Audit is a common term in the corporate world, but an arising question is, it as simple as the people outside the profession believe it to be? This arises due to the auditors being questioned on the major scandals that took place in the corporate world such as Enron, WorldCom, and Tesco. There are a range of regulations governing the auditors and various changes are taking place in the functioning of the auditors, and in contrast, there are regulations protecting the people in the profession. The practitioners in the field face many ethical dilemmas and try to overcome them successfully by complying with the code of conduct by the governing bodies.
An audit is a search for evidence to enable an opinion to be formed on the truth and fairness of financial and other information by a person or persons independent of the preparer and persons likely to gain directly from the use of the information, and the issue of a report on that information with the intention of increasing its credibility and therefore its usefulness (Gray & Manson 2000). The roots of auditing in the UK dates to the early 1300s when a public official was charged with auditing government expenditure (NAO), hearing of account by auditors which were read out by stewards, from there auditing grew gradually. In 1559, auditing responsibility of Exchequer payments was established under Queen Elizabeth I, but this system lapsed over time. During the period of Industrial Revolution in the 1800s, the practice of auditing started setting off, the Joint Stock Companies Act 1844 provided the appointment of auditors but was not compulsory and the growing need of audit led to the formation of ICAEW in 1880 to give the professionals a supervisory body to carry out company audits. There was a quick transition in the 1900s with 90% of the organisations using audit programmes in 1980s in contrast to the checking of transactions in 1940s and not to overlook the formation of the Audit Practices Committee and published auditing standards in 1970s give the practitioners an authoritative standard for financial reporting and outline procedures which are required to produce audit reports.
Supervisory bodies like ACCA, ICAEW, and ICAS maintain rules or directives known as regulations. Audit is carried out by understanding the activities of the organisations such as cost allocation, its current and future investments. Identifying risks associated with the major activities listed in the financial statements and reports such as threat liquidity, inflation. Then after examining supporting evidence to ensure the financial report prepared by the organisation is accurate, an audit report is prepared by the auditors setting out their opinion that the financial statements prepared by the organisation are free from any material misstatement which may influence the decision of the stakeholder or users.
Regulations require the auditor to perform additional procedures and take further actions. Own procedures may be developed by many firms to comply with these regulations but compliance with the regulations by the auditors is crucial. Part 16 of The Companies Act 2006 gives guidelines on Audit with an in-depth explanation of requirements for audit, the appointment of auditors, functions of auditors and other regulations to be considered in the practice. ICAEW also laid out some principles that an auditor needs to comply within the profession, they are; integrity, objectivity, professional competence and due care, confidentiality, and professional behavior. Since 2009, there have been some developments to the ICAEW Code such as changes in provisions relating to the breach of the code, section 290 which relates to independence. Integrity refers to the fair dealing and truthfulness of the auditors in their work. Objectivity refers to the judgement of the auditor not being over-ridden by bias or outside influence. Professional competence with due care refers to the maintenance of knowledge and skill whilst acting in accordance with the standards when providing services. Confidentiality refers to the non-disclosure of any information to third parties as well as not using the information for personal gain. Professional behavior refers to the compliance of the laws and regulations that govern the profession.
Three issues regarding the client-auditor relationship which could weaken independence were raised by Imhoff (1978). They are as follows: (1) the client may be deemed as a potential employer by the auditor, (2) the closeness of the auditor with management may create a distance with the real employer of the auditor i.e. the shareholders, and (c) difficulties may be faced by the auditor in maintaining independence in front of their former colleagues. Keeping this methodology in mind, we can look at the significant changes that took place in the development of practice. In 2012, FRC wanted the board to set out why they consider the statements to be free from material misstatement i.e. truthful and understandable. Also, to put the audit contract to tender at least every ten years. (FRC). Similarly, there were changes over the years such as an audit partner required to rotate after five years, the explanation of engaging with shareholders when majority of them have voted against any resolution and the functions of the audit committee.
A situation where there is a difficult choice to make between two courses of action is called ethical dilemma (Oxford Dictionary). The decision is based on the morals which are generally derived from religion, society, and the upbringing of an individual. Ethical dilemmas are faced by most of the people in their day to day life and auditors are no exemption from it. Some of the common ethical dilemmas which the practitioners in the field face are being given extra fees to sign the financial statements prepared by the organisation i.e. declaring them true and fair, developing friendship with the directors in the process of audit and being asked to overlook some costs to overstate profits to attract shareholders, overlooking of some misstatements in the financial statements due to time constraint or some other reason such as pressure from managers or colleagues as very few people can interpret and read them. When faced with these some of the key principles that come into account are integrity, professional behaviour, objectivity, and confidentiality. Regulations such as following the code of conduct, responsibilities of the auditor against that of the director (ICAEW). These regulations ensure that the auditors act ethically against the self-interest threat of getting away with the extra fees paid to act against the law and morals. One of the prime examples of an auditing firm going against the principles and closing is Arthur Anderson, they lost the public trust in them in search of extra profits but unethical decision making and neglecting their own values led to their collapse.
Considering the situation of being asked by the director to overstate profits can be solved appropriately by explaining the director about the professional integrity and behaviour to be maintained towards the profession, explain the consequences and impact it can have on the firm’s image in the society if the overstating is discovered at some point of time in future (E.g. Tesco), if the director still insists on doing it, the auditor can report the issue to the professional body and seek assistance to prevent the material misstatement in the statements.
Recently, KPMG was faced with $6.2m fine over oil company audit errors which had certain assets overvalued by more than 100 times (Financial Times). In 2015, Toshiba who were audited by EY also had their profits overstated by £738m. A common reason as to why these scandals take place is to give a good impression of the company to the stakeholders thinking that when the position of the company “actually” improves things will get normal and the overvaluation (profits) or undervaluation (debts) will be unnoticed. But the other side is, when things get out of control and the organisation files for bankruptcy or the management is caught, who should be responsible for giving the false image of the financial statements. Should it be the auditors who have overruled their fundamental principle of integrity and objectivity or should it be the management who were the mastermind behind it is a question which still has no proper answer to it!
In conclusion, the question which arises is, are the regulations made by the regulatory bodies appropriate and is it compulsory to abide them? An auditor is the one who is registered with the regulatory bodies and needs to comply with some principles and regulations developed by the regulatory bodies. The effectiveness of the regulations is there to a certain extent (keeping the scandals in mind) and having regulations is good but these regulations are made by highly qualified and experienced individuals in the profession therefore it is debatable whether they are reliable or not because it can also be made with self-interest or in interest of the firms they have previously worked at. “The Opera reminds me of my tax audit. It was in a language I didn’t understand. And it ended in tragedy.” Chris Cassatt and Gary Brookins (Jeff MacNelly’s Shoe). Considering the literature, it appears that regulations has a lot of content to go over and understand but at the end of the day what matters is the purpose of audit which is to give an opinion on the truthfulness and fairness of the financial statements.
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· Imhoff, E.A., Jr. (1978). Employment effects on auditor independence. The Accounting Review, 53, 869-881.