Post Financial Crisis: Role of Audit - Essay Example

?Post Financial Crisis: Role of Audit Contents Contents Introduction 2 Critical Analysis of Extended Audit 3 Implications of Corporate Governance Audit 4 Corporate Governance and audit 4 Implications of Enhanced Audit on Stakeholders 5 Challenges for Auditors 6 Expectation Gap 9 Conclusion 10 Reference 11 Introduction The world faced a global financial crisis during 2008 after the bankruptcy of Lehman Brothers. Enron’s’ bankruptcy to bankruptcy of Lehman’s Brothers the financial reporting, disclosures and auditing practices and external auditing have remained a sensitive issue investors. . This report is an attempt to analyze the role of audit and the actual responsibility of the auditors toward the stakeholders on the basis of the concept of extended audit as suggested by ACCA in its report ‘A Framework For Extended Audit Reporting’. The paper highlights expectation gap and the framework of extended audit which could make the auditor’s report more informative for the general public so that they can make more informed decision. Critical Analysis of Extended Audit As per the research commissioned by ACCA it was found most of the readers of the annual report and financial statements were not much interested in the auditors report of the views and opinions of the external auditors. The main reasons behind these behaviours were unable to interpret the result of the auditors’ report. Some of the users of the financial results also wanted some additional information which would enhance the quality of the audit (Vanstraelen, et al, 2011, p.4-17). Extended audit report is an attempt to make the users educated of the auditing process, scope of the auditor and informing about other useful information. The institutional investors rely very less on audit report as they find that the audit report does not reflects the overall performance and the auditors report is not customized as per the business model. I think the framework suggested by the MARC will make the audit report more informational. As mentioned in the framework the simplification of the language will enable the users of the annual report to understand the audit report more clearly. If additional information is added to the report as suggested in the framework then the institutional investors will also be able to utilize the audit report more for their investment decisions. As auditing is generally based on sample testing therefore I think enhanced audit will eliminate the limitation of sample testing. Thus from my point of view of making the audit report more informational and useful for the general public in making an informed decision enhanced audit will be quite beneficial. In my opinion the expectation gap is will reduce with the help of the enhanced audit report as the users will be more informed about the scope of the audit. Apart from the benefits I believe that the enhanced audit could pose some limitations to the companies. I think one of the major limitations of enhanced audit cost the company more than having ordinary audit report, would definitely increase the liabilities of the auditors. I think the having an extended audit report will create a sort of disturbance in the company as the auditors will need more time to produce an extended audit report. Extended audit does have both advantages and limitations in my opinion the extended audit would be beneficial for the stakeholders and other users of the audit report. Therefore in my opinion the enhanced audit should go ahead. Implications of Corporate Governance Audit Corporate Governance and audit Corporate Governance is the policies which define how a corporation would be controlled. The principle of corporate governance is respecting the rights of the stakeholders of the company. The company management should also ensure that the information disclosed by them is transparent; also they are maintaining the corporate social responsibility and all these can be achieved when there is enough communication between the board of directors and all the company employees. In short corporate governance means the decision making and monitoring of the performance by the company management to the best interest of the stakeholders of the company and there comes the role of auditor. For making the decisions, for monitoring the systems the company management or the investors need transparent information, the auditor check whether the information provided to them is transparent or not. The international Standard of Accounting 260 requires determining the persons who are in charge of governance by the auditors. The auditors are there to look after that the financial statements are not containing any error or there is any fraud happened during the construction of the report. After the bankruptcy of Enron the Sarbanes-Oxley act was introduced, which requires reports on the internal control effectiveness separately. The ISA, the SOX act and the EU 8th directive all need to communicate to the board about the details of the audit, the limitations of the audit, the weakness of the accounting control systems followed by the company and if any uncertainty associated with the company’s future by the auditor (Broadley, 2006, p.2-17). From this information the board of directors takes the future steps for ensuring effective corporate governance. They identify the flaws of the internal management control and take certain steps so that the company can serve to the stakeholders so their best interest. Implications of Enhanced Audit on Stakeholders In the report ‘A Framework for Extended Audit Reporting’ MARC has proposed that the corporate governance should be implemented in the audit reporting format. They have given the example