Audit Reforms in the EU - Essay Example

Audit Reforms The background to the EC audit reform proposals Auditing is a profession that is entrusted with the responsibilityof giving fair and balanced opinion, regarding the truth and accuracy of the financial transactions and reporting of the client firms (Garcia, 2005 p13). However, the fact that the underlying principle in auditing is the concept of ‘opinion’, leaves the process of auditing with much to be desired, considering that conflict of interests or biased opinions have arisen from the auditing firms in relation to the truthfulness and accuracy of the transactions and financial reporting of their clients, eventually resulting to financial crisis, scandals and company failures that could eminently have been avoided, should the auditing reporting and opinion have been fair and balanced (Deloitte, 2012 p2). This has resulted in the emergence of the phrase that “auditors are the dogs that did not bark during the crisis”, and thus their role in helping avert financial crisis through detecting and reporting any anomaly or perceived misrepresentation of the financial truthfulness of organizations has been put to question (Fielding, 2011 p35). Therefore, considering that there are four major auditing firms that operate globally and monopolizes the European Union regions, namely PricewaterhouseCoopers, Ernst & Young, Deloitte and KPMG, concerns have always arisen regarding the collusion between the auditing firms and their clients to give unfair and unbalanced financial reporting information and opinion (Clifford, n.p.). This has necessitated the need for introducing reforms that would see the already existing collusion, as well as the conflict of interest in auditing, effectively addressed (IFAC, 2013 p36). EC audit reform proposals and the underlying areas of concern that they seek to address First, the EC audit reform proposes a system of compulsory rotation of audit firms amongst their clients (Crump, 2011 n.p.). This proposal has arisen from the fact that; it has been noted that many firms and organization have enlisted the services of a single audit firm for many years, even running for decades, something that has made it possible for the audit firms and their clients to develop a collusion mechanism that prevents the auditors from applying prudence in auditing the transactions and the financial reports of their longstanding clients (Irvine, 2013, n.p.). The effect of this has always been unbalanced and misleading audit reports, which are only proven wrong, when such firms are eventually netted in big financial scandal or when the firms are forced to close down, due to financial problems, despite the fact that their previous reporting and audit reports have been indicating favorable financial positions (Garcia, 2005 p56). Consequently the EU has introduced a proposal requiring that the client firms will have to change their auditors after a maximum period of 6 years, or a maximum of 9 years, on condition that the client firms have enlisted the services of joint auditing services, since there is a potential of the audit firms increasing the quality of the auditing done, when the firm is audited by two different firms (IFAC, 2013 p42). Thus, this proposal was meant to introduce measures that would encourage joint services, even where it is has not been made obligatory; to avert the problem of conflict of interests and collusion, amongst the auditing firms and their client firms (Orlik, 2011 n.p.). Mandatory audit tendering The EC reform proposal also introduces a proposal for the audit client firms for all public-interest entities to mandatory introduce obligatory open and transparent selection procedures for the new firms (Lovells & Banerjee, 2011 p44). Under this requirement, the EC also proposes that the audit committee should effectively be involved in the selection procedure of the new auditors, to ensure the prudence of the selection process, since the auditors selected also influences the nature of the reporting and financial opinion given by the audit firms (Clifford, 2013 n.p.). This proposal was introduced to address the issue of perceived lack of independence for the auditors, considering that they are not selected through a transparent and competitive tendering process, which then creates a sense of favor for the selected audit firms, which in turn has to reciprocate through ensuring that the audit reporting and the opinion regarding the financial situation, reporting and transactions of the client are favorable, even when in essence the case might be different (Deloitte, 2012 p7). This has always been the core of future failures of companies, as well as the emergence of huge financial crisis and scandals, that could have otherwise been averted through prudent auditing and reporting. Separation of audit from non-auditing services The EC reform proposals have also introduced a requirement that prohibit the auditing firms from providing non-auditing services to the clients (Crump, 2011 n.p.). This proposal has been introduced courtesy of the observation that the offer of both audit and non-auditing services to the same client has been responsible for the creation of a conflict of interest in the auditing firm, where the auditing firm may highly specialize in meeting the clients demand for the non-auditing services, while negating its responsibility for prudent auditing of the financial reports and the transactions of the client (Irvine, 2013, n.p.). In addition, large firms that have combined the offer of both audit and non-audit services will also be obligated to separate the services, such that they are no longer offered as a single package. This proposal was introduced as a measure to address the conflict of interest of the audit firms, where they are more enticed to provide better non-auditing services, while negating their auditing responsibilities (Euractiv, 2013 n.p.). Coordination and Supervision of the Audit sector The EC reform proposals further introduce a requirement, to have standardized supervision of the auditing sector within the framework of the European Markets and Securities Authority (ESMA), to ensure that the auditing firms