Regulation Of Auditing Profession In UK - Essay Example

Regulation Of Auditing Profession In UK Introduction This paper provides an insightful study into the UK auditing profession and the alleged claims on its trustworthiness for investors and shareholders. Corporate scandals having taken place on the UK as well as International level for over a few decades further erupted the issue of professionalism in the context of auditing. In particular, the cases such as Enron and WorldCom and the proved auditors’ involvement in the professional misconduct shook off the international concern for investor protection. Therefore, in such a situation every country needs to re-evaluate its regulatory structure and tighten the control on the auditing firms dominating the whole profession. The paper investigates the UK auditing profession, its involvement in corporate mishaps, and the regulatory framework before and after the Enron failure while comparing it with the US auditing regulation. UK Auditing Profession— An Overview Accounting profession in UK with particular emphasis on auditing has been in the limelight for years concerning its practices and compliance with the rules and regulations. The corporate collapses taken place during the recent years have further ignited the issue concerned with audit fairness on the part of the auditing professionals. Larson (1977) says that the individual behaviour of certain professionals can lead to the disgrace and dishonour of the profession as a whole. This notion is confirmed in the case of auditing profession not just in the UK but also throughout the world. The indulgence of certain auditing firms in professional misconduct raises questions to the reputation of auditing profession as a whole. Interestingly, the profession in question being accused of professional malpractice was itself effectuated to curtail professional misconduct by the corporate sector. Chandler and Anderson (1993) propounds that in the United Kingdom, the profession of auditing was brought about by the rise of abounding fraudulent cases on the part of the corporate sector particularly the limited corporations. He says that the need to furnish useful information to shareholders with due integrity nurtured the growth of auditing professionalism in the UK. Anderson et al. (1996) corroborate that in the United Kingdom, the professional accountants from the Institute of Chartered Accountants in England and Wales generally performed the external audit of all the listed companies even before the legal requirement was actually imposed on companies to get their financial statements audited from qualified accountants. It therefore suggests the need and criticality of auditing profession in the UK corporate environment, where the shareholders are desperately relying on the profession to carry out a check on the utilisation of their investments. Auditing profession in Britain captures every sector of the society and dominates the regulation no matter how often this profession has been found to be involved in corporate scandals. Regardless to what happens to both the sides i.e., the shareholders and management, this profession remains to be the beneficiary class (Sampson, 2004). The level of professionalism demonstrated by the auditing firms enhances the importance of a keen eye that needs to be placed over the auditing profession in the form of regulations. Cousins et al. (2000) emphasise that the shareholders and investors coming from the general public in UK have been victims of corporate scandals owing to audit failures and the oversight of auditing firms. The auditors in UK are proficient enough in their profession to play around with the standards set by the regulatory bodies. Hence, it is increasingly important to continuously revise the efficacy of standards in protecting the shareholders’ interest. One of the major causes behind such exploitation of professional influence is to a great extent brought about by the concentration of ‘auditing power’ among a few firms in UK. Arnold and Sikka (2001) illuminate that UK accountancy profession is highly dominated by a handful number of firms i.e., the big four firms with their head offices in the tax heavens having no liability to share internally secret information with the external parties. These firms (PricewaterhouseCoopers, Deloitte, KPMG, Ernst & Young) audit all the giant companies in the UK driving the whole industry towards their interests. This shows that UK auditing profession revolves around the four giants, which authenticates the fact that the implementation of auditing standards in UK rests within the hand of these four auditing firms. Bodies Of Audit Regulations In UK The ICAEW (Institute of Chartered Accountants in England and Wales) is the largest professional body to regulate auditing profession in the United Kingdom, while the APB (Accounting Practices Board) is engaged in creating and drafting the standards for Auditing practices. However, the auditing regulatory bodies in United Kingdom have been changing constantly over the decades. It started with the framework provided by the Companies Act 1985 in which the auditing and accounting regulatory powers were vested within the Department of Trade & Industry. This governmental department had different authorities to deal with the regulatory framework. For instance, FRS (Financial Reporting Standards) was responsible to oversee and address the issues raised by investors’ concern for protection. The Accounting Standards Board (ASB) was entrusted the task of issuing and implementing of various accounting standards and FRRP (Financial Reporting Review Panel) performed the task of identifying the weaknesses in financial reporting on the part of companies (Turely, 1992). Later in the Companies Act 1989, in compliance