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External audits are so important that publicly held corporations are required by law to
have external audits regularly, as assurance to investors that the financial reports are
reliable.
Unfortunately, flaws in the auditing process played a major role in the downfall of
Enron and several other major firms. The problem can be traced back partially to the
auditing groups’ problems with conflicts of interest and eventual loss of objectivity. For
instance, Enron was such an important client for its auditing firm, Arthur Andersen, that
the auditors started letting the firm take liberties with its accounting systems for fear that
if they were too strict, Enron might take its business to another auditing firm. In the
aftermath of the resulting scandal, Arthur Andersen was forced to close its doors,
Enron had to liquidate all of its assets, several top managers from both firms went to
jail, and the entire accounting profession was forced to reexamine its basic businesses
practices.
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Some organizations are also starting to employ external auditors to review other
aspects of their financial operations. For example, some auditing firms now specialize
in checking corporate legal bills. An auditor for the Fireman’s Fund Insurance Company
uncovered several thousands of dollars in legal-fee errors. Other auditors are beginning
to specialize in real estate, employee benefits, and pension plan investments.
Whereas external audits are conducted by external accountants, an internal audit is
handled by employees of the organization. Its objective is the same as that of an external
audit—to verify the accuracy of financial and accounting procedures used by the organi-
zation. Internal audits also examine the efficiency and appropriateness of financial and
accounting procedures. Because the staff members who conduct them are a permanent
part of the organization, internal audits tend to be more expensive than external audits.
But employees, who are more familiar with the organization’s practices, may also point
out significant aspects of the accounting system besides its technical correctness. Large
organizations like Halliburton and Ford have an internal auditing staff that spends all
its time conducting audits of different divisions and functional areas of the organization.
Smaller organizations may assign accountants to an internal audit group on a temporary
or rotating basis.
Satyam Computer Services in India falsely reported profits of over $1 billion when in
reality it had only $66 million. The Indian affiliate of PricewaterhouseCoopers, PW
India, was in charge of routinely auditing the firm, but failed to follow basic auditing
procedures. Rather than confirming the supposed $1 billion cash balances with the
banks, PW India relied solely on the information provided by the firm’s management.
In some cases, auditors failed to follow up on confirmations sent independently by the
banks that showed significant differences from the balances reported by management.
PW India was eventually fined $7.5 million—the largest penalty ever imposed by India
on a foreign accounting firm.
21
STRUCTURAL CONTROL
Organizations can create designs for themselves that result in very different approaches
to control. Two major forms of structural control, bureaucratic control and decentralized
control, represent opposite ends of a continuum, as shown in Figure 14.6.
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The six
dimensions shown in the figure represent perspectives adopted by the two extreme
types of structural control. In other words, they have different goals, degrees of formality,
performance expectations, organization designs, reward systems, and levels of participa-
tion. Although a few organizations fall precisely at one extreme or the other, most tend
toward one end but may have specific characteristics of either.
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