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Question:

Discuss about the Auditing Principles and Practice.
 
 

Answer:

Introduction:

The current report aims to evaluate the provided article of the “Accounting Scandals of Dozy Watchdogs”. The first section of the report aims to depict brief description of the article along with personal views about the article. The second segment deals with critical assessment of the roles and responsibilities of an auditor. In addition, the independence issue has been discussed as well in the context of the auditor. Finally, the report sheds light on discussing the regulations and deregulations in auditing and the function of improvements to enhance the overall role and function of auditing.

Brief explanation of the article:

The article provides a survey of current fiascos. For instance, Tesco has announced that its guidance of profit in the initial half of 2014 was $408 million due to overstatement of rebate income received from the suppliers. Another instance includes the reporting of a Spanish court about the misstatement of finance of Bankia, after it became public in 2011. In addition, it has been observed that the top four audit firms have 98% market capitalisation. In most of the markets, only two or three large firms have knowledge in a particular industry (Bisogno 2016). A large firm needs diverse range of talent for completing a large audit. However, there is absence of massive scale in most of the places.

Furthermore, it has been observed that the smallest of the large four firms is KPMG, which is bigger than the next four firms combined. The article provides an overview of the audit profession and the need for compulsory audits developed. 80% of the public firms in 1920 have obtained an audit voluntarily; however, there is no such requirement. The article explains four main influential dynamics, in which the big firms are cited as motivators for performing well. These factors are related to the conflict of interest, which are briefly stated as follows:

  • The first factor is the disconnection of the audit committee from the management
  • Reputation is another factor, which could be used as a vital defence in contrast to conflict (Burtles 2016).
  • Legal risk is another potentially stronger prevention.
  • The above factors leave only a single force that would be effective and it is regulation (Christ and Janvrin 2014).

This article does not take into account the first three influential dynamics; however, it concedes that the Public Company Accounting Oversight Board (PCAOB) might have some effect. In addition, this article explains various ideas to improve the overall performance of the big four firms. Unlike the other articles, this specific article has not denied that there are certain shortcomings and tradeoffs to every recommendation. Finally, the most innovative idea is to replace the need for a yearly audit with a need to gather financial statement insurance. The only drawback is that it would need a refurbishment of the overall regulatory and legal structure for the public markets and the profession of audit with the formation of an innovative and large niche in the insurance industry (Cook, Van Bommel and Turnhout 2016).

 

Self-view of the article:

According to my view, the article has correctly pinpointed the conflict of interest as the main factor to the audit failure. However, lamenting self-regulation or hoping for effective external regulation is definitely not the solution. This is because in case of more regulations, such wisdom needs to come perforce from the auditors. In other words, as per my view, the auditors would not modify any stuff rather than their personal benefits. Hence, from my point of view, this is an issue related to feedback and incentives. This is because the auditors form a part of the organisations, in which they are more watchdogs and fewer bloodhounds. Thus, the auditors are required to be replaced individually or in mass at the time of systemic and evident failures. According to my opinion, the global organisations are on the cusp of an accounting revolution in the existing era. The techniques of cryptography like “triple entry block chains” enable outside and trustful evaluation to a level that is not precedent. Henceforth, there has been dramatic shift in the goalposts with the movement from “intra-corporate bookkeeping” to “inter-corporate settlement at real time”.

In case, any benefit is associated with the real time information, it would play out in the costs of capital. When the actual transactions are effective to work with for the relying parties along with monitoring health to the minute or the day, the investment of the savers could be directed according to the crowd monitoring. This would emerge out as the new risk-free rate, which is the investment obtained at the expense of public knowledge.

 

Critical evaluation of the auditor’s role and responsibilities:

The roles and responsibilities of an auditor are of prime significance in the modern capitalism. With the initiation of joint stock corporation, a mismatch has inundated the shareholders between the interests of the owners and the managers of an organisation (De Santis 2016). As the executives of an organisation have more knowledge about its operations compared to the investors, they could hide the actual financial condition of the same. As a result, the market would restrict capital to the firm due to the distrustful attitude of the managers. In this case, the auditors enter for resolving such issue, which is termed as information asymmetry (Gabl, Wieser and Hemetsberger 2016).

For instance, the early joint stock organisations such as the Dutch East India Company has chosen a group of investors for ensuring the inclusion of books; however, the conventional auditors have lacked in expertise or time for providing an efficient management check. With the increase in the number of investors in the modern day organisations, their inefficiency of sending different sleuths for keeping the management in track has increased as well (Gustavson 2015). In addition, the auditors are responsible for making vouchers for the organisations planning to minimise finance costs. The auditors, in turn, have been paid for assessing their clients in a fair manner to win the overall market trust.

