Quality Control in Audit Firms and Audit Market Concentration - Term Paper Example

INTRODUCTION Auditors are not only expected to detect mis ments due to fraud or error because they are only tasked to look at the financial ments of the company and objectively expressed their audit opinions (Day, 2006, p.20). The overall result of the process is expressed in a transparency report. If there is an audit, there must also be an audit quality whose role is carried out by the auditor team or quality auditor. The financial scandals that had happened to Enron, WorldCom, and Andersen had strengthened the decision that audit process, accounting issues, and financial regulatory regime should be analyzed, reviewed, and reformed. The collapse of these three big companies has confirmed how important the role of audit quality in the International Organization is for Standardization (IS0). Different professional and regulatory requirements have contributed to the achievement of audit quality, and enhancement of confidence in the capital market. Among the common contributing factors that emerged are the auditor’s ethical requirements such as independence in expressing opinions. “The form of the auditor’s opinion, however, will depend upon the applicable financial reporting framework and any applicable law or regulation” (International Federation of Accountants, 2010, p.83). This paper discussion will focus on the issue about audit quality, the problem of audit market concentration, and possible solutions in relation to audit quality. SIGNIFICANCE OF AUDIT QUALITY IN RELATION TO EXTERNAL AUDIT SERVICES One of the functions of an auditor is to express an opinion that must be in accordance with the generally accepted auditing standards or regulatory framework. Although the fermented opinion is based on applicable law, users and commentators still considered this judgment subjective. Limited transparency is the reason why the term ‘audit quality’ has no single agreed definition at all. Good thing that there are other factors that prevented them to question the underlying quality of audit process such as the professional qualifications of auditors, firm’s quality control policies, and the regulatory requirements. To ensure that the internal or external quality auditor has complied with this quality standard raised by the organization, audit quality is being performed. Based on the first discussion paper presented by FRC (2006), it has been illustrated that audit quality will only be attained if the auditors expressed their opinion objectively, comply with professional, regulatory and legal requirements, and if auditor’s reports are supported by appropriate audit evidences. If this would be the case, investors and other financial statement users’ confidence to the quality of audit and audit opinion in capital allocation will be strengthened. Audit is being performed to know exactly if the process in relation to the provision of the external audit services has been successfully implemented, if evidences support the opinion and the report, and if judgment is objectively given. The performed audit must have high quality so that confidence for capital market will be reinforced, and most importantly, the opinion must not only focus on negative or corrective actions, but also on the good points to have continual improvement (International Federation of Accountants, 2010, p.84). Audit quality is also significant in the sense that it determined if the audit process comply with the professional, regulatory and legal requirements, and in other appropriate circumstances (International Federation of Accountants, 2010, p.133). PROFESSIONAL REQUIREMENTS, REGULATORY OVERSIGHT & OTHER INITIATIVES In financial reporting, companies are required to prepare their financial statements in conformity with the new set of accounting standards called the International Financial Reporting Standards (IFRS). On the other hand, audit process needs to be in accordance with the Generally Accepted Auditing Standards (GAAS). These are some of the regulatory requirements that need to be considered in order to produce audit quality. The Financial Reporting Review Panel had increased the scope of information that needs to be reviewed and reported, this is to make sure that expressed opinions from auditors are reliable and with quality. Likewise, the Quality Control Review which is created under the International Standard on Quality Control (ISQC) had also set out additional requirements and responsibilities so that quality of audit process will be clearly evaluated (International Federation of Accountants, 2010, p.38). One of the most common professional requirements that has been stated in the progress report established by FRC is ethical requirement. Auditor’s independence is the ethical and legislative framework that is closely related with the quality audit process because without this requirement, fraud will not be detected. It has been stated in the Code of Ethics for Professional Accountants (IESBA code) that auditors need to be independent both in mind and in appearance, and to be free from any self-interest with the clients’ financial position (Carmichael & Swieringa, 1968). Independence also enhances auditor’s ability to express their opinions objectively and to improve the quality of the audit process (Pierce & Kilcommins, 1996). The lack of independence among auditors has a great effect on the quality of audit just like what had happened to Enron, WorldCom, and Andersen. The lack of attention with regard to this requirement might be the reason why several procedures and policies have emerged nowadays. In fact, countries like U.S. and UK are into self-regulatory system that will enable the committee to see if this requirement is strictly followed by auditors. Another responsibility that falls under this requirement is the creation of audit report. It is expected that this audit report must be free from biases and