Legislation and the Auditing Profession in the UK - Essay Example

? [AUDITING AND ASSURANCE] The auditing profession is largely self-regulating within the UK, and sits within a regulatory framework, encompassing Legislation, Common Law, and Regulatory and Professional elements. Each of these elements controls the auditing profession in the UK in a certain way. This paper explains how Legislation, Common Law, and Regulatory and Professional elements control the auditing profession in the UK. It also assesses the adequacy of the auditing profession in the UK, with illustrations of recent corporate collapses. Legislation and the Auditing Profession in the UK According to the True and Fair Organisation (2012), the audit profession in the UK is monitored closely, and regulated tightly in accordance with strict professional standards and legislation. Also, companies and individuals who breach any of the rules, outlined by Legislation, will face strict penalties. The audit profession is under the Legislation provisions of the UK Government. The government controls the audit profession through Legislation such as the Companies Act on Audit, Inspection and Community Enterprise of 2004 and 2006 (True and Fair Organisation, 2012). There are also the Auditors Regulations of 2007, which control the activities of the Audit profession in the UK. This Legislation controls and monitors how audits are carried out in the UK. Legislation regulates the auditing profession in the UK, under the Companies Act 2006 (Collings, 2013, p. 237). Therefore, it is a requirement that professional accountants should attain a senior statutory auditor position for them to be able to practice audit-related work in the UK. Further, UK Legislation requires that companies must have their annual financial statements audited. Auditors are required by Law to follow ISA (UK and Ireland) 700 in the formation of an auditor’s report on financial statements, as issued by the Financial Reporting Council. Common Law versus Auditing Profession in the UK The UK court system has taken responsibility of safeguarding shareholders, who are termed as third parties, from fraudulent activities of company directors, in collaboration with auditors and audit firms. Therefore, it acts as a quality-control mechanism for the auditing profession (Johnstone, Gramling, & Rittenberg, 2013, p.14). Common Law requires that auditors should observe care of professional advice to avoid violating the provisions of the civil law of negligence (Davies, 2011, p. 7). Auditors should also observe their duty of care diligently, while performing audit work because the UK Legal System is based on Common Law (Davies, 2011, p. 7). Company directors have the responsibility of preparing financial statements that should present a true and fair value of the organisation. Therefore, they contribute to the outcome of audit processes in one way or the other. The public may sue auditors and auditing firms under state statutes and Common Law for substandard audit work (Johnstone, Gramling, & Rittenberg, 2013, p. 14). The public, in this case, comprises of shareholders and other investors who may rely on the information provided by company directors and auditors to make financial decisions. In some circumstances, according to Common Law, disclosure may be justified in the public interest where there is no instance of noncompliance with Law regulations. For instance, where the public is being misled or the public’s interests are being damaged by auditors’ activities (FRC, 2013, p. 17). Therefore, Common Law controls the audit profession in the UK in that, it requires auditors to comply with the provisions of Common Law. Auditors and audit firms, who violate Common Law provisions, can be sued under Common Law by third parties. Regulatory and Professional Elements versus Auditing Profession in the UK Various independent Regulatory and Professional bodies have been created to control the auditing profession in the UK. The Regulatory and Professional elements play a role in controlling the auditing profession in the UK. One such Regulatory and Professional body is the Financial Reporting Council (FRC). The Financial Reporting Council is responsible for keeping watch over the audit profession in the UK. It is responsible for setting standards for corporate reporting and actuarial practice. FRC also supervises and implements accounting and auditing standards. The body oversees and ensures that accountancy bodies operate within an independent arrangement for the good of public (FRC, 2013). Institute of Chartered Accountants of Scotland (ICAS) is a professional accounting and external auditing organisation (O'Regan, 2004, p. 144). It is among the oldest organisations of its type. Its role is to ensure that external auditors who seek registration meet specified qualifications. Therefore, it controls the auditing profession by ensuring that standards and qualities of external auditing are met, and that audit practice is carried out with the UK rules and regulations. It should be noted that Institute of Chartered Accountants of Scotland supports the work that FRC does to raise the matter of limited choice in the audit market for listed companies (Great Britain Parliament, 2011, p.54). For instance, Institute of Chartered Accountants of Scotland supports the view that the big four firms should continue to exist. Also, Institute of Chartered Accountants of Scotland took part in debates that led to the previous government to appear to accept removing the “unlimited liability” regime for auditors, a few years ago (Great Britain Parliament, 2011, p.54). Adequacy of the Control of the Auditing Profession in the UK UK banks are required to appoint an external auditor. Also, the banks’ published accounts must have the opinion of an external auditor regarding the completeness and accuracy of their financial statements (IMF, 2003, p. 41). At the same time, auditors should comply with Statements of Auditing Standards which have been issued by the Auditing Practices Board. The auditors are required to comply with these standards by their professional bodies (IMF, 2003, p. 41). According to the Chartered Institute of Internal Auditors ( 2013), there has to be adequate criteria in the evaluation of governance and internal controls, as well as, risk management. Auditors should establish that a company’s management has set appropriate criteria for the determination of the accomplishment of company goals. According to the current UK Law, small companies that are less than a certain size in terms of their earnings and subsidiaries may not be required to have a compulsory, annual audit on their financial