Finance - Audit and Assurance - Essay Example

?Audit and Assurance Table of Contents Table of Contents 2 Introduction 3 Difference of Interest in the Auditing Profession 4 Analyzing the Relationship of the Auditor to Enron 5 The Reasons behind the Auditor’s Act 7 Identifying the Causes for Impairment of the Auditor Independence 8 The Regulatory System 14 The UK and the US Regulatory Responses on Auditor Independence Issue in Post-Enron 15 Conclusion & Suggestions 16 References 18 Bibliography 21 Introduction Disagreement of interest is a common element that is present in the relationship between an auditor and his/her client. A clash in the interest happens when an individual’s self-regarding interest disagrees in complying with the individual’s fiduciary responsibilities. It might also take place in an instance when an individual is accountable for discharging two fiduciary responsibilities and the obligations of one comes in the way of others. Thus, this difference in the interest of the auditors and the clients makes it tough for the auditors to remain ethical while dealing with the clients (Rennie & et. al., 2006). Accountancy and auditing have been referred as complicated as well as practical procedures. In comparison to these characteristics, ethics could be considered to be far less complicated. Ethics can be described to be the honest, loyal, truthful and reliable way of performing an action. It is considered to be significantly important for auditors to perform their actions and their ways of working in an ethical manner. Ethics is required to be paid attention in case of auditing for the reason of reducing risk with regard to grave illegal actions (Campbell & Houghton, 2005). Auditing is concerned with dealing with financial statements and accounts of an organisation. Therefore, this process needs adequate compliance with ethical manners or specification. This is important as this would help to keep away the auditor from getting involved into any kind of legal liabilities or earn a bad reputation (Campbell, 2004). Unethical dealing by an auditing firm named Arthur Andersen gave rise to the scandal of Enron who was one of the firm’s client. The revelation of the corruption and the deliberate fraud proved fatal for both the company, Enron as well as for Arthur Andersen. The company was compelled to declare itself to be a bankrupt and the subsistence of the ace auditing firm came to an end with the exposure of this scandal (Cunningham & Harris, 2006). Difference of Interest in the Auditing Profession It has been already mentioned earlier that corruption is considered to be a result of difference of interest between the clients and the auditors. However, it requires to be mentioned in this context that there could be various kinds of differences of interest in the profession of auditing. A proper analysis of the Enron case would assist in providing a lucid understanding of this fact. The business model of Enron was stated to be quite complicated as it involved a broad range of products from trading functions, physical assets as well as going beyond the national borders. All these factors extended the boundaries of accounting. Enron took the opportunity of exploiting these accounting boundaries to the maximum in controlling its revenues along with its balance sheet so as to depict a favourable performance scenario. However, in this case two matters emerged out to be extremely problematic for the company. The company’s transactions related to trading engaged complicated contracts which involved extended time period. The form of accounting followed by the company compelled the management of the company to predict its future prices related to the energy operations along with the rates of interest. It was also found that the company depended broadly on the financial dealings that were considered to be quite controlled and engaged in developing or creating ‘special purpose entities’. These particular dealings involved sharing the possession of particular flows of cash as well as risks with lenders as well as investors from outside. The conventional form of accounting, which emphasises on non-interfering dealings among autonomous entities, had to witness problems in handling such transactions (Collier & Agyei-Ampomah, 2009; Gupta, 2004). The chief problem that arose for the company was to predict the market worth of its contracts, few of which were for a time period of as long as 20 years. The revenue was predicted or calculated on the base of the current worth of the net cash flows in the coming years. The other significant issue associated with these kinds of predictions was the practicability of the contracts and costs relevant to them. All these issues along with other accounting problems were faced by the company. These gave rise to accounting abnormalities and business malfunctions and ultimately led to the final breakdown of the company (Collier & Agyei-Ampomah, 2009; Gupta, 2004). Analyzing the Relationship of the Auditor to Enron The company’s auditor, Arthur Andersen was mainly held responsible for not being able to identify and detect the company’s problems. The auditing firm Arthur Andersen was charged of implementing negligent specifications and regulations with regard to their auditing practices that were applied on the company. It was stated that such an act was committed by the auditing firm owing to a difference in interest on the issue of consulting charges that was offered to the firm by Enron. In the year 2000, an amount of 25 million USD as audit charges along with 27 million USD as consulting charges was received by Arthur Andersen. It became tough to ascertain that whether the company’s audit related problems which rose because of Arthur Anderson was for the reason of holding on to the company to be an audit client, consulting client or both owing to the financial inducements offered by the company. However, the amount of just the audit charge was stated to possibly create a noteworthy influence on the local associates with regard to their cooperation between them and the management of the company. The audit charges of the company attributed approximately