with the European 8th Company Law Directive, the ICAEW, ICAS, ICAI, ACCA and the APPA were made the ‘Recognised Supervisory Bodies’ that served to be the regulatory bodies for auditing and accounting. These institutions became the authority to grant auditing power to an auditor and to regulate the power granted. These institutions were authorised to control the corporate practices as well as regulate the conduct of auditing firms in their course of investigation and inspection, along with the right to take action against any of the parties. The structure of regulatory body in United Kingdom was further transformed after the Enron-issue, with a view to advance shareholders’ protection from professional malpractice. The Role Of Auditors In Corporate Scandals The role of auditors around the world has been evident throughout the history of corporate bursts. Pope and Young (2000) comments that the 68% of all the financial statements detected to have misrepresented or mismanaged corporate earnings were found to be audited by the then big-five auditing firms. Cousins et al. (2004, p23) propounds that, “Auditing firms have a history of accepting dodgy clients (Maxwell, BCCI, Enron, WorldCom, etc.), and keeping quiet about the consequences of their practices”. This reflects the subsequent damage to the investor confidence in the integrity of auditing profession. Clarke et al., (1997) suggest that companies for the last few decades have been constantly accused of managing earning to their interests while inducing investors to keep pouring in money through subsequent disclosure of false profits. Cousins et al., (2004) also confirm that all the failed companies concealed losses and misrepresented the financial statements with the help of auditing firms. The companies like Enron, WorldCom, Transtec, Parmalat and Tyco have been few of the abounding number of such corporate burst backed by the auditors’ oversight. Of all these failures, Enron and WorldCom particularly shook the world of investment. Baker and Hayes (2004) show that the management of these companies concealed heaps of debts and reported increasing profits with the consent of auditors. Mitchell et al., (2002) emphasise that there followed no investigation on the independent level to trace out the causes behind the audit malpractice in the Polly Peck, Levitt Group of Companies, The Accident Group, Resort Hotels, Enron (UK), WorldCom, Ahold, Parmalat, WestLB, Hollinger and Xerox. He further claims that UK auditing firms seemed unwilling to share information with international investigators owing to the fact that they believed that their regulators were not strong enough to compel them to do so. The fact is that all these firms dominating the auditing profession have been accused for the professional misconduct. In the case of Enron, the auditing firm Andersen and in the case of WorldCom, KMPG was found to be involved. Particularly in the case of Enron, sufficient evidence was visible to the regulatory bodies in consequence of which the Andersen disappeared from the world of auditing. Most of the auditors’ influence in earnings management was owing to the consultancy services they provided to the company’s management. Gore et al., (2001) confirm that the consultancy services provided by the auditing firms to the companies vitiates the audit integrity and makes the auditor dependent on the management to form his opinion. The same was the case in Enron. Sze (2002) exposes that Andersen provided non-audit services to Enron and billed the company about $5.7m alone for the consultancy services to the company. He claims that the fees drawn by Andersen for their consultancy services accounted for more than 50% of their total fees. This shows the extent of Andersen’s indulgence in the scam plotted by Enron to deceive the shareholders. The auditors seem to have played a dual role in great corporate failures. They provide consultancy services to advice their clients on playing around with accounting regulations and at the end of the day they confirm the validity and integrity of the company’s financial statements. Cushing (2002) illustrates that Enron utilised the defects in accounting standards to the fullest possible advantage. It used creative accounting and managed to conceal debts in the balance sheet whilst following the standards. Madrick (2002) claims that the alarm announcing the failure of Enron rang earlier in the year 2001, but the shareholders and investors were deceitfully kept under the dark as to its real financial position. The company’s financial statements were highly painted to reflect a rosy picture to the shareholders while the auditors remained unsighted in their confirmation of ‘true and fair view’ of financial statements. This suggests that Andersen was involved in assisting the corporate failures in both the two ways. Similarly in the case of WorldCom, the auditing firm KPMG was involved in providing consultancy services to the company to evade taxes and report financial statements deceitfully. Although the company was greatly engaged in avoiding government taxes, the auditors’ report presented the same ‘true and fair view’ of the financial statements. It is therefore manifested from the above discussion that auditors have had played a major role in supporting corporate scandals. The last few decades in particular have sufficient evidence to prove the statement. Even though there has been an array of activities concerning the revision of regulatory practices in the world, yet the corporate failures continue to take place. It is however to be noted that in order to curb the situation and enhance the level investor confidence, there remains an immense need to regulate the auditing profession in the first place so as to avoid the occurrence of similar mishaps in