statements. However, large companies are required by Law to provide audited financial reports annually, which means that an annual audit is mandatory. It should also be noted that UK companies that prepare their accounts under International Financial Reporting Standards (IFRS) have been urged to move to UK Generally Accepted Accounting Principles (GAAP) and benefit from reduced disclosures (GOV.UK, 2012). This means that, in the UK, companies make reduced disclosures on their financial statements. Auditors do not follow ISA 700 because it has not been adopted in the UK, meaning that the form of auditor reports made in the UK and Ireland may not be exactly as the precise design of auditors’ reports, required by ISA 700, issued by the IAASB (Financial Reporting Council, 2012). However, according to APB Staff (2009), auditors must follow International Standards on Auditing (ISA) provisions in reporting and formulating of their independent opinions. Given the recent collapse of major corporations of the world because of poor auditing, the UK has sought to streamline its auditing profession to enhance its adequacy. The major recent corporate collapses are the demise of Enron and WorldCom, both based in the United States of America. For instance, Enron had conditions that escaped notice or were not acted upon by any audit link in the chain (Niskanen, 2010). The company directors had violated the accounting rules and auditing procedures. They also made bad business decisions, which led to the collapse of this company and misuse of the investors’ funds (Niskanen, 2010). Another major corporation that collapsed recently is the Lehman Brothers. It was revealed that the company’s executives had inflated their financial information with multi-billion transactions. These transactions had a major objective of painting a good impression of the company’s financial data. Also, the executives wanted to use these transactions to enhance a financial ratio, which was taken as a key indicator of the company’s overall financial position by regulatory authorities, investors and stock market analysts. Lehman never disclosed nor referred to the transactions that led to the company’s liabilities being understated by as much as fifty billion dollars in the 10-K and 10-Q registration statements that it filed with the Securities and Exchange Commission (Knapp, 2011, p. 23). The company’s auditors, Earnest and Young did not establish these misstatements in the financial statements of Lehman Brothers Holdings. This could have been caused by the UK’s reduced disclosure requirements for companies, which alters auditors’ work. Lehman Brothers’ management had manipulated its balance sheet in a way that could lead a legal proceeding, and its auditor, Ernest and Young did not meet professional standards. Further, Ernest and Young took no steps to question or challenge the non-disclosure by Lehmann executives of the off-balance sheet transactions (Hamilton & Webster, 2012, p, 311). The recent corporate collapses provide evidence that the auditing profession in the UK is partly inadequate. This is because the accountancy profession in the UK has some degree of self regulation. Self-regulation has led to many collapsed businesses that led to the end of Enron and WorldCom. Also, there have been steps of introducing ethical codes, auditing standards, licensing, monitoring and disciplinary actions to formalise audit regulation and to improve auditor independence in the UK. However, these steps have been taken reluctantly or hesitantly, under the continuous control of the profession (Bode, 2008, p. 12). This has negatively affected the objective of having a fully regulated and reliable auditing process in the UK. Finally, the fact that there is reduced disclosure on UK companies’ financial statements, contributes to the inadequacy of the accounting profession in the UK. This is what led to non-disclosure of off-balance sheet transactions by Lehman Brothers’ management, where the company had liabilities equivalent to fifty billion dollars. Also, because of this provision, auditors were unable to pose questions to the company directors regarding the status of these liabilities. References APB Staff., 2009, October. Summary of the Main Changes in the New ISAs (UK and Ireland) . Retrieved from http://www.frc.org.uk/getattachment/05f649a3-2d4d-45ed-92fa-43eecd1de2c8/Summary-of-changes-in-the-new-ISAs-%28UK-and-Ireland%29.aspx Bode, S., 2008. Auditor Independence and Regulation. Mu?nchen: GRIN Verlag GmbH Press. Chartered Institute of Internal Auditors., 2013, July 23. Performance Standards . Retrieved from http://www.iia.org.uk/resources/global-guidance/international-standards/performance-standards/ Collings, S., 2013. Frequently Asked Questions in IFRS. Chichester: Wiley and Sons Press. Davies, J., 2011, May . Audit Reform: Aligning Risk with Responsibility. Retrieved from http://www.accaglobal.co.uk/content/dam/acca/global/PDF-technical/business-law/tech-af-arar.pdf Financial Reporting Council., 2012, June 6. Auditing Standards . Retrieved from http://www.frc.org.uk/Our-Work/Codes-Standards/Audit-and-assurance/Standards-and-guidance/Standards-and-guidance-for-auditors/Auditing-standards.aspx FRC., 2013. About the FRC. Retrieved from http://www.frc.org.uk/About-the-FRC.aspx FRC., 2013. International Standards on Audititng (UK and Ireland) 250. Retrieved from https://www.frc.org.uk/Our-Work/Publications/APB/ISA-250A-Consideration-of-laws-and-regulations-in.aspx GOV.UK., 2012, December 12. Audit, Accounting and Reporting: Guidance for UK Companies. Retrieved from https://www.gov.uk/audit-accounting-and-reporting-guidance-for-uk-companies Great Britain Parliament., 2011. Auditors: Market Concentration and Their Role,. London: Stationery Office Press. Hamilton, L., & Webster, P., 2012. The International Business Environment. Oxford: Oxford University Press. IMF., 2003. United Kingdom: Financial Sector Assessment Program Technical Notes and Detailed Standards Assessments. Washington D.C: International Monetary Fund Publication Services. Johnstone, K. M., Gramling, A. A., & Rittenberg, L. E., 2013. Auditing: A Risk-Based Approach to Conducting a Quality Audit. Mason: South-Western Cengage Learning Press. Knapp, M. C., 2011. Contemporary Auditing. New York : Cengage Learning Press. Niskanen, W. A., 2010. Enron, WorldCom, and Other Disasters . Retrieved from http://www.kuratrading.com/CATO/hb108-22.pdf O'Regan, D., 2004. Auditor's Dictionary: Terms, Concepts, Processes, and Regulations. Hoboken: Wiley and Sons Press. True and Fair Organisation., 2012. How is Audit Regulated? Retrieved from http://www.trueandfair.org.uk/what_is_an_audit/audit_regulated Read More