Advanced Auditing: Social and Environmental Audits - Essay Example

Advanced Auditing Question a) Social and Environmental Audits 1 Social Audit: Social Accounting has been defined in a number of ways. Rob Gray tries to identify the scope of social accounting as "the preparation and publication of an account about an organisation's social, environmental, employee, community, customer and other stakeholders' interactions and activities and where possible the consequences of those interactions and activities" With the increase in the business activities backed by globalization, business enterprises have started locating their production facilities across the world, breaking cross border barriers. Such a rapid development, many a times will result in the firms overlooking their social obligations in the interest of maximizing their profits. Hence there has been a good deal of efforts being taken to devise the techniques that measure the contribution of an enterprise to the society. These developments may be considered as the result of the increasing realization of the Social Responsibilities of the enterprises and it becomes necessary that the performance of these enterprises should be seen in the context of their fulfilling their social obligations. According to George Clark "What is now coming to be called Social Auditing is similar in many ways to Financial Auditing except that it is about everything else that an organisation does apart from handling money." There has been a number of proposals put forth to design an extended accounting system that measures the social performance of an enterprise. Linowes has proposed the preparation of a Socio-Economic Operating Statement (SEOS) to show the various social costs and benefits of actions of enterprises. This statement proposes to indicate monetary values of various actions of an enterprise classified in to following categories: Relations with people - to include items like training programmes for handicapped workers, contribution to schools for employees, extra costs incurred in hiring persons from minority or suppressed communities. These items would constitute the contribution of the enterprise in 'improving' the relations with the people. The 'detriments' that need to be shown may be items like postponement of installing safety devices etc Relations with Environment - monetary values of improvements and detriments are to be listed and the net effect shown separately. Relations with Products - In a similar way, monetary values of improvements and detriments are to be listed. Since there is yet to be a significant development to take place in this area, many of the existing models aim at measuring the performance of an enterprise vis--vis the society tales into account the factors like human resource contribution, public contribution, environmental contribution, product or service contribution and net income of the enterprise. 1.2 Environmental Audit: "An environmental audit is a means by which businesses can assess the environmental impacts of their operations. At its core is the measurement and evaluation of all inputs and outputs from the production process." (Australian Government) In the context of the increasing emphasis on protection of environment, environmental accounting and auditing have assumed special importance in recent years. Environmental Accounting aims at measuring the impact of the activities of an organization on the environment. The resultant product is the environmental statement, containing the following among other things to be asserted by the management: A brief description of the activities of the organization and the effect of such activities on the environment as envisaged by the organization A description of the organisation's environmental policy, programme and management systems to implement the stated policies A summary of the figures of emissions which may cause pollution of air and water, waste generation, consumption of raw material, energy, water and other significant environmental aspects. There should also be presented a comparison of such data with the legal norms if any A summary of costs incurred to protect the environment classified into capital costs and expenses. Environmental Audit is concerned with a systematic process of obtaining and objectively evaluating the evidence relating to performance of an organization as reflected in the environmental statement. Hence there is a close nexus between the environmental statement and the environmental audit. Thus the environmental audit attempts to examine and report on quantitative and qualitative information in the areas of environmental concerns. Getting the ISO 14001 certification dealing with compliance based environment management system by the organizations and compliance thereof would greatly facilitate the functions of the environmental auditor. 1.3 Impediments of the Auditors while Undertaking Social and Environmental Audits: The basic problem that an auditor doing an environmental audit may encounter is the lack of complete overall knowledge of all the aspects of environmental protection. Since environmental audit involves specialized skills the environmental auditor should have qualification and experience in: Concepts and techniques of auditing Environmental related disciplines and Knowledge of environmental legislation Since quite a single individual is not likely to possess all of these qualifications and experience an environmental audit generally requires a multi-disciplinary audit team. 1.4 Relevance to the Statutory Audit: The statutory audit encompasses the review of the operations of the company purely on a financial basis. Hence it may not cover reviewing the performance of the organization from the view point of environmental protection and compliance with various environmental regulations. However, in recent periods the ramifications of the environmental issues start affecting the organization seriously. Even the organizations fail to recognize this fact in time. Gray et al (1998) recognize that the environmental issues may become 'going concern issues' even without the knowledge of the organization. This can happen too suddenly also. Further such environmental factors do affect various matters relating to the economic issues of the organization like, writing off of worn out stock, depleted plant and machinery, provisions, contingencies and various other liabilities of the organization. Hence it becomes the responsibility of the statutory auditor to assess the impact of the environmental factors on these issues and also ensure that the organization has taken reasonable and effective steps to combat these issues which may affect the smooth functioning of the organization financially. Smaller audit firms may not have a real insight in to these issues and hence the scope of their work may not really identify this problem area and make an assessment