However, the traditional investors have not contrasted between the auditing firms and their lower scrupulous peers. For instance, Swedish Match, a firm in Europe, specialised in ensuring state-sanctioned monopolies; however, its aggression of accounting had surpassed. As a result, it has collapsed in 1932, which has resulted in loss of American investors of $4.33 billion (Knechel and Salterio 2016). After such incident, the governments have made it mandatory for all the publicly listed organisations to issue audited financial statements. However, no rules and regulations were imposed on the auditors about the items to be disclosed in the audit report. For example, according to the verdict of a British judge, the auditors are not bound to be detectives. Instead, they are just watchdogs and not bloodhounds. Hence, in this case, the auditors are not required to offer services for including value to the investors for compelling the organisations to avail their services. In addition, the auditors have shifted from the statement that the financial statements are accurate to mere judgement (Li et al. 2013). Based on the above discussion, the following could be identified as the major role and responsibilities of an auditor:

  • Inquiring the management to develop an insight of the organisation, its financial reporting, operations and error or fraud
  • Analysing and understanding the internal control system of the organisation (Qasaimeh et al. 2016)
  • Confirming the balances of accounts receivables and other accounts with a third party
  • Not involved in making changes for sourcing documents
  • Not serves as the stock of a client
  • Not involved in designing the financial management system of a client
 

Independence issue:

The auditor independence is associated with the circumstances that surround the audit including employment, business, personal and financial relationships between the auditor, the auditing entity and related parties (Rafiei and Moeinadin 2014). The major issues associated with the independence of the auditor are stated briefly as follows:

  • The threat of self-interest arises at the time the auditor has financial interest that might have negative impact on the audit firm for recovering long accrued fee from the corporation for recovering long accrued fee from the corporation. For instance, Arthur Andersen, a peer of the big four global firms have been charged with lawsuits for the Enron scandal due to financial interest in auditing the financial statements of the organisation.
  • The threat of self-review occurs when the outcomes of non-audit services performed on the part of the auditor within the auditing firm are represented in the amounts disclosed in the financial statements (Kumar and Sharma 2015). For instance, the auditors are not allowed to provide valuation services to their clients, in opposition, it could be considered as self-review threat.
  • The threat of management takes place when the staffs and partners of the audit firm undertake decisions for the management of the audited firm. For instance, as observed from the provided article, the organisations with an experienced executive that the Big four has previously employed, are probable to be audited by that firm rather than its rivals. The head of the audit committee of Tesco Plc has previously worked in PWC, which might increase the threat of management.
  • The threat of advocacy arises when the audit firm takes work that includes acting as a supporter for an audited entity and position of the management in an unfavourable context (William Jr, Glover and Prawitt 2016). For instance, although the big four firms occupy a greater portion of the market share, some of their approved statements have been later revealed as incorrect. This resembles with the advocacy threat, as these audit firms intend to support the management of the multinationals in unfavourable situations.
 

Regulations and deregulations in auditing and function of improvements in improving the role and function of auditing:

Even though the regulators have admitted that the role of government inspections would be immense in minimising gross negligence, it is difficult to transform the auditors into trusty allies for the shareholders. In that case, the structural reforms need to be introduced for improving the overall audit quality (Zadek, Evans and Pruzan 2013). The diversification of the audit report is the easiest option available for improvement. It has been observed that UK has replaced the sole page statement of pass or fail with a detailed overview of the activities and area of focus of the auditors. Thus, the accountants could use a broader group of value drivers, which might include oil reserves for energy firms or drug pipelines for the pharmaceutical organisations.

Another possible deregulation would be to increase the level of competition amongst the audit firms. The big four firms mainly dominate this industry and such dominance has restricted the government in prosecuting KPMG, as it has marketed illicit tax shelters. This is because it might destroy in KPMG and the balance of the oligopoly market might be lost (Zeff 2016). Therefore, in order to increase the level of competition, the team of weaker networks could be merged to develop a new global player. Such entry of the new audit firm might help in increasing the overall audit quality.

The audit committee needs to be shielded from the influence of the management. This could be made through nomination by a distinct proxy vote, instead of the board of directors. Such change would enable in minimising the risk of the Chief Financial Officer recommending an auditor to a member of the committee (Zeff, Radcliffe and Gunz 2014). Hence, these above-stated regulations and deregulations would help in improving the overall quality of audit.

 

Conclusion:

From the above discussion, it has been evaluated that most innovative idea is to replace the need for a yearly audit with a need to gather financial statement insurance. In addition, the auditors are involved in certain roles and responsibilities that include gaining an insight of the organisation through management inquiry, understanding its system of internal control and confirming the balances of accounts receivables and other accounts. The independence issue of the auditor is concerned with certain threats like threats of management, self-interest, self-review and advocacy. Finally, in order to improve the overall audit quality, diversification of audit report, increasing the level of competition amongst the audit firms and shielding of audit committee from the influence of the management are necessary.

OR

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