future. Audit Regulation In UK And US—A Comparison In the pre-Enron world, the audit regulation in United Kingdom was still continuously being revised in consequence of subsequent corporate failures in the region owing to the ambiguities in regulatory framework. While in the United States, much of the efforts were put forward by the governmental authorities after the Enron-shock to the US corporate world. In the post-Enron environment, United Kingdom has revised its major regulatory standards for accounting and auditing, whereas the United States that was extremely shaken by the fiasco, set up a separate commission for the regulatory tasks known as the Securities and Exchange Commission. In UK, the Financial Reporting Council serves to be the eminent regulatory body overseeing the overall accounting and auditing framework in the country. The functions and organisation of FRC was further revised after the Enron collapse that pointed the questioning finger on the auditing profession in UK as well. The FRC now comprises five Boards being the Accounting Standards Board (setting accounting standards), Auditing Practices Board (setting auditing standards), the Financial Reporting Review Panel (regulating corporate financial reporting standards), the Accountancy Investigation and Discipline Board (monitoring financial reporting) and the Professional Oversight Board for Accountancy (monitoring and regulating the professional accountancy bodies i.e., ICAEW etc). In this way the whole structure of regulatory bodies was revised in UK to ensure better protection of shareholders’ interest. The US learned a terrible lesson form the Enron experience and deviated en masse from its existing regulatory structure. In the year 2002, it placed its focus entirely on the auditor independence by passing the Sarbanes-Oxley Act in consequence of the increasing number of auditing failures in exposing the corporate malpractices (Felo and Solieri 2003). Under the Act, the Public Company Accounting Oversight Board (PCAOB) was created and entrusted with the role of creating and regulating the auditing standards. The Board now serves as a regulating body overseeing the auditing activities of the big-four accounting firms (Parker, 2004). The PCAOB greatly emphasised the value and need for auditor independence by imposing restriction on auditors curtailing the provision of non-auditing services to the client companies. The major contrasting element observed between the two regulatory systems is the fact that in UK, the audit regulatory Boards are independent private bodies while in the US, the regulatory body remains under governmental control. The increasing need for the countries to comply with the ISA (i.e., International Standards on Auditing) led the Auditing Practices Board in UK to adopt several standards put forward by the ISA after making necessary amendments so as to suit the difference. In order to make the audit regulation more efficacious, the UK Companies Act makes the auditors and directors collectively liable for any loss in the company’s property while auditors remain highly liable to detect and identify any mishaps as concerned with the company’s assets, allowing for an extensive internal control. On the contrary, the US Sarbanes-Oxley Act only covers the financial reporting aspect of the controls. The Act also vests the entire liability for control on the directors who are highly responsible for the company’s financial reporting. The major distinction between the UK and US regulatory framework thus lies in the fact that UK laws require the auditors to reflect the company’s actual situation and the representation of financial facts. The UK financial reporting laws are designed to transmit the information to shareholders so as to assist in decision-making. The US laws, on the contrary, require the auditor to present opinion only to ensure the demonstration of compliance with the laws. Conclusion The discussion presented above highlights the importance of regulating the auditing profession in order to curb their tendency to get involved in the corporate malpractices through the false opinions and provision of non-audit services as evidenced in corporate failures such as Enron, WorldCom, Transtec, Parmalat and Tyco etc. It is therefore evident that UK auditing regulatory framework was reinforced soon after the corporate collapses in the country owing to weaknesses in accounting standards, while the US regulators took no notice of the situation that led to the occurrence of the largest bankruptcy in the country seriously harming the public interests. However, after the Enron collapse, Sarbanes-Oxley Act enforced extensive regulation on the auditing practices especially concerning the auditor independence and restrictions on non-audit services. The UK regulatory structure was also revised for improvement and today it is considered as the best regulatory system in the world. Where the US standards lack a satisfactory regulation of financial reporting to meet investors’ interests, the UK laws direct the auditors to provide opinion on the company’s state of affair as well as presentation of financial facts. This represents the adequacy of UK regulatory system in meeting investors’ interests, however it can be further fortified by decentralising the regulatory power from professional accountancy bodies to more independent regulators. It will not only fortify the auditors’ independence but will also curb the occurrence of wrongdoings on the part of auditing firms making the regulatory system much stronger. References Anderson, M. & Chandler, R. (1993), “Changing Perceptions Of The Role Of Company Auditor, 1840-1940”, Accounting and Business Research, Autumn Anderson, M., Edwards, J. and Mathews, D. 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