around 27 percent of the total audit charges paid by the public clients to Arthur Andersen (Knapp, 2010; Niskanen, 2007). The company had to gravely suffer for the auditing firm who was unsuccessful in implementing and practicing proper and appropriate business judgement while evaluating the company’s transactions. The dealings of the company were found to be evidently structured or developed for the purpose of financial reporting and not for business reasons. However, the reason for not being able to identify and find out such faults in the transactions was yet to be determined. Either the individuals who worked as auditors in the firm had disagreement over the inducements or the dearth of needed expertise to assess such financial complications sufficiently. Once the faults in the transactions of the company became evident, then the auditors finally gave in to the demands made by the management of the company. This made the auditors allow Enron to postpone accepting the allegations that were made against it with regard to the accounting assessments. On the other hand, the internal management at Arthur Andersen which was structured to safeguard against disagreed inducements of their local associates also collapsed. For instance, the office of Arthur Andersen at Houston that was in charge for conducting the audit of Enron was permitted to take precedence of the grave assessments that were made regarding the accounting judgments of Enron by the Practice Partner of Arthur Andersen in Chicago. Ultimately, Arthur Andersen tried to obscure its lack of good behaviour with regard to its audit practices by way of destroying the supporting papers after the inquiries that was made by Securities and Exchange Commission of Enron was flashed in public (Rapoport & Dharan, 2004; Barreveld, 2002). The Reasons behind the Auditor’s Act Instead of providing justifications for the actions carried out by the auditors of the company, it would be helpful to find out their actions next to the background of the ways which gave way towards development of the accounting industry. The two vital alterations in the period of 1970 gave rise to considerable pressure which was exerted on the auditing firms. This pressure made the audit firms to trim down their costs and look for other sources of earning income. Initially, the Federal Trade Commission in the middle of the period of 1970, involved with a probable oligopoly practiced by the big and well known auditing firms made it mandatory for the profession to alter its regulations and specifications. This was done in order to permit the auditing organisations to promote and contend insistently with one another for the reason of acquiring clients. After these alterations were made, the legal specifications were transferred during the same period. These transfers in specifications were made taking into concern the company’s investors who suffered from accounting issues. Under these fresh specifications, such investors did not require to demonstrate that they particularly depended on doubtful accounting information while deciding on their investments. As an alternative, they were provided the benefit of declaring that they depended on the price of the stocks which were manipulated owing to the deceptive revelations (Easterbrook & Fischel, 1984). This alteration accompanied with the augmenting litigiousness, noticeably amplified the risks associated with legal actions for the auditors (Healy & Palepu, 2003). The auditing organisations acted in response to the fresh environment of business in numerous manners. The organisations came together for the support of mechanical accounting as well as auditing regulations and initiated to structured functioning procedures so as to bring down the inconsistency in relation to audits. This particular approach trimmed down the expenses related to the auditing functions and offered a justification in the matter of litigation. However, this implied that the auditors would become increasingly inclined to perceive their job or duty narrowly compared to issues of wider business verdicts. Additionally, it even brought to light the fact that while mechanical specifications and regulations made the process of auditing easier but it did not facilitate in amplifying the level of corporate transparency (Healy & Palepu, 2003). Identifying the Causes for Impairment of the Auditor Independence It was determined by the auditing organisations that the scope of profit would become continually slim in a business environment of standardised and mechanised audits which made them respond in two different manners. The organisations along with the auditors insistently followed a plan of high-volume. This strategy made the audit associated costs and advertising become increasingly closely associated to a pleasant rapport with the persons involved in the top management and lured fresh audit clients along with holding on to the already existing ones. This strategy made it a bit hard for the associates to act as effectual watchdogs. The big auditing organisations even acted in response to the problems originating in their central part of the business by structuring fresh higher-growth as well as higher-margin consulting services. The fresh structure of charges helped the auditing firms to earn enough revenue. This particular plan of diversification warded off the power of the top management along with the associates competency to a lucrative consulting division from just the business of auditing (Gray & Manson, 2007). The disaster of Enron brings into notice the issues related to a method of standardised as well as mechanical way of performing audits. It had compelled the competent professionals to recognise the auditing profession to be unappealing and unbeneficial. It had also compelled clients to believe in the fact of conducting audit just for the reason of regulatory requirement and not a service which actually added worth to the business. It made the controllers and the ordinary people believe that auditors were obliged to their respective clients. Therefore, it is evident from the facts discussed above that the fresh regulations failed to function as a