and report thereon. It should be remembered that there are no unimportant issues with respect to the compliance of the environmental requirements on the part of the organization. Rob Gray (2000) opines that going forward the organizations would be subjected to increased environmental exposure through legislation or otherwise and hence all auditors should be conversant and aware of the latest developments in this front. Another area where the statutory auditor may be of immense use to the firms is in checking the authenticity and accuracy of the social and environmental reports which are produced and reported as a part of the Annual Report. It seems that presently auditors just attest the information as provided by the management which may not be of any use either to the organization or the community in general. Since information on social issues like donation to charitable and political organizations, data on employee remuneration and statements of corporate governance occupy the annual report of the companies with the attestation of the auditors only because they are made mandatory. It is better that the statutory auditor verifies the accuracy and reasonableness of the data and information presented by the management. Rob Gray (2000) opines that the auditors should be given an extensive training to develop their skills in social and environmental areas so that they can approach the social and environmental issues of the organizations with knowledge based confidence. 1.5 Relevance to Assurance Services of an Auditor: In the changing business environment, professional accountants are increasingly being asked to provide assurance beyond the traditional audit of financial statements. Such services extend to areas like quality and financial viability of trading partners, security of data and reliability of information systems. These services are being recognized of great value in the modern days of doing business based on advanced information and communication technologies. Apart from these, there are International Accounting Bodies constantly increase the reporting and disclosure requirements through various standards. Such reporting and disclosure requirements, while predominantly financial, most of them also relate to the social and environmental issues that are being faced by the organizations. Auditors in addition to their usual functions of auditing and reporting on the financial position of the organisations engage themselves in such assurance services to meet the latest trends in reporting like International Financial Reporting Standards. A thorough knowledge about the industry, wider experience on effectively analyzing the social and environmental issues and possessing the required to skills to deliver an effective assurance service is a pre requisite for an auditor. Just as in the case of the statutory audits, in discharging the assurance service also the auditor must use his diligence and audit skills to find out any issues that may have relevance to the social and environmental standing of the organization concerned. 1.6 Impact on the Management of a Company: Normally the social and environmental reports are prepared by the organizations with the objectives of representing the actual intentions of the management or due to the compulsion of the regulatory provisions. It may be observed that in general the preparation and reporting of these two issues often have mixed objectives, the degree of each of which is determined by the impact of the respective forces namely the intentions of the management and the accountability of the organization. More often than not such reports get the attestation by the auditors. According to Rob Gray (2000) audit signifies the "attestation to some characteristics of a report as opposed to other meanings". The industry experience is that the quality of attestation by the auditors to the social and environmental reports are not that authentic in the sense that such attestations neither certify the extent of completeness nor vouch the intentions of the management. "Consequently, the attestation has little or more likely negative value to a reader who could easily be fooled into believing that attestation means that they can rely upon the report as true and fair reasonable (or whatever) picture of the organisation" Such kind of reliance on the report by an outsider and any action taken by him based on such reporting has a very serious consequence on the confidence that the management of a company can build on the external stakeholders. If the information contained in the report turn out to be false or have material defects, the management becomes accountable for such serious lapse. However, since instances using of such social and environmental reports for investment and other decisions are negligible the managements who made reports as well as the auditor who attested the reports do not have any serious consequences. The increased legislative pressures on the organizations with respect to reporting on social and environmental issues signify that the day is not far off when much reliability will be placed on the dependability of such reports. Considering the impact of the social and environmental reports internally on the various functions of the organization, an accurate and proper accounting and review of the financials involved in the various social and environmental issues will enable the management to improve the employee morale and thereby the overall efficiency of the organization. By highlighting the social issues tackled by the management during any particular review period, the management would be able to win the confidence of the workers and other employees of the organization. However this requires a true assessment of the developments that has taken place in this respect, as any reporting on the social issues made by the management is verifiable internally. If some information turns out to be untrue, the management may have to take a longtime in winning back the confidence of the internal stakeholders of the company. Question 2 2.1 Independence of Auditors: Independence implies that the judgment of a person is not subordinate to the wishes and directions of another person who might have engaged him or to his own self interest. The need for auditor's independence has been proved beyond doubt. The Enron debacle is the classic example of the violation of auditors of their moral responsibility of independent reporting. If the auditor is not independent of the management, his opinion would mean little to shareholders, prospective investors, bankers, government agencies and others who are concerned and guided by the financial statement s of a company. Independence is a well accepted standard of auditing. The Code of Ethics (2001) for Professional Accountants of International Federation of Accountants state that when undertaking an assurance assignment as audit, the