying bribes or kickbacks to officials of foreign governments to secure international business.

6. AWB modified its Corporate Ethics and Code of Conduct Policy to make its employees aware
that bribery payments to officials of foreign governments to secure business were not permissible.

7. AWB’s corporate policy statement did not prohibit “facilitating payments,” i.e., “small benefits
to foreign public officials in order to facilitate routine government action of a minor nature.”

8. Certain AWB executives ignored the new Australian law and the company’s stated policy by
paying bribes to obtain Iraqi wheat contracts administered under the U.N.’s Oil-for-Food Program,
bribes that they concealed from their independent auditors, the U.N., and other parties.

9. A report by an Arthur Andersen consulting team suggested that illicit payments were being
made by the company to acquire international business contracts; AWB’s top management ignored
that report and Andersen’s recommendation that the company strengthen its “ethical culture.”

10. A U.N. task force chaired by Paul Volcker discovered that AWB had paid $300 million in bribes
to Saddam Hussein’s regime to acquire the Iraqi wheat contracts.

11. The Cole Commission, an investigative committee established by the Australian government,
berated AWB for making the payments to Hussein’s government but ruled that those payments were
technically not bribes since they were not illegal at the time in Iraq.

12. Despite the Cole Commission’s ruling, AWB suffered serious consequences as a result of the
Iraqi wheat scandal, including losing its monopoly over Australia’s wheat exports.

Instructional Objectives
 Case 8.7 Australian Wheat Board 333

1. To demonstrate the serious consequences that an unethical business culture can have for a
company.

2. To introduce students to ethical challenges faced by companies competing in global markets.

3. To acquaint students with the requirements of the Foreign Corrupt Practices Act of 1977 and
similar legislation adopted in other countries.

4. To examine auditors’ responsibility to discover illegal acts by an audit client.

Suggestions for Use

Since this case is ongoing, consider having one or more students or student groups research and
report on recent developments in the case. This case typically piques students’ interest since it
involves a context with which they are all very familiar, namely, the ongoing Middle Eastern crisis.
You will likely want to discourage students’ from debating the various political issues related to this
case since such debates can easily become heated and divert attention away from the central focus of
the case, namely, the importance of companies establishing and maintaining an ethical corporate
culture.
Unlike most cases in this text, this case does not highlight or focus on specific technical
accounting or auditing issues. Having said that, the ethical culture of an organization obviously has
pervasive implications for the entity’s accounting staff and independent auditors. If you want to add
a more technical “angle” to this case, consider having one or more student groups prepare a
comparative report on the key differences between U.S. accounting and auditing standards versus the
comparable standards applied in Australia.

Suggested Solutions to Case Questions

1. “Yes,” the FCPA applies to foreign companies that have securities listed on a U.S. stock
exchange.

2. Payment of such bribes would qualify as an “illegal act,” meaning that the provisions of AU
317, “Illegal Acts by Clients,” would apply. The degree of responsibility that an auditor assumes for
detecting illegal acts by a client depends upon the nature of those acts as discussed in AU 317. That
section of the professional auditing standards distinguishes between an auditor’s responsibility to
detect illegal acts that have a “direct and material” effect on a client’s financial statements and illegal
acts that have a “material indirect” effect on a client’s financial statements. Since bribery payments
could fall into either category, the next two paragraphs highlight the auditor’s responsibility to detect
illegal acts in each category.
Auditors generally have much less responsibility to detect illegal acts that have a material
indirect effect on a client’s financial statements. AU 317.06 observes that an auditor “ordinarily
does not have sufficient basis” for recognizing such violations by clients. Later, this section adds:
“If specific information comes to the auditor’s attention that provides evidence concerning the
existence of possible illegal acts that could have a material indirect effect on the financial statements,
the auditor should apply audit procedures specifically directed to ascertaining whether an illegal act
has occurred.”
334 Case 8.7 Australian Wheat Board

AU 317.05 notes that an auditor’s responsibility to detect and report “misstatements resulting
from illegal acts having a direct and material effect on the determination of financial statement
amounts is the same as that for misstatements caused by error or fraud as described in Section 110.”
In turn, AU 110 notes that an auditor “has a responsibility to plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement
whether caused by error or fraud.”
Following are examples of specific audit procedures that may be effective in discovering bribes
paid by a multinational audit client to obtain or retain international business relationships.

• Determine whether the client has specific policies that prohibit such payments and that
clearly distinguish between bribes and facilitating payments. Determine whether these
policies appear to be properly communicated and enforced within the organization.
• Obtain and review contracts pertaining to international business relationships. Inquire of
management and/or client’s legal counsel regarding any unusual features or clauses in these
contracts. Consider having independent legal counsel review these contracts.
• Review details of major transactions with international parties to determine whether those
transactions appear to be in compliance with contractual requirements and the requirements
of the FCPA.
• Prepare horizontal analyses of gross profit percentages and other key ratios and measures
relevant to the given international transactions. Determine whether there are unusual trends
or outliers evident in those data items.
• Compare pricing information and other information that may be available regarding
international transactions of competing companies that are similar to those engaged in by the
client. Investigate unexpected or otherwise unusual differences across the two information
sets.

3. Neither the OECD Convention, nor the FCPA prohibit “facilitating payments.” Nevertheless, if
an audit client is routinely making such payments, that would certainly appear to be a fraud risk
factor that should be monitored. At a minimum, such payments document that the client is doing
business in one or more countries where “shady” payments are required to consummate business
transactions. I have no empirical support for this statement, but it would be reasonable to assume
that in those countries such payoffs would likely be required from the bottom to the top of the “food
chain.”
When an audit client routinely makes facilitating payments, the audit program should likely
require expanded internal control testing. A principal objective of this testing would be to determine
that company policies and applicable laws and regulations, such as the FCPA, are not being violated
by those payments. Likewise, substantive tests of transactions should likely be expanded. These
expanded tests would focus on potential violations of the key management assertions pertinent to
material international business transactions.

4. This question has prompted lively discussions in my auditing classes. An effective method that
I have used to address this question is to have two groups of students debate this issue. One group
has the responsibility of defending the position that the overriding responsibility of corporate boards
is to “act in the public interest,” while the other group defends the position that the overriding
responsibility of corporate boards is to “act in their stockholders’ interest.” Obviously, there are
many scenarios and circumstances in which those interests diverge. You might consider requiring
Contemporary Auditing Knapp 9th Edition Solutions Manual

Case 8.7 Australian Wheat Board 335

your students to develop general guidelines that companies could follow in dealing with such
situations.

5. Australia’s Auditing and Assurance Standards Board (AUASB) (www.auasb.gov.au) is

responsible for issuing Australian Auditing Standards. The organization’s website indicates that its
mission is: “To develop, in the public interest, high quality auditing and assurance standards and
related guidance as a means to enhance the relevance, reliability, and timeliness of information
provided to users of audit and assurance services.” The organization’s website also notes that
“wherever possible” it uses “International Standards of Auditing (ISAs) as a base for its proposed
Auditing Standards, in order to achieve conformity with international auditing standards.”

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