Investigation Of Audit Risk And Earning Management - An Essay.

The Background and Context

Questions:

1. Discuss the risks auditors face when considering management earnings management practices?

2. Are auditing standards important and do they matter?

3. Discussion on Cyber-security, auditing and audit committees?

4. Discuss these pictures as views of the audit function?

The study tries to investigate how the risk relates to the potential earning management of the company that impacts the auditing services (DeFond & Jiambalvo, 1991). In context of the present developments that includes about the companies like Lernaut, Enron, Hauspie, and Xerox, it is appropriate to follow how the auditors could actually deal with the different risks earning management (DeFond & Jiambalvo, 1991). Its noted that not only the companies tries to suspect about the manipulation of earnings, but even their auditors who has tried to prevent or either corrected this kind of manipulation. As per Butler, Leone & Willenborg (2002), the auditors could actually deal with the risk earning management in five different ways such as they could actually screen out the clients with high risk, they can charge the free premium in case of the risky clients, they can enhance the efforts of clients, they can even try to negotiate for the adjustments towards the financial statements, and they can even report conservatively through issuing the updated report towards the clients of high risk (Butler, Leone & Willenborg, 2002).

Apparently the earning management is not considered as the common practice within the companies of Australia and in other countries (Butler, Leone & Willenborg, 2002). It’s noted that this management practice might have the bad results for both the companies and investors (Dellaportas, Yapa & Sivanantham, 2008). For example, HIH in the Australia presents the information that is actually not faithful of what is actually happening within the company and even the managers make use of the magic realism in order to bring out the results that lead the company to get collapse and the work of the auditors without any credibility (Burilovich & Katelus, 1997). For the purpose of understanding why the managers have actually done this, it is significant to analyze the incentives, which are behind it along with the role and regulations of the auditors for helping to prevent it (Burilovich & Katelus, 1997).

Prior research conducted on the audit hours and fees has also offered the great deal of the facts, about which the auditors are actually sensitive in context of pricing and also conduct the audits towards the conditions that heighten the risks (Burilovich & Katelus, 1997). Bradshaw, Richardson & Sloan (2001) has actually shown about the unusual levels about the accruals that are related with the laws against the auditors (Dellaportas, Yapa & Sivanantham, 2008). Therefore, the key question that arose is whether the management of earning is perceived under the risky conditions through the auditors, and the necessitating adjustments in the way they actually deal with the clients (Bradshaw, Richardson & Sloan, 2001). The huge research conducted on the audit fees has clearly demonstrated which fees are actually sensitive towards the conditions, which enhances the risk for the auditors (Dellaportas, Yapa & Sivanantham, 2008). However, the previous research has tried to link all the measures about the potential management of earnings towards the audit fees which is scarce (Bradshaw, Richardson & Sloan, 2001). In the current study about the evaluation of client acceptance, Bedard & Johnstone (2002) has found that the partners of audit has planned over the charging rates of higher billing when the risk of earning management was high (Dellaportas, Yapa & Sivanantham, 2008).

The Relationship between Risk and Potential Earning Management

Bedard & Johnstone (2002) along with the subsequent research has tried to well establish that the fees of audit is quite sensitive in the risky conditions like the size of the clients, composition of asset, complexity, risk of business, industry, structure of ownership, financial distress along with risk of litigation (Bedard & Johnstone, 2002). These studies has clearly tried to shown about the basic model of the audit fees which is robust all across the time period, composition of sample, and countries (Bradshaw, Richardson & Sloan, 2001). Research which has tried to examine the efforts of audit has made use of the models that are similar to the one which is used for the fees and has also explored that efforts of audit is responsive to various risky conditions (Bedard & Johnstone, 2002).

However, it is noted that the previous research conducted over the audit efforts is less cohesive as well as extensive, due to its examination about the efforts at various levels in terms of activity, aggregate and rank and is limited through the lack of data availability (Bartov, Gul & Tsui, 2000). It is noted that the auditors try to perceive about the risk of earning management to be same like the conditions of risk, which leads towards the high fees and more efforts of audit (Dellaportas, Yapa & Sivanantham, 2008). It’s true that auditors can also charge the risk premium, enhance the efforts of audit, along with substitutes with the experienced personnel in the audit for responding towards the risk (Bartov, Gul & Tsui, 2000).

In order to minimize the risk of audit, it is required by the auditors to conduct the assessment of risk in which they could explore about the indication of fraud and even explore the important risks, which also need the special focus (Bartov, Gul & Tsui, 2000). It is also important to hold the sample of representation in order to avoid the sampling risk (Dellaportas, Yapa & Sivanantham, 2008). There are various standards of auditing that relates with the issues of earning management, such as SAS 57 that is auditing accounting estimates, SAS 90 that is audit committee communications, and SAS 57 that tries to warn the bias potential for the purpose of determining the accounting estimates, which also implies that the auditors are encouraged and even expect to become more effective in the audits execution and supports in preventing the practices (Bartov, Gul & Tsui, 2000).

