Audit and Assurance - Essay Example

Auditing is the process by which something is examined with a view to form an opinion; this allows others to gain assurance that some information, ora process can be trusted. In many countries around the globe, companies are required to produce annual financial statements and have them audited by an external auditor. The audit, which is mandatory and is required as per the legal obligations, is some times referred to as statutory audit. The statutory audit is going through a period of criticism and change. This is partly because of the failure of auditors to notice companies about to collapse, often due to massive frauds and accounting irregularities. Linked in to this is the growing belief that many firms of auditors are unable to make objective judgments because they are either too close to the clients that they are auditing or they get close to them during recurring audits of the same clients. This is the main area where an auditor’s independence is brought under question. The basic idea of audit is to bring in an independent assessor of the financial statements; the assessor i.e. the auditor should be honest while giving out his conclusion on the financial statements. The auditor issues a report explaining the audit process and gives his opinion as to the truth and fairness of the financial statements i.e. whether they are prepared in accordance with the relevant legal and accounting standards. There are many different types of assurance engagements: Audit of the financial statements Internal Control Review Financial Statements Review Best Value/ Value For Money work in private/public sector organizations Systems reliability reports Performance Measurement Reports Social and Environmental Audits Risk Assessment Reports An auditor usually gives out two types of assurances, Reasonable or Limited Assurance. A reasonable assurance is of high level while a limited assurance is a moderate level assurance. When giving out a reasonable assurance, the auditor gives out a positive report (means the statement given out would be a positive one as opposed to a normative statement given out in limited assurance). Many companies get their financial statements audited by different audit firms, along with these external audits, companies also assign other assurance services to the existing auditor, this issue has caused a bit of concern over the recent years. The independence of the auditor is questioned when he takes up such assignments along with the external audit assignment. To avoid such situation, the auditor can perform certain strict procedures while performing the external audit along with other assurance services: The auditor chooses different teams to handle different assurance services in a same firm; each and every assurance service provided is looked upon and handled by different partners of the audit firm. To keep independence intact, the audit company rotates its partners every 3 to 5 years on a particular audit or non-audit assignment. In the UK, according to the ethical standards, any particular client should not account to 15% of the audit firms’ total revenue (for a listed company the limit is 10%) Audit firms should have strong control environment to assure that none of their employees take up any huge gifts or hospitality from the clients. Audit firms should not take up any assurance assignment in a company where there are legal proceedings between the audit firm and its clients. The treasury selection committee in May 2009 published a report to address the issue of increasing investor’s confidence in a firm, in this report, the main aim of the committee was to stop audit firms from conducting non-audit services for a company which it is already auditing. This would help in increasing investor confidence. To answer to these remarks of the Treasury committee, the APB suggested that since the collapse of Enron, many developments have been made in this particular respect. Besides all these, the participation of the audit committees in such issues has increased investor confidence along with amendments made to better transparency to the fees paid for non-audit services. The basic aim of APB in this consultation paper was to review the support of investors regarding the two contrasting comments given out by the Treasury committee and the APB itself. The International Federation of Accountants (IFAC) has over the years developed a “principles based” approach rather than a “rules based” approach. This approach has helped in identifying possible ethical threats that any company faces, the identified threats are: Self – Interest Self – Review Management/ Familiarity Intimidation Advocacy Since 2004 there have been many recent developments to erase such ethical threats and issues, the APB, when reviewing its ethical standards (originally issued in 2004) in 2007 pointed out a major reduction in audit firms providing audit and non-audit services together for the FTSE 100 companies. This reduction is also reflected in the fees structure set by audit firms for auditing and non-auditing services, since 2002 there has been a major increase in the audit fees and a reduction in the fees for services provided regarding non-audit issues. The introduction of audit committees in the companies has helped a lot to overcome issues related to auditor independence; such committees have a very hard check upon issues related to auditor independence. After 2004 when APB gave its first set of ethical standards, they have only used consultation technique rather that a forceful regulatory way to pressure companies. The recent issue of KPMG in 2009 created a major hue and cry amongst the big 4 firms and other auditing bodies, when the firm won the audit of Rentokil, it put a big question mark over the threat of Self – Review (Auditor preparing the accounts and auditing them as well) and Management (Auditor taking on client’s management roles), as KPMG was providing both external as well as internal audit for Rentokil. Many commentators were of the view that KPMG was playing and testing the guidelines provided by the IFAC. The international company later promoted this as this had led to a 30% cost saving for the company. Such arrangements are highly restricted in the U.S.A and France as they have strict policies regarding independence. This recent issue of KPMG may lead APB or other auditing bodies to take more strict measures so as to totally eradicate any concern regard auditor independence. Audit firms and companies should try and remove this auditor independence concern so as to increase investor and shareholder confidence. In order to guard against such threats, firms need to have procedure that can enable it to: Identify such threats Evaluate risks arising from these threats Ensuring possible safeguards to avoid or reduce such threats Take corrective action if the need arises The possible safeguards that need to be in place of two types: General Safeguards Safeguards created by profession; i.e. giving out appropriate knowledge, training before entering into the profession. Safeguards relating to work environment; such as ethics and conduct programmes, strong control environment, proper internal controls, fair recruitment policy, etc. Safeguards created by individuals; complying with latest professional development requirements, keeping record of upcoming issues, etc Specific Safeguards Segregation of Duties; assigning different teams to different audits to avoid conflict of interest between two or more companies in the same industry so that its information does not leak out, different teams for audit and non-audits services provided to the same client Review; audit of one company reviewed by partner other than the one conducting the audit There are many other situations which are identified by the code itself: Partner or employee of the audit firm must not be holding any financial interest in the company whose financial statements are to be audited. No loan should be either given or taken from the audit client, any client lending money would be considered as a bribe which eventually would dent the auditor independence as well There should not be an over dependence of fees upon one major client An audit firm should not provide non-audit services (such as internal audit) to any client whose financial statements are already audited by the firm. The audit firm should not engage into the designing, provision and implementation of information technology of any audit client as the system concerned would also be regarding that particular accounting statement. When the valuation of any particular asset of an audit client is concerned, third party valuation should be sought rather than providing the valuation service itself. This would increase the integrity of the opinion formed by the audit company. The basic concepts of professional concepts should always be followed when audit or non-audit services are provided. These concepts are: Objectivity; Auditors should carry out their work with impartiality (with no other matters in mind) Integrity; Auditors should be honest and honest in all business and professional relationships Professional Competence and Due Care; Auditors should only accept work that they are competent to do and should perform it with due care and skills Confidentiality; They should respect confidentiality of information acquired as a result of professional and business relationship Professional Behavior; Complying with relevant laws and regulations. References; APB issues a Consultation Paper on audit firms providing non-audit services to listed companies that they audit, 2009 http://www.frc.org.uk/apb/press/pub2125.html International Ethics Standard Board for Accountants Releases New Code; Clarifies Requirements and Strengthens Independence, 2009 http://www.ifac.org/MediaCenter/?q=node/view/657 McMeeking, Kevin Paul. An Empirical Analysis of the Level and Changes of UK Audit and Non Audit Service Fees. University of Lancaster, 2000. Debate rages on over KPMG’s cut-price Rentokil audit deal http://www.accountancyage.com/accountancyage/news/2248103/debate-rages-kmpg-cut-price FRC urges caution on KPMG audit mix http://www.accountancyage.com/accountancyage/news/2253010/frc-urges-caution-kpmg-audit-4895116 Robertson, Jack C. Auditing. Homewood, IL: BPI/Irwin, 1990. Read More