are uniformly applying the proposed auditing standards, and that the standards are applied equally between the big and small auditing firms, which are highly capable of influencing and circumventing the regulations (Garcia, 2005 p21). The supervision and coordination should also be introduced beyond the jurisdiction of the European Union regions, to ensure that standardized regulations and supervision is also offered internationally. This proposal was introduced to address the issue of the auditing sector being a self-regulated sector, which then create an opportunity for the sector to negate its responsibility, due to lack of effective coordination and supervision (IFAC, 2013 p51). Finally, the EC has introduced a proposal for the establishment of single market for statutory audits in the audit profession, to enable auditors to exercise their auditing profession throughout Europe, as a result of provision of European passport for auditors (Clifford, 2013 n.p.). This proposal seeks to ensure that auditors can serve anywhere within the European Union, while also ensuring that the auditing firms will comply with the international auditing requirements to this effect (IFAC, 2013 p48). This proposal has been introduced to tackle the problem of the disparity of auditing regulation applications, which has created a loophole for negligence and non-adherence to the required auditing standards (Crump, 2011 n.p.). Reaction to the proposals from the audit profession, audit clients and wider society The EC audit reform proposals have been met by both favorable and unfavorable reactions. The different stakeholders opposing the proposals introduced by the EC, who especially include the big Four audit firms and the clients, have based their dissent on the fact that; the requirements to introduce audit-rotation every6 years in impractical, considering that it would increase the burden for the organizations and company clients, due to the costs and time implications that will be required in recruiting new auditors every few years (Lovells & Banerjee, 2011 p39). Further, those opposed to the proposals have found it even more limiting and business damaging, considering that they perceive it as a proposal aimed at making audit firms single business entities, since they are forced to separate the audit and the non-auditing services offer to the clients, meaning that the costs of their business will even be much higher (Fielding, 2011 p35). On the other hand, those welcoming the proposals, who especially include the small-auditing firms, individual auditors and the wider society, have found the proposals suitable to address the problem of failures that are caused by the negligence of the auditing firms to effectively offer proactive financial supervision for firms and organizations (Irvine, 2013, n.p.). Additionally, the auditing professions has found the EC proposals as a welcome move towards thrusting their profession to a higher level, due to the introduction of privileges such as the provision of European passport for auditors and measures to ensure auditors can serve anywhere within the European Union (Crump, 2011 n.p.). The extent to which the proposals have been and are likely to be implemented The proposals introduced by the EC are a sure source of controversy between the supervising and the coordinating agencies, considering that there will be eminent resistance, especially from the Big Four audit firms, as well as their longstanding clients, to implement the measures suggested by the EC proposals (Orlik, 2011 n.p.). The greatest challenge emanating from the implementation of the proposals is that; the EC did not undertake any empirical study to assess the practicality of such proposals, and thus most of them, especially the proposal for auditing rotation and separation of the audit from the non-auditing services are fundamentally flawed, and thus largely impractical (IFAC, 2013 p35). Justified conclusions and final recommendations The conclusion therefore is that while the intention by the EC audit reform proposal is noble, the measures suggested are largely disruptive and impractical. Therefore, it is recommended that a different approach is adapted to resolve the challenges currently posed by external auditing, which by large, should be the introduction of more oversight and supervision of the auditing firms and their procedures, while introducing further training requirements, especially in the area of risk assessment and reporting, to ensure that financial risks and possible organizational failures are detected and prevented in good time (Clifford, 2013 n.p.). References Clifford, A. (2013) ‘The outlook for audit reform.’ Accounting and Business. [Accessed on 4th December 2013] http://blogs.accaglobal.com/tag/audit-reform-future-of-audit-european-commission-audit-in-europe/ Crump, R. (2011) ‘Concerns raised over evidence for proposed EC audit reforms.’ Accountancy Age. [Accessed on 4th December 2013] http://www.accountancyage.com/aa/news/2190708/concerns-raised-over-evidence-for-proposed-ec-audit-reforms Deloitte. (2012) Deloitte Audit Reform Briefing: Unprecedented reform proposed for the EU audit market. Deloitte Global Services Limited. Euractiv. (2013) ‘MEPs dilute audit reform rules.’ [Accessed on 4th December 2013] http://www.euractiv.com/euro-finance/meps-dilute-audit-reform-rules-news-519375 Fielding, R. (2011) ‘Radical Reform.’ Accountancy Vol. 148, no. 1419, p. 35. Garcia, C. M. (2005) Public expenditure control in Europe: Coordinating audit functions in the European Union. Cheltenham: Edward Elgar. IFAC. (2013) Handbook of the Code of Ethics for Professional Accountants (2013 edition). International Federation of Accounts. 1-154. Irvine, J. (2013) ‘Mandatory auditor rotation agreed.’ Economia. [Accessed on 4th December 2013] http://economia.icaew.com/news/october-2013/mandatory-auditor-rotation-agreed Lovells, H. and Banerjee, N. (2011) EU proposals on audit reform. Globe Business Publishing Ltd. Orlik, R. (2011) ‘November is the cruelest month (for audit).’ Accountancy Age. [Online] [Accessed on 4th December 2013] http://www.accountancyage.com/aa/blog-post/2124532/november-cruellest-audit Read More