Proper understanding about the economic role in the standards of auditing is the significant step in enhancing the audit efficiency as well as effectiveness (Asare, Hackenbrack & Knechel, 1994). This study will try to observe about the standards of auditing, which are crucial in the case when auditors might have incentive towards under the audit (Dellaportas, Yapa & Sivanantham, 2008). While its conclusion might not be surprise, but the conditions under the standards might holds the expected impacts over the quality of audit (Asare, Hackenbrack & Knechel, 1994). Specifically, the study will explore about the observations related to what actually standards are, as auditing standards can try to compensate towards the lack of observe-ability of results of audit through stressing over the process audit (Asare, Hackenbrack & Knechel, 1994).

Different Ways Auditors Can Deal with the Risk of Earning Management

It also represents the mitigation of the benefits of information that is possessed through the auditors as the professional experts, which try to motivate the auditors (Baber, Brooks and Ricks, 1987). It also tries to counterbalance the demand of diversity in various stakeholders, which try to drive the audit towards the lesser denominator and also try to develop the market base over the adverse choice (Baber, Brooks and Ricks, 1987). It also offer the benchmark that try to facilitate the auditors calibration towards the legal liability within the event of the substandard audit. However, it also present the observations related to what the standards should need not try to do (Dellaportas, Yapa & Sivanantham, 2008). It’s noted that standards need not try to discourage the judgment use through the auditors (Baber, Brooks and Ricks, 1987).

It should also set the limit for the potential demands towards economically valuable assurance level, and it should also be set according to the agenda of enforcement, and it should also lead towards the excessive routine of procedural while conducting the audit (Baber, Brooks and Ricks, 1987). At last the auditing standards might overreach and even undermine the value of economy in audit for various stakeholders and this lead towards the fee pressure for the firms of auditing (Baber, Brooks and Ricks, 1987). This insight might inform about the debates for future related to the level and various standards, which were appropriate for the profession of auditing (Dellaportas, Yapa & Sivanantham, 2008).

The Auditing standards is establish through the board of Australian auditing standards in order to review the companies under the s336 of the 2001 Corporations Act and also support in generating the report of audit in order to offer the high assurance level to the users in the financial information (Baber, Brooks and Ricks, 1987). It’s noted that Australian securities and investment commission has registered the auditors in order to monitor the auditing companies compliance and auditors into the standards of auditing (Westfield, 2003).

Partakers in the auditing standards play integral role in the economic cycle of the country. They are actually devised and has even enacted for protecting the interest of the public in order to permit the economic resources distribution towards the credible entities (Westfield, 2003). For example, in HIH, the corporate collapse happen in the year 2010 that provide the auditors independence and put the standards of auditing at the radar. Westfield (2003) has also proclaimed the accomplice in order to hide the scandal of HIH (Westfield, 2003). Significance for holding the high standards of auditing in the country is initiated for attracting the foreign direct investors through offering them with the high assurance of audit. Global business is also trending due to the result of globalization and investors could invest their capital when the standards of auditing might differentiate from the Global standards of auditing (Pratt & Peursem, 1996). Standards of auditing, which gratifies the expectation level of the global investors includes the risk of audit and portrays the materiality, reliability and the integrity of market (Pratt & Peursem, 1996).

Previous Research on Audit Fees and Efforts

Auditors can also offer the facts of their facts of the compliance with the standards of auditing in order to defense and the fraudulent organization that is ordered through the court to actually undergo the investigation of Australian securities and investment commission. Mak, Cooper, Deo & Funnell (2005) also mention that due to the gap in expectations among the unrealistic belief in the society and the real job of the auditor, the standards of auditing is actually anticipated to be much high and it’s also capable while dealing with the detected frauds (Mak, Cooper, Deo & Funnell, 2005).

Nonetheless, even by the standards of auditing holds the guidelines for dealing with the frauds, a change in the attitude of the auditors could actually recourse towards the lesser performance, which own towards the interest conflicts, lack in experience and compromise in the independence (Mak, Cooper, Deo & Funnell, 2005). It’s noted that auditing standards also matters in the purpose of the audit assurance. It even improves the confidence degree of the users in the financial information through offering the reports of high quality audit (Mak, Cooper, Deo & Funnell, 2005).

Cyber-Security

Cyber security is implies as the security of information technology that focuses over protecting the networks, computers, data and programs through the unauthorized or either unintended access, changes or either through destruction (Hassink, Meuwissen & Bollen, 2010). Corporations, governments, hospitals, military, financial institutions and various other businesses gathered, stored or either process for the purpose of large confidential data of the computers and this information is then transmitted across the networks (Hassink, Meuwissen & Bollen, 2010). Through the increasing volume and through the cyber-attacks sophistication, more and more attention is placed for protecting the sensitive business along with personal information in order to safeguard the security of the nation (Hassink, Meuwissen & Bollen, 2010).

Cyber security standards try to enable the companies to practice the techniques of safe security (Dellaportas, Yapa & Sivanantham, 2008). These guides also offer the basic outlines and particular techniques for the purpose of implementing the cyber security (Hassink, Meuwissen & Bollen, 2010). In specific standards, certification of the cyber security by the help of accredited body could be easily achieved. There are many benefits, which are required for obtaining the certification, which includes the ability to receive the insurance of cyber security (Hassink, Meuwissen & Bollen, 2010).