plan for controlling the risk related to legal actions. The depicted facts also prove the statement that auditors can hardly be independent of their clients and also cannot be appropriately ethical with their dealings for the reason of their fees relevant to their offered service (Healy & Palepu, 2003). Several of the accounting standards in the US have been stated to be mechanical along with it being inflexible as well. Clearly laid down regulations do come with few benefits, but the negative aspect of this particular approach is that it encourages financial engineering structures particularly to avoid these kind of regulations. In accounting, owing to few of the ‘special purpose entities’, the company Enron competently structured or rather developed dealings that fulfilled the specifications related to law. However, in the process it desecrated its own intention in such a way where the balance sheet of Enron failed to reveal the financial risks (Healy & Palepu, 2003). The role of the auditing firm Arthur Andersen was identified to be the major reason that resulted in collapse of the company Enron. Conflict of interest was stated to be the main issue that led Arthur Andersen towards such an unethical conduct. Majority of the suggestions regarding enhanced way of auditing have highlighted on the probable differences among the auditing as well as the consulting applications. This particular incident of Enron made it necessary for the audit firms to reassess their complete model of business. The incident made the fact clear that the auditing organisations or the firms needed to act in the best interest of the company or their clients and not just think about their profits and charges. In order to behave in a responsible manner, it was essential for the auditors to recognise the reason behind their existence which is to assist and guide the investors towards such stocks which would prove to be lucrative investments for them (Healy & Palepu, 2003). It was considered essential for the auditors to alter their plan of bringing down their expenses and legal hazards of carrying out their job and the efforts of amplifying their revenues in other fields like consulting. Instead of such plans the auditors were stated to emphasise more towards enhancing the worth and the implications of audits. It was found that a proper conduct of actions could be only ensured after introducing an appropriate restructuring of the audit committees. It was stated in this regard that complete independence could only be attained by an auditor when auditors would perceive the committees to be their actual clients and not the top management. Until and unless the audit committees are restructured, the auditors could never be independent of their clients and which would again lead them towards indulging in unethical conducts. In case of Enron as well, it was observed that the audit committees followed the ordinary prototype of meeting that had short durations and aimed to address quite a number of issues in that time period. This made the committee overlook and miss out on certain grave issues which if addressed timely would have saved the company from the downfall (Healy & Palepu, 2003). The subject of auditor independence was always given significance and attracted serious attention after the tragic incident of Enron. The influence of auditor independence has been stated to prove extremely beneficial for ethically carrying out the process of audit. The auditors are given the responsibility and duty of providing truthful details and assurance regarding the dependability and exactness of the accounting procedures of its clients’ and a true picture with regard to the financial reports. Lack of independence from the clients would involve partiality in the provided opinions of the auditors as was seen in the case of Enron-Anderson. Therefore, owing to this reason the auditors are expected to stay completely independent of those clients for whom the audits are being performed. This independence is considered necessary for the public as it facilitates in rationalising their trust that is placed by them on the auditors. The factor of independence of the auditor is often seen to be manipulated under several situations and the most common being the financial relationship among the auditor and the clients for the reason of fees. Apart from this, the other reasons could be close associations with the clients, carrying out management operations and widening non-audit as well as consulting services. In the case of Enron, it was stated that the reason of economic relationship was considered to be vital for the auditing firm that led it to such faulty practices (Healy& Palepu, 2003). The vital risk posed to the liberation of the auditor has been stated to be the condition of the option of providing non-audit services as well as consulting services to the clients. It is evident that the mutilation of independence could simply arise irrespective of the business environment where the audit is being performed. The character of the service of auditing itself integrates an association among the client and the auditor and is considered to be tough to separate. Taking into concern the reality that auditors are open to the elements of such probable threats that are tough to be stayed away from, it is rational to state that mutilation of the independence of auditors’ might all the time prevail till there exists an association among the auditor as well as the auditee (Healy& Palepu, 2003). The matter of auditors providing numerous services of non-audit nature to their accessible audit clients have been considered to be strongly related to independence. It was found that the non-audit services provided to the clients by the auditing firms have greatly played a part behind majority of the instances with regard to corporate failures. The auditing firms are more inclined towards delivering non-audit services to their clients as these services have been found to form around two-third portion of the entire revenue earned by a firm. Thus, it appears that these kinds of audit firms give the impression of being dependent of their clients for the reason