The Essay Explores The Impact Of Auditing On Liabilities And Assurance Services.

Literature Review

Discuss about the Impact on Liabilities Auditing and Assurance Services.

The recent global financial crisis of 2007-08 has made significant influence on the role of auditing and assurance services that laid considerable changes in the liabilities of auditors.  The global financial crisis primarily occurred due to risk taking behavior of top five banks of US. These banks increased financial risk that caused manuapltion in the financial system. The role of investment bank in creating housing and credit bubble in the economy raised several concerns for the liability of auditors (Andenas and Chiu, 2013). Lehman Brothers was fourth largest investment bank in US, which collapsed in financial crisis. 

This paper includes discussion over the liabilities of auditors after the global financial crisis. In this, research is performed by using several resources such as peer-reviewed journals, internet and books. Through this, the impact of global financial crisis on the responsibilities and liabilities of auditors are analyzed. At last, recommendations are provided for an accounting firm to ensure effective fulfillment of enhanced liabilities.

Lehman Brothers appointed Ernst & Young (EY) for auditing their accounts and financial reports independently. Due to this, EY as independent auditor was responsible for presenting fair opinion regarding the accuracy of financial statements and their ability to present true financial condition of the company. EY was aware about the faulty accounting practices of Lehman Brothers such as Repo 105 and liquidity pool assets. Due to this, the practice of EY was accused in public (Wiggins et al., 2014). It failed to fulfill its duties and responsibilities of presenting true picture of a firm’s financial state. Due to this, the global financial crisis has considerable impact on the liability of auditors.

According to Xu et al., (2013), audit behavior significantly changed in Australia after the global economic crisis. In 2008-09, auditors became more active in terms of providing opinions related to the going concern issue than the period 2005-2007. They have increased their efforts to audit the financial statement of the firm and to provide reasonable assurance. The auditing report and fee reflects the changes in the process of audit. In this study, it is also found that audit fee has increased after the global financial crisis as the auditors’ efforts also increased in significant manner. 

On the other hand, Carson et al., (2012) state that going-concern opinions of auditor played critical role in causing financial crisis. By reviewing financial statement’s fairness at the reasonable level, auditors provide opinions regarding going-concern of firm. Auditor’ opinions set expectations among investors for the stock value and return. Compensation structure, auditor size and auditor-client relationship are important factors that influence an auditors’ going-concern opinions for a firm. In this way, this study depicts that the auditors are liable for giving right judgment regarding the going-concern of firm.

Application

Dart (2011) found in his investigation that auditors’ economic dependency and non-audit service create threat for the auditor’s independence. Auditors provide audit and non-audit services jointly to the client that causes more threat for the independency. It is also determined in this research that auditor’s economically depends on the firm and this also has potential to influence their opinions for the firm’s financial statements. Although, long term relationship among client and auditor affect the independency of auditors but the above stated factors causes great impact. Investors’ perceives that auditors’ independency may affect the audit quality and consequently consequences for them.    

Tepalagul and Lin (2016) also highlight the relationship between auditor independence and audit quality on the basis of articles which were published from 1976-2013. There are mainly four sources are determined that have great impact on the independence of auditors such as client-auditor affiliation, significance of client, working period and non-audit provisions are identified in this research as major areas of limiting the independence of the auditor for presenting fair opinions regarding the fairness of financial statement. The independence of auditors affects quality of audit at the greater extent and due to this global financial crisis is responsible for enhancing liability of auditing firms for the maintenance of auditing.  

The silence of auditors at the time of global financial crisis caused changes in the liabilities of auditors. In accordance to Mala and Chand (2012), International Auditing and Assurance Standards Board (IAASB) issued an audit alert and depicted responsibilities of auditors in terms of applying Fair Value Accounting (FVA) practices. They became more accountable to acknowledge rule of FVA and to disclose them properly. Auditor’s liability to understand accounting practices and their proper disclosure became more complex after the global financial crisis.

Rotta (2010) stated that lack of ethics is also closely related to the role of auditors during the financial crisis. The profession of auditors was insufficient to understand ethical responsibilities towards the stakeholders. Ethics has close connection with the quality of audit and consequently the financial downturn. In auditing professional, the inclusion of ethical rules and standards becomes highly importance after the collapse of major financial institution during global financial crisis.

On the basis of above literature review, it can be stated that auditor failed to reflect the actual condition of firm’s financial condition and this caused raised concerns for their ability to perform audit functions. After the financial crisis, liabilities of auditors extended through the application of range of regulation and ethical principles within this profession.