of the listed companies of Johannesburg Stock Exchange. They are required to publish an integrated report which should contain the financial information as well as the non financial information. The integrated reporting committee of South Africa recommends the assurance of other parts independently in the integrated report (Vanstraelen et al, 2011, p.18). This integrated report should be audited by the auditors complying with the international standard and this audited, transparent report would be more helpful for the stakeholders for assuming the future of the company and also be helpful for the company management for take strategic decisions about the company. In my opinion the enhanced audit would surely enhance the value of the report and it would be useful for the different stakeholders of the company. The enhanced audit should be implemented which would include both qualitative and quantitative information about the company and that would be helpful for the stakeholders. Challenges for Auditors In the time of the financial crisis of 2008-10 the questions about the value of the auditing was raised. During the financial crisis it was seen that certain organizations mainly the banks went bankrupted in some of the biggest economies of the world, which raised the questions about the accuracy of the report of that organizations and as well as the quality of report produced by the external auditors (Sikka, 2009, p.4-6). This economic crisis was certainly stated as a challenge for the auditing firms. Following the economic crisis situation there were certain proposals which includes making the rotation of the auditing firms mandatory, as a result no malpractices can take place in the organizations and the probability of the getting transparent information about the company increases. There were also proposals to make joint auditing mandatory. These two options were rejected by the Association of Chartered Certified Accountants (ACCA). Rather ACCA backs a new enhanced role for the audit committees which would include the audit on the areas such as corporate governance, risk management and testing the concerned company’s business models (ACCA, 2011, p.3-8). There are many challenges faced by the auditors when in the time of auditing. The accounting standards followed by the companies are different, the information available from the concerned employee are not accurate always. Moreover when fair value model is followed by the companies then the auditors face a challenge like the information given about the investments in the financial instruments especially in illiquid markets. It is tough for the auditors as they know that the fair value method is not a method to be applied in practical market though it is theoretically strong and also approved by the accounting standards board (IAASB, 2008, p.2). The certified auditor would check the accuracy of the financial statements, any fraudulent done in the statements, would also check the stability of the company from the financial viewpoint. The statutory auditors make it sure that the financial statements presented by the company management is transparent so that the shareholders of the company can take the decision of further investing and also the other stakeholders can take decisions for fulfilling their respective needs. The auditors challenge also include that the journal entries should be appropriate, they also have to do enquiries about the persons who are involved in the process of financial reporting. The auditors have to check for any bias has taken place in the estimates for the future and the auditors also have to analyze the unusual transactions which does not happened in the normal course of the business. The auditor also has the responsibility that the company’s are abide by the laws that they are supposed to do. Business risk is always there in a company. According to the report of MARC the enhanced auditing report would contain the client company’s risk assessment, the risk of the misstatement of the financial reporting that is all the risk associated with the company would be analyzed by the auditors. Thus the users of the audit report may understand the risk of the business and the factors. However in the current process there is no opportunity for the auditors to identify the non financial risk (the risk of the business model of the company) and therefore the auditor report doesn’t result in some document, based on which the stakeholders can take the decision. If there is the scope of disclosing the information about the audit team, the transparency of the auditor’s can be assessed by the users. The user would be obviously interested in the report generated by the auditor as this would include the report on the risk associated with the concerned business, report on the internal control system of the business and analysis of the entire business model. For example a company has the objective to be the market leader. It means the company like to have the lion’s share in that industry. Being a market leader means proper planning by the management of the company which surely include discussion about the risks associated with the business. This should be properly audited by the auditor (the auditor would check how accurate are the assumptions taken by the company) as he has the responsibility to analyze the business and his report would be valued by the users. In my opinion analysis of the entire business model would surely enhance the value of the report. It would be helpful for the users, the external one means the investors or the regulators or the internal stakeholders that is the management of the company. Besides this the management of the company and the board of directors would find it helpful make the