interests so that the general public can rely on this information. Users and commentators of financial statements have demanded the review panel to set a much higher ethical standard so that confidence between the two parties will be strengthened. Professional skepticism and professional judgment are also mentioned as part of the ethical requirements. Professional skepticism talks about audit evidences that will support the report and opinion of an auditor. To gain quality, audit evidences must be carefully assessed whether it is genuine, and if not the auditor needs to investigate further before accepting the records (International Federation of Accountants, 2010, p.159). On the other hand, professional judgment deals in determining evidences that have been misstated due to fraud. Other relevant ethical requirements that can be found in IESBA Code include: integrity; objectivity; professional competence and due care; confidentiality; and professional behavior (International Federation of Accountants, 2010, p.53). In terms of regulatory oversight, different regulatory committees have been established in order to properly delegate audit responsibilities. In UK, the functions of Accounting Principles Board (APB), Review Board, and Ethical Standards Board are assumed by FRC, this is to regulate and improved the information and communication between the parties and strengthen the independent monitoring of audit quality (FRC, 2006, p.12). Another regulatory requirement for audit quality is monitoring. This is a “process designed to provide the firm with reasonable assurance that its policies and procedures relating to the system of quality control are relevant, adequate, and operating effectively” (International Federation of Accountants, 2010, p.131). In terms of initiatives, the market participants in UK which are the respondents of the proposed progress report by FRC have recommended the development of Audit Firm Governance Code (FRC, 2010, p.2). This code will support the firms in performing high quality audit work by requiring auditors to state in their transparency report the compliance of the code provisions as well as an explanation for any non-compliance. AUDIT MARKET CONCENTRATION, POSSIBLE OUTCOMES & POTENTIAL IMPACT As what has been presented in the fifth progress report of FRC (2010), it is very apparent that UK’s audit market is extremely concentrated. The concentration of the Big Four international accountancy and professional services firms are really untouchable. PrincewaterhouseCoopers, Deloitte, KPMG, and Ernst & Young are the Big Four in the top 50 accounting firms in 2010 (Accountancy Age, 2010). The significant gap (e.g. size) between the Big Four firms and the mid-tier firms are not actually the problem, but it is the negative perceptions, entry barriers, and the lack of choices. In the fifth progress report (FRC, 2010), FTSE 100 and FTSE 250 are the segments that are being used, and based on figures, almost all of the audit services are performed by the Big Four firms. Likewise, in FTSE Small segment, the market is shared both by the Big Four and mid-tier firms. Obviously there is no balance in terms of supplying audit services between the Big Four and the mid-tier firms, and if this would continue competition will not work, and entry in the FTSE 350 by the mid-tier firms will be uneconomical. Unless there would be changes in the perceptions and regulations, it would be impossible for mid-tier firms to fully enter the audit market. As expected, once the audit market will be opened to each of the suppliers, audit quality will be affected, and this is the great concerned of audit regulators. On the other hand, looking beyond the Big Four is also advantageous because auditor independence will increased as well as competition, and companies will have the chance to choose an auditor from outside the Big Four. CONCLUSION Once the auditor started to express objective opinions, and comply with the professional, regulatory and legal requirements, the audit process will have a higher quality. An audit with quality is encouraging to the users and commentators of financial statement because their confidence on the process and audit opinion will be strengthened. This is the primary reason why FRC had established reports about promoting audit quality. In terms of audit market concentration, audit regulators need to look beyond the Big Four firms, and companies need to be open-minded. This change of perceptions could lead to an increase in competition and auditor independence which is favourable to the auditing companies. References Accountancy Age. (2010). Top 50 plus 50 accounting firms. [Online] [Accessed on 22nd December 2010] http://www.accountancyage.com/static/top50-this-year Carmichael, D.R. and Swieringa, R.J. 91968) ‘The compatibility of auditing independence and management services.’ In: J.E. Ketz (Ed.) Critical perspectives on business and management. New York, NY: Routledge, pp. 188-195. Day, J. (2006) Book5: audit theory, practice and ethics. Milton Keynes: the Open University. FRC. (2006) Discussion paper: promoting audit quality. [Online] [Accessed on 21st December 2010] http://www.frc.org.uk/images/uploaded/documents/Promoting%20Audit%20Quality% 20paper%20web%20optimised.pdf, pp. 1-71. FRC. (2010) Choice in the UK audit market: fifth progress report. [Online] [Accessed on 22nd December 2010] http://www.frc.org.uk/images/uploaded/documents/Choice%20in%20the%20UK%20Audit%20Market%20Fifth%20Progress%20Report.pdf, pp.1-26. International Federation of Accountants. (2010) Handbook of international quality control, auditing, review, other assurance, and related services pronouncements. 2010 ed. New York: IFAC, pp. 2-811. Pierce, B. and Kilcommins, M., (1995-1996) The audit expectations gap: the role of auditing education, [Online] DCUBS Research Paper Series: No. 13. [Accessed on 22nd December 2010] http://www.dcu.ie/dcubs/research_papers/no13.htm Read More