Financial crisis made auditors more liable to access the declaration in concern of the stated accounts. They need to assess an organization’s approach of valuing the asset and liabilities completely. Due to this, auditors become responsible to examine the approach of organization to value their assets. Through this, auditors can detect the misstated financial values in the accounting statements and to prevent fraud (Laux and Leuz, 2010). After economic crisis, auditors’ duties and responsibilities in terms of reviewing the financial statements is likely to become highly complex and broad. An accounting firm may need to improve practices of valuing assets of the organization, which auditing financial statement.

The global financial crisis raised concerns for auditors’ independence. They become ethically responsible for ensuring objectivity and independence in the reviewing the financial statement of firms. Ethical issues for auditors mainly occur when they provide audit and non-audit services to a client. It creates relationship between auditor and firm that affects their ability to audit the financial statements and accounts independently (ACCA, 2011). Auditing fee is considered as important factor to raise concerns for the auditor after the financial crisis. Huge amount of fee was provided by the firms to the auditors for giving consultancy services that played critical role in creating ethical issues for the profession of audit. The audit fee affects independency of auditors in maintaining transparency and objectivity (Pál, 2011). The auditor independency factors have potential to make auditors and accounting firms more liable to follow ethical standard in providing audit and non-audit services to the client.

The relationship of auditors’ fee and audit quality has potential to create liability for disclosing remuneration.  Auditors become liable to disclose the information regarding remuneration and other perks and benefits receive from a client for their services. They also need to mention the type of non-audit services offered to client and corresponding fee. Through this, auditors are liable to declare their independency within auditing of financial accounts of firms (ACCA, 2011). On the other hand, global financial crisis made auditors ethically responsible to make required disclosure for non-audit services. Auditors became responsible for framing, implementing and disclosing audit committee’s policy in regard to the offered non-auditing services for ensuring transparency (ACCA, 2011). Due to this, accounting firm may experience increase in liabilities towards client, public and investors.

Internal audit is a major area in which liability of auditors has changed significantly after the global financial crisis. Auditors became liable to examine the application informed management practices and safeguards for ensuring reporting of accurate financial data about firm’s operations. Without ensuring this, they are prohibited to examine the accounts of a firm. Auditors are ethically responsible to examine the arrangements of internal control within an organization (Healy and Palepu, 2012). By gaining satisfaction for internal control arrangements, auditing firm can serve to the client. It is critical for an accounting firm to ensure accomplishment of this liability for preventing legal claims.

In the global financial crisis, auditors’ silence and negligence increased ethical responsibilities towards the public. Professional competence and due care and professional behavior becomes major principle for the auditing service. These principles made auditors ethically liable for ensuring maintenance of professional competence in auditing the financial statement of a firm. They become responsible for behaving more professionally by taking reasonable steps to reduce audit risk (Gramling et al., 2012). Auditors are liable to take reasonable actions and steps for indentifying and accessing risk of financial misstatement, obtaining required audit evidences, providing fair opinion about the accuracy of firm’s financial statement. The role of auditors in the global financial crisis increased ethical liabilities of auditing firms (ACCA, 2011). These have significant potential to increase liability of auditors in an accounting firm.

Auditor’ independence before the global financial crisis was limited due to their multidisciplinary practices including tax practices, consultation and legal advisor. This caused development of familiar relationship between client and auditors that limits their independency. Due to this, auditors become responsible for establishing a supervisory board for examining and ensuing auditor’s independence throughout the process of auditing (Du Plessis et al., 2010). Similarly, professional skepticism and professional judgment are two aspects included in the auditors’ responsibility. It makes an auditor’s liable to exercise relevant training, knowledge and skills to make informed decisions and actions in regard to the auditing firm. Similarly, auditors are also ethically responsible to have an attitude of questioning the accounting practices and reporting. It makes them liable to being alert for the conditions that may raise the possibilities of material manipulation in the financial statement (Adelopo, 2016). In this way, auditors’ liability becomes broad in terms of planning and providing audit services to the firms.

Auditors’ became liable to address the needs of public in terms of providing opinion for the audited financial statement of a firm. They are required to collect sufficient evidences for proving the accuracy of their opinions and consequently financial statements. Through this, they need to ensure that enough evidences are presented by them to ensure independence in auditing process (Rapoport, 2011). The auditors of accounting firms are liable to provide evidence-based opinions for the firm’s operations and financial statement.

