BBAC601 | Auditing and Assurance Assignment Help
Introduction
The profession of auditing is a very honorable one as it requires expressing a professional opinion on the accounting records and financial statements of the business entity which is relied upon by the shareholders of the company. Audited financial statements as such inform the users of those financial statements that the information reflected in these statements represent the true and fair view of the business affairs of the company. The overall purpose of the audit is to enhance the degree of confidence reposed by the intended users in the financial statements of the entity. Without conducting an audit, the shareholders and other users wouldn’t know whether the management of the company including its directors are taking all necessary steps to conduct the business and whether the financial statements are prepared in all material respects in accordance with the entity’s applicable financial reporting framework (IAASB, 2010). The level of confidence can only be enhanced by appointing a third party auditor who is totally independent of the management of the business entity. However, there are certain controversies and issues that have been observed in the current business environment and which repose significant threat to the profession of auditing and true and fair financial reporting. This essay briefly sheds light on the purpose of appointing an independent auditor and discusses in detail the recent controversies relating to the rotation of independent auditors, and the threats to the auditor’s ethical obligations to remain objective in all aspects of his profession.
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Why Independence is Essential?
Audit is concerned with the public interest and the overall corporate governance environment in the entity. Therefore it is of utmost importance for the auditor to remain objective, act with integrity and to remain skeptical through the audit. These objectives cannot be achieved if the auditor is dependent on the entity in one way or the other, e.g., if the auditor is an employee of the business entity then the management could easily influence his opinion on the financial statement by either threatening the job or increasing the incentive schemes. Therefore all the corporate environments and economies in the world require the external auditors to be independent of the audit client. According to the International Standards on Auditing published by the International Federation of Accountants, independence enables the auditor to form opinion on the financial statements without being affected by the potential influences (internal or external) that may compromise that opinion (IAASB, 2010). These standards are the most recognized and most followed framework of auditing standards throughout the world. Auditors in most of the economies are also required to follow the Code of Ethics for Professional Accountants as promulgated by IESBA. That code lays a primary obligation on all external auditors to accept only those audits where auditor is completely independent of the entity.
Therefore, independence is considered to be the most fundamental attribute of audit throughout the world and without it the underlying objective of conducting and audit would never be achieved. Firms providing audit attestation and assurance services also engage in non-audit services and engagements. In this regard, there has been a debate in the business world regarding whether the audit firms should engage in non-assurance services due to the possibility of their independence in audit engagements being impaired (Antle, 1984). Securities and Exchange Commissions of various countries and the regulating authorities have often tried to assess the auditor’s independence by comparing the fees derived from providing non-assurance services with the fees derived from audit engagements. This simple measure can provide a good idea about the auditor’s dependence on the client.
Despite such emphasis on independence in the auditing and accounting literature about the independence of the external auditor, the actual definition of what constitutes auditor’s independence is somewhat vague or is quite lengthy to give a reasonably clear conclusion. Independence of the auditors has therefore always been the most controversial and debated area in the profession of auditing.
Controversies Relating to Auditor’s Independence
In the past few decades the overall focus of corporate governance and regulation is to enhance the shareholder value and to promote transparency in the corporate world. Although shareholders are the ultimate consumers of the auditor’s work and they are the persons who pay auditor for his work, little has been heard about their opinion about the auditors and what independence means to them. Shareholders and other users of the financial statements make their decisions based on the audited information presented in the financial statements. Likewise the auditor’s report is also addressed to the shareholders of the company. Therefore, any shortcomings are likely to directly affect the quality of the decisions made by the users.
The recent scandals, cases of frauds and the inability of auditors to warn of problems beforehand have directed the attention of the United States’ and European regulators towards the integrity of auditors and the means to promote transparency and enhance the quality of audits. There have been numerous financial scandals around the world. What began with the Enron scandal (Hilzenrath, 2001) was extended to the WorldCom (Pulliam & Blumenstein, 2002) and has also led to the downfall of the Andersen’s audit firm (McRoberts, 2002). Many audit firms including Deloitte have been knowingly or unknowingly found to have committed fraud at one time or another (Hamilton, 2013).
The controversy over auditor’s independence also existed before these scandals were unveiled when it was observed that the auditors have been charging more fees for providing non-assurance services engagement than that for providing assurance services. This trend has been seen in many countries in the world including New Zealand (Cheung & Hay, 2004). The previous studies and research on the topic of auditor’s independence has shown that these issues raiding the question of independence are interpreted and perceived differently by the auditor than other groups. Most of the studies are concentrated on the user groups other than shareholders. The corporate laws in most parts of the world prescribe the method of appointment of external auditors, and prohibit any person from becoming the auditors of the company, whose opinion may be unduly compromised by the management of the company. Therefore any person who has been a director or employee of the company for a prescribed time period, a partner or employee of the director or employee of the company or its related party, close family members of the directors, shareholders and liquidator of a company or nits related party are often prevented from acting as auditors of the company by these laws. The IFAC laws also require the auditor to constantly maintain “independence of mind” and “independence of appearance”. The Code defines independence of mind as, “The state of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgment, thereby allowing an individual to act with integrity and exercise objectivity and professional skepticism.” (IFAC, 2010)Independence of appearance is defined by the code as, “The avoidance of facts and circumstances that are so significant that a reasonable and informed third party would be likely to conclude, weighing all the specific facts and circumstances, that a firm’s, or a member of the audit team’s, integrity, objectivity or professional skepticism has been compromised.” (IFAC, 2010) The IFAC Code also requires the chartered accountants to remain alert to the possible threats to their independence and employ all possible safeguards.
A study conducted by Jeff Cheung and David Hay identified the core issues that shareholders of the company are concerned with when it comes to independence of the auditor. According to the findings of the survey, the self-interest threats are most common among the auditors and shareholders rated the auditor receiving greater non-assurance fee than that from the audit engagement as their major concern and the greatest threat to their independence and objectivity. Self-review threats include the auditor keeping an executive payroll by providing confidential internal audit and financial systems development and transaction advisory services. Familiarity between the directors and auditors, along with the auditor to take a key management position in the client company immediately after conducting the audit were the major concerns for the shareholders as far as familiarity threat is concerned. Advocacy and intimidation threats were found to be rare and fairly harmless to the auditor’s intimidation (Cheung & Hay, 2004).
The IFAC code also requires the independent auditors to constantly review their independence in various terms such as when auditor derives significant proportion of his audit fee from just one client, audit fees that remain unpaid, acceptance of gifts and major rewards etc.
Recent Controversies Relating to Rotation of Independent Auditors
The rotation of independent auditors has been a hot topic for debate for the last decade. Rotation refers to the change in the audit firm by the companies after a specific period of audits or financial years. The debate originates from the fact that when auditors keep auditing the financial statements of the same client for many consecutive periods, they may develop dependence due to the resulting familiarity with the audit client. This is strictly against the principle of independence principle and at the same time very difficult to avoid. There are two schools of thoughts who believe contrary to each other. One group believes that the imposition of mandatory rotation rules would not enhance the quality of audit but only reduce its efficiency, and would result in unnecessary red tape and legal procedures relating to the work of auditors which should be kept highly professional and independent. On the other hand, the other group believes that without mandatory rotation the same auditors would continue to audit the financial statements of the most largest public companies and eventually develop familiarity and independence with their client, which would comprise their objectivity and greatly impair the overall objectives of the auditor as well as the shareholder value.
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