auditor should be independent of the client. Government Auditing Standards (2002) provide that "In all matters relating to the audit work, the audit organization and the individual auditor, whether government or public, should be free both in fact and appearance from personal, external, and organizational impairments to independence" Independence of the auditors relates to both audit and non-audit services by the auditors to different clients. The underlying Principles behind the independence with respect to non-audit service are that the auditors should not take part in the management decision making functions nor they should perform any management functions by themselves. Similarly the auditors should restrain themselves form providing non-audit services in those circumstances where the volume or the financial implications are very significant to the purpose of the audit. If the auditors follow these basic guiding principles, they can ensure their independence with respect to the non-audit services. According to Jeffrey Steinhof the auditors can take supplementary precautions to protect their independence by adopting the policy of "Personnel who perform certain nonaudit services would be precluded from performing related audit work". Similarly the auditor should insist that certain documentation and quality assurance requirements are met. Moreover the auditor should also insist that the scope of his work should not be subjected to any realignment below the level that would ensure his independence, in cases where the non-audit services are performed by another unrelated person. The Institute of Chartered Accountants of England and Wales has issued the guidance note for audit committees in connection with the reviewing of the independence of the auditors. According to the Institute's Guidance for Audit Committees "The quality of the audit opinion is a vital element in maintaining confidence in financial reporting." An analysis of this guidance note reveals that the audit opinion to be free from bias is the basic requirement to vouch for the independence of the auditors. An objective approach is required on the part of the auditors and also in respect of the public limited companies the consideration of external perception about the values of independence is of prime importance for the quality of service being provided by the auditors. 2.2 Personal Views on the Independence of the Auditors: As stated earlier, independence is an attitude and state of mind. In order to remain independent the auditor he should create a working environment in that his opinions are valued and are not jeopardized with extraneous factors that may have an influence on the auditor with respect to his relationship with the management of the company. The auditor should maintain the regard and respect otherwise being given to him by virtue of his position. This requires considerable self discipline on the part of the auditor in the discharge of his functions not only as an auditor, but also he should be regarded as an individual above board simply by the qualities he possesses. Some of the following suggestions if followed will enhance the independence of the auditors: There should be a restriction on the person to act as a director if he is related in any way to the directors, or if the auditor has common financial interest with the directors in any business ventures. This suggestion has been derived on the basis of the bad experience the corporate world has with the rise and fall of Enron. It is not a matter that can be forgotten so easily. The unprofessional approach of the auditors, in developing close relationship with the top executives has vitiated the independence of the auditors to such an extent that the whole episode proved gravely detrimental to the internal and external stakeholders of the company. It also has spoiled the growth of an organization which otherwise would have been successful, had the auditors exercised independence in their functions. By virtue the auditor should not accept goods, services or other hospitality from the clients or their suppliers or associated companies. The position of the auditor is so vulnerable that he will have every chance to be lured by the companies to do some favours in connection with the presentation of information in the financial statements. Under such circumstances the auditor should restrain himself from accepting any favours which will enhance the chances of maintaining his independence. May be it is a good thing not to appoint the auditors of the company for non-audit services in the same company altogether. Perhaps this suggestion would result in a lot of hardship for both the auditors as well as the companies, as the auditors in most cases may have to depend on the opinion of the persons responsible for the non-audit services in respect of inclusion of some statements or information which are based on such non-audit services. The guidance issued by the Government Auditing standards in this respect is relevant to refer. The independence of the auditors can also be achieved by rotating the auditors during the interval of a fixed period say three years. This will deter the auditors as well as the clients from establishing a close relationship with each other over a period of time. Similarly where there is a potential chance that litigation may develop between the auditor and the client it is advisable for the auditor to renounce his position as the auditor with that company. This would avoid lot of embarrassments as the independence of the auditor is sure to be affected by such entanglement. Word Count: 2997 References: 1. Australian Government Environmental audits Department of the Environment and Water resources http://www.environment.gov.au/settlements/industry/corporate/audits.html 2. Code of Ethics for Professional Accountants (2001) International Federation of Accountants New York Pars 8.1 3. Gray R.H K.J. Bebbington D.J.Collison, R.Kouhy B.Lyon C.Reid, A.Russell and L.Stevesnon (1998) The Valuation of Assets and Liabilities: Environmental Law and the Impact of the Environmental Agenda for Business Edinburgh: ICAS 4. George Clark Social Auditing - Feedback Control for Organisations The Caledonia Centre for Development http://www.caledonia.org.uk/ 5. Government Auditing Standards (2002) Answers to Independence Standard Questions United States General Accounting Office 6. Guidance for the Audit Committees Reviewing the Independence of the Auditors Institute of Chartered Accountants of England and Wales 7. Jeffrey Steinhof Auditor Independence New GAGAS Independence Standards Government Auditing Standard 8. Linowes, David F, Socio-Economic Accounting LKHH Accountant Vol. 52 No 3 9. Rob Gray (2000) Current Developments and Trends in Social and Environmental Auditing Reporting and Attestation: A Review and Comment International Journal of Accounting Vol.4 PP 247-268 Read More