Additionally, global financial crisis also placed liabilities for auditors in disclosing discussion between the client and auditing firm to make the auditing process valuable from the perspective of stakeholder. Auditors’ responsibilities are to present clear and precise statement about business model and potential risks, going-concern opinion and capital structure. Through this, auditors inform the stakeholders and other concerned parties about the fairness in reporting financial accounts (Kennedys, 2011). Auditors in accounting firm may face these liabilities in auditing process as the result of the financial downturn.

On the basis of above discussed literature for the impact of global financial crisis on the liabilities of auditors, it is determined that an accounting firm becomes responsible for fulfilling ethical and legal responsibilities, while auditing the financial statement of a firm. They need to ensure independency and reasonable assurance for their opinions for a firm’s financial conditions. The Association of Chartered Certified Accountants (ACCA), International Federation of Accountants (IFA) and International Auditing and Assurance Standards Board (IAASB) are some key global accounting and regulatory bodies that are accountable to regulate the auditing firm by defining roles, responsibilities, duties and rights of the auditing firms (Adelopo, 2016). These bodies aim to regulate the auditors’ practices and to ensure adherence of professionalism throughout auditing process for ensuring objectivity, integrity and independence.   

By following the guidelines of these professional bodies, an accounting firm can fulfill its extended liabilities towards the stakeholders. This could be useful for firm to take required steps to improve the quality of auditing process. For managing audit quality, an accounting firm can follow the below framework, which is provided by IAASB to ensure auditors’ independency and integrity:

(IFAC, 2013)

On the basis of above framework, accounting firms needs to develop an environment for ensuring improvement in the quality of auditing. This framework indicates that an accounting firm should understand the interrelationship between input, output and process to develop a culture of produce quality audit. Input and process elements include personnel training and education, methods, standards and practices. Output can be improved by understanding stakeholders’ perception about audit quality as it would help an accounting firm to address the concerns of financial statement’ users, while providing auditing services (IFAC, 2013). It may improve the audit report value for the users.

Conclusion

The above framework also indicates importance of contextual factors in improving the quality of audit. Corporate governance, regulatory environment, cultural values and information systems some contextual factors should be considered by an accounting firm to improve quality of audit. These factors influence quality of audit either in direct or indirect way. Thus, IAASB’s audit quality framework would be effective to include all concerned parties of the financial auditing process from the auditors to client, regulators and users (IFAC, 2013). These are ultimately for improving the quality audit and their inclusion could auditors to provide opinions independently.

In the words of Al-Khaddash et al. (2013), litigation environment and regulatory framework can be used by accounting firm to improve the quality of audit as it provides a legitimate framework to determine financial reporting requirements of the firms in accordance to their operations, nature and size. This could allow an accounting firm to audit process more effectively and to provide fair opinion to the users. On the other hand, Knechel et al., (2012) state that the impact of auditors’ expertise and knowledge on the quality of audit process and consequently. By focusing on educating auditors about their emerging roles, responsibilities, duties and ethical liabilities in auditing process, an accounting firm can be effectively reduce the possibilities of any faults in the process of auditing and consequently causes of financial crisis in global economy. Additionally, Sweeney et al., (2010) state that ethical values of auditors have potential to influence the quality of audit report and opinion. Weak ethics may allow auditors to provide importance to personal benefit over utmost people. In such cases, auditor may flaw the process of auditing. Due to this, accounting firm can improve the quality of audit by encouraging auditors to maintain ethics of audit profession, while auditing client’s financial statement. This may help to reduce the scope of faulty audit report.

References

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Al-Khaddash, H., Al Nawas, R. and Ramadan, A. (2013) Factors affecting the quality of auditing: The case of Jordanian commercial banks.International Journal of Business and Social Science, 4(11).

Andenas, M. and Chiu, I.H. (2013) The foundations and future of financial regulation: Governance for responsibility. UK: Routledge.

Association of Chartered Certified Accountants (ACCA) (2011) APB Tightens Ethical Standards. [Online]. Available at: https://www.accaglobal.com/pk/en/technical-activities/technical-resources-search/2011/july/apb-tightens-standards.html (Accessed: 14 September 2016).

Association of Chartered Certified Accountants (ACCA) (2011) Audit reform: aligning risk with responsibility. [Online]. Available at: https://www.accaglobal.com/content/dam/acca/global/PDF-technical/audit-publications/tech-af-arar.pdf (Accessed: 14 September 2016).

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