The aim of the auditing process is to promote the administration of program and financial management in effective way, in order to ensure about the governance integrity (Anderson & Zéghal, 1994). The basic purpose of the audit is actually to evaluate the operations through the perspective towards enhancing the future performance (Anderson & Zéghal, 1994). The auditing report that holds the joint efforts from the part of auditor and agency is considered as the final result of the process of audit (Code of Conduct: Audit and Risk Committee Chairs and Members, 2015). In this recommendations from the auditing reports could be made use by just adjusting the priorities, policies or either procedures for making the operation more effective, efficient as well as economical Code of Conduct: Audit and Risk Committee Chairs and Members, 2015). It’s noted that all the audits are actually conducted according to the standards of government auditing, and is applied in the local laws, federal, state and regulations Code of Conduct: Audit and Risk Committee Chairs and Members, 2015).

The Role of Auditing Standards in Audit Efficiency and Effectiveness

Auditors also play crucial role in order to ensure about the reliability and integrity of the public companies financial statements (Dirsmith & McAllister, 1982). Currently, in Australia, the objectivity and the independence of the auditors is the key issue and has even brought the forefront (DeAngelo,1981). It’s noted that new rules are also proposed in order to deal with such concerns (Dirsmith & McAllister, 1982). This has lead towards the adoption of the new needs that should be followed by the Australian auditors (Dellaportas, Yapa & Sivanantham, 2008). There are many user groups, which holds the economic consequences at both the lobbied and stake towards the Securities and Exchange and commission that could be a good solution (Wilson & Root, 1989). This was also performed by the submission of the comments towards SEC and by participating in the hearing of public that permit to have the discussion on proposed rules (Wilson & Root, 1989).

The role of audit committee has become important in order to remain up to date as well as aware about the changes towards the responsibilities (Auditing and Assurance Standards Board, 2015). The audit committee acts under the delegated authority that offers links between the groups. It can pressurize the board for addressing the financial reporting and for controlling the internal issues (Auditing and Assurance Standards Board, 2015). The responsibilities of the audit committee could be determined by complying with the needs of FMA Regulations and Act and CAG Act and regulations. As per FMA regulation 2C, it includes governance framework of agency and mechanism for assurance, main risks related to the agency, which includes risk associated with the program delivery and its implementation (Auditing and Assurance Standards Board, 2015).

In CAC entities, the functions of Audit Committee are to conduct entity governance arrangement, in order to ensure about the risks and operations. It also covers business risk of entity and offer independent assurance. It also takes inputs from the stakeholders (Auditing and Assurance Standards Board, 2015).

The picture brings out the statement “The opinion that counts”, which set out the opinion of the auditor in the scope of the audit. The opinion comprises of the records as well as procedures of for producing the statements, and the opinion of the accountants related to the financial statements clearly presents the picture about the financial condition of the company (PWC Australia, 2015). There are different opinions, one is the clear opinion about the financial statement of the company that tries to present the actual picture of an organization and comply with accounting principles. These opinions decide the scope of the audit. There is also a adverse opinion, which is also referred as warning (PWC Australia, 2015). The other well known opinion is the going concern exception, which doubts about the ability of an organization.

The picture depicts the scene of the meeting between the audit committee members. These meetings are held for monitoring the audit process of an organization and for analyzing the activities of internal control (PWC Australia, 2015). The picture shows that there are seven audit members and one is chair person. All the members have not put their documents in proper way and members are looking lazy in the meeting. The focused agenda of the meetings is on top of the checklist and it depicts the dedication as well as strength of the members for performing their duty (PWC Australia, 2015). The picture also displays the qualities of strong leadership. The audit committee meetings in the company are held for 4-5 times annually in order to explain the weariness (Causholli, Knechel, Lin & Sappington, 2013). The picture shows the unethical behavior of the members that could be deemed under the board of Australian auditing standards, society and the shareholders. The picture even depicts the unprofessional behavior by the audit committee members, and this clearly insinuates how challenging the job of auditor is (Causholli, Knechel, Lin & Sappington, 2013).

This picture clearly reflects about the process of internal auditing (Causholli, Knechel, Lin & Sappington, 2013). This process is mainly used for evaluating the company’s internal process along with verifying the regulations and then giving recommendations in bringing improvement in internal process (Standards Australia, 2015). Both the internal and the external process of auditing are executed with certain aim, integrity, due care, confidentiality of the information, and through professional competence and behavior (Causholli, Knechel, Lin & Sappington, 2013). The pictures mention that internal auditing clearly presents every task, which are completed and afterwards how the management review is conducted in the reports (Standards Australia, 2015). Through analyzing the task, auditors document every work and that too within the set time limit (Causholli, Knechel, Lin & Sappington, 2013). This helps in ensuring that management gets the enough time in conducting the quality improvement and performance review for mitigating the risk (Standards Australia, 2015).

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