of the fees received by them. It is important to note in this regard that this issue of mutilation of the independence of the auditor becomes irrelevant when the mentioned kind of services is provided to ‘non-audit clients’ (Healy & Palepu, 2003). The Regulatory System Since the previous three decades, the regulators and the government has been continuously introducing enhancements on the management and organisation of auditor independence. This is being seriously done with the intention to bring back the lost trust of the people which happened because of the Enron case and to enhance public confidence and also to fortify the auditor independence. However, it needs to be mentioned that not much success have been attained in this regard. In the UK, the progress of auditing along with accounting standards was done by the way of approach that was based on principles and a method that was self-regulative. To be specific, professional entities that are identified by the Department of Trade and Industry (DTI) like the Ethics Standard Board (ESB) and Auditing Practices Board (APB) have been entrusted with the responsibility of dealing with issues related to auditor independence. The auditing and the accounting regulatory method of the UK have been referred to as an appropriate model and example for other countries. This has been inferred owing to the existence of a powerful professionalism which did not call for the requirement for numerous alterations in the UK standards. Preferably, the APB has been given the responsibility to build the future of the UK auditing. In the US, the American Institute of Certified Public Accounts (AICPA) and the Securities and Exchange Commission (SEC) have been largely entrusted with the responsibility of regulating as well as screening the practices related to auditing existing there. The Independence Standard Board (ISB) was initiated by AICPA and SEC in the year 1997. The ISB has been stated to be acknowledged to be the entity or unit of standard-setting. This particular unit structures and designs standards as well as concepts related to the profession of auditing. To be specific, it can be stated that the US takes on an increasingly vigorous and thorough regulations in relation to the issue of auditor independence. Alternatively, it has been found that the Eight Council Directive (Eight Directive) of the European Commission (EC), that was agreed to and implemented in the year 1984, passed on to the Member States. This was adopted so as to make certain of adequate independence of the statutory auditors from their auditing clients (Stevenson, 2002). The UK and the US Regulatory Responses on Auditor Independence Issue in Post-Enron In the case of Enron, the revealed collapses of the well reputed prestigious companies without a doubt aggravated a discussion among the regulators, professional entities, government and standard-setters. This discussion supported the parties to come forward with suggestions with the objective of working out a solution or even bring down the degree of problem. This made it necessary to reassess few of the standards with regard to the rules related to auditing as well as accounting in the UK. The reassessments were initiated with the purpose of enhancing the audit independence management and also to control any additional corporate failures. Additional alterations are being predicted by the DTI with regard to the management of accounting as well as auditing along with company law. As mentioned earlier, SEC and AICPA in the US act as crucial bodies in reacting in this issue. The approach adopted by the SEC is considered to be more strong and thorough in comparison to the practices adopted in the UK. The SEC has been stated to amend the regulations related to the independence and entailed thorough necessities on the condition of offering non-audit services. At this particular point of amendment, the SEC has been thought to be quite confident regarding the fact that the fresh amendments or the regulations would offer adequate protective steps so as to stop the negotiation concerning audit independence. They are also expected to reassess the regulations at periodic intervals. To reinstate public confidence, a public accountability board was established as per SEC recommendation along with strengthening of independent rules as well as certain alterations in the models of accounting were made. After the incident of Enron, SEC was stated to reassess and alter the necessities related to auditor independence so as to investigate the sufficiency of the present regulations and also for the reason of suggesting required alterations or additions with regard to the laws. These aspects have certainly made a contribution towards enhancing public confidence (Abdullah, 2002). Conclusion & Suggestions From the above discussion, the reason for the downfall of Enron is quite evident. The auditing firm responsible for the audits of Enron was held accountable for the collapse. The relationship of Enron and its auditor was analyzed and it was found that the auditor got involved in such faulty practices while performing the audit of the company just for the reason of fees. It was observed that the auditing firm Arthur Andersen was inclined in providing non-audit services to Enron with the intention of earning additional fees. These services was attributed to be the main reason behind the collapse of both the prestigious companies i.e. the Enron and the auditing firm Arthur Andersen. From the above discussion the reason, importance and need for the auditors to be truly independent of the clients could be clearly identified. The ways of dealing and responding to the subject of auditor independence by the US and UK governments and the auditing professions have also been discussed in the paper. Strict regulations and screening of the auditor independence by the governments and auditing professions would prevent such issues from occurring again. Enactment of certain regulations to ascertain transparency in the entire auditing process can also help to improve the position. References Abdullah, D. F., 2002. 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