internal control that is to make corporate governance effective. Here a question arises about the cost of the enhanced audit. There are many companies who are reluctant to bear much cost in auditing, when the enhanced auditing would increase more cost. So it is a matter of argument that how many companies would accept the new enhanced audit reporting though it would increase the value of the report and useful for the stakeholders of the company. For preparing a quality audit report the auditor has to make it sure that the concerned employees who are preparing the important financial and non financial report communicate effectively between themselves and with the external auditor. The information about the company checked by the external auditor and the final audit report become transparent and the needs of the stakeholders are met. In this scenario some new challenges would be there for the auditors. They have to make it sure that the information about the company is accurate and the persons associated with the authority to prepare various reports of the company are communicating with the auditor and maintain the laws. Proper training is necessary for the staffs of the company. The staff of the company should be aware of the rules and regulations and should also be aware of the various business risks. In my opinion all this things should make sure by the auditor that the employees are properly trained about these risks and regulations, as it is the responsibility of the auditor to produce the final report. In the new form of report preparation the power of the auditor would increase much. It should be make sure by the regulators that the auditors are not misusing their power of authority and produce a quality audit report. Expectation Gap The term expectation gap signifies the difference between the expectation of the some people who have knowledge about some particular thing and the expectation of the people who depends upon the knowledge of the former. The external auditors report is utilized by a number of people like the shareholders of the company, other investors, market players, investment institutions, banks and other loan providers etc. All the users of the financial statements depend upon the external auditors’ report and opinion. Their expectations many types do not match with that of the actual responsibility of the external auditors which gives rise to a gap of expectations. As per Porter the expectation gap has three main components which are deficient standards, sub-standard performance and the third one is unreasonable expectations. Among the three components deficient standards comprises maximum of the gap which can be easily corrected followed by unreasonable expectations and sub-standard performance. The main reason behind the creation of the expectation gap is misunderstanding and ignorance in terms of understanding the auditors’ actual responsibility and comprehending the information from the auditors’ report. The reasons behind the expectation gap are such which makes it difficult to fill up the gap but if audit education is provided to general public than the unreasonable expectation can be corrected which will in turn make the gap little narrower (Ojo, 2006, p.3-5). This gap can be filled by presenting some additional information, making the language of the report more clear and educating the users of the audit report in terms of scope of the audit. Conclusion The basic question arises about the quality of the auditors when they have failed to forecast about the economic crisis worldwide in the year 2008-10. Many banks and other corporations declared themselves bankrupted and as an effect the investor lost their money and world economy was in a crisis. Some proposals were made by the economic regulators like joint auditing, rotational auditing which was not acceptable for the ACCA instead they offered if an extended audit report replace the existing one then the problem can be solved and the objective of the audit report can be achieved. From the research done by MARC it was found that the enhanced audit format which includes the scope of corporate governance and risk management assessment by the auditors would make the report more informative and effective for the users of that report. I think that the auditor should be given the power to get the important information (financially and non-financially) periodically so that he can prepare an effective audit report. Reference ACCA. (2011). Audit under Fire: a Review of the Post-Financial Crisis Inquiries. [Pdf]. Available at: http://www.acca.co.uk/pubs/general/activities/library/audit/audit_pubs/pol-af-auf.pdf. [Accessed on: December 3, 2011]. Broadley, D. (2006). Auditing and its Role in Corporate Governance. [Pdf]. Available at: http://www.oecd.org/dataoecd/50/6/37178451.pdf. [Accessed on: December 3, 2011]. IAASB. (2008).Challenges in Auditing Fair Value Accounting Estimates in the Current Market Environment. Available at: http://www.ifac.org/sites/default/files/downloads/staff_audit_practice_alert.pdf. [Accessed on: December 3, 2011]. Ojo, M. (2006). Eliminating the Audit Expectations Gap: Myth or Reality. [Pdf]. Available at: http://mpra.ub.uni-muenchen.de/232/1/MPRA_paper_232.pdf. [Accessed on: December 3, 2011]. Sikka, P. (2009). Accounting, Organizations and Society. [Pdf]. Available at: http://www.wu.ac.at/taxmanagement/Institut/Mitarbeiter/Hoermann/antibilanz/downloads/financialcrisisandthesilenceoftheauditors.pdf. [Accessed on: December 3, 2011]. Vanstraelen, A. et al. (2011). A Framework for Extended Audit Reporting. [Pdf]. Available at: http://www.acca.co.uk/pubs/general/activities/library/audit/audit_pubs/extended_audit_reporting.pdf. [Accessed on: December 3, 2011]. Read More