Increasing the Effectiveness in Auditing Process - Literature review Example

Increasing the Effectiveness in Auditing Process Introduction Enron’s failure in 2001 and other corporate scandals that came into the limelight in 2002 and henceforth have diminished the confidence, that people had all over the world, in financial reporting, auditing and other corporate governance practices (Ivaschenko, 2004). According to Mingus (2007), a scandal can be described as a widely publicized incident that accuses a company of wrong – doings, disgrace and moral outrage. Research scholars such as (Sivakumar, 2011), corporate scandals are reported when officials of a particular organization is accused of behaving unethically on behalf of his corporation. Thereafter the author described financial scandals as those corporate scandals that involve misappropriation and misuse of money or economic resources. The chronicles of business history are filled with errors related to accounting, judgements, financial management and financial skulduggery. Over the last few decades unscrupulous entrepreneurs have been heavily involved in financial scandals where they allegedly diverted funds from one stated use to another, paid dividends out of borrowed money or capital, traded stocks on the basis of insider information as well as concealed vital information regarding those stocks, practiced creative account thereby altering the company’s records so on and so forth. Auditing failure has been a major concern over the last two decades with case of Enron and WorldCom coming into the limelight. According to Tackett, Wolf and Claypool (2004), a severe distortion in the financial statements that has not been reported in the audit report can be termed as audit failure. Thus the auditor has committed a serious mistake while conducting the auditing process (Arens, 2002). Normally, auditing failure would not happen if an auditor is abide by the Generally Accepted Auditing Standards despite the fact whether the financial statement is accurate or fair. In general auditing failure can be attributed to four systematic causes. Firstly, auditing failure can occur if the auditor misinterprets the generally accepted accounting standards. Secondly, the auditor can commit fraud intentionally by issuing audit reports which has been prepared with complete biasness over the company. Thirdly, auditing failure occurs when the auditor is lured into committing such frauds by the company. Lastly, auditing failure might occur if the audit officer may commit fraud intentionally because of having some private relationship with the client beyond a certain level which is normally not expected in normal audit between independent parties. The following sections will highlight the integrity in the System of Corporate Accountability thereby commenting on the role of auditors and their effectiveness in the auditing process. The issues which undermine the credibility of audit reports will also be discussed. Thereafter, the changes that have been made in the auditing regulation will be explained followed by an explanation of the corporate governance framework that exists in Parmalat. Henceforth, the issues of audit reporting will be discussed and appropriate conclusions will be drawn. Integrity in the System of Corporate Accountability Corporate accountability is of utmost importance in debates around social issues, ethics and businesses (Brenkert, 2004). Accountability generally refers to the reliability and authenticity in the financial accounts reporting related to the financial status of any corporation. Integrity in the corporate accountability system should be maintained in order to reduce fraudulent activity within the financial reporting system. In the latter half of the twentieth century, the social and environmental issues were also brought under the financial accountability making them responsible for the environmental and social records. Linkage between the accountability and the integration of the Corporate Social Responsibility within the businesses helped to take the Business for Social responsibility to greater heights. It gave importance to the practise of accountability in businesses including various arguments like reduction of costs, improved financial performance, increased investor attractiveness and enhanced organizational efficiency. Role of Auditors Financial statements are very useful for a number of decision making purposes. The financial statement is generally used by the owners for evaluation of the management stewardship (Iyoha and Faboyede, 2011; Okpala, 2012; Spiceland, Sepe and Tomassini, 2001). It is used by the investors in their decision making, whether to purchase or sell the securities. It is used by the credit rating agencies for rating the financial performances of various organizations and also by bankers for various decision-making related to borrowing money. The effective use of financial statement needs understanding of the role of auditors as well. Financial statements are generally the representation of management. Its importance is apparent from the aforementioned statement. Thus it becomes very important to maintain the reliability and authenticity of the financial statements in order to avoid fraudulent activities in the preparation of these statements. The auditors are responsible for expressing their view whether the management has maintained fairness in the information of the financial statement. In audit, the auditors have the responsibility of evaluating the financial statements in order to test the reliability of the information available in such statement. The auditor gathers evidences to assure that the figures mentioned in the information of the financial statements are free of material misstatement. The auditor evaluates whether the audit evidences raised distrust related to the client’s ability in continuing as the going concern in the future. The auditor increases the credibility of the financial statements of the organizations by means of their audit process. This allows the creditors, bankers, investors, and owners etc to use these financial statements with higher confidence. Thus the auditor upholds a big responsibility related to the trustworthiness of the information in the financial statements. The auditor’s report has high impact on the decision making of the investors, creditors, bankers and other stakeholders. Issues which undermine the credibility of audit reports Corporate governance failures might lead to worsened conditions for the organizations. One such example is Parmalat’s failure. The main reason behind such failure is the corporate governance structure of the organization (La Porta, et al., 1997; Macey, 1998; Johnson, et al., 2000). It is always compared with the structure of the Italian-listed companies and those with highest standards of corporate governance in Italy (Consob, 2002). Empirical evidences claim that the lack of monitoring structure, which makes the corporate insiders responsible in presence of the corporate governance system, is the main reason behind this scandal (Mulligan and Munchau, 2003; Heller, 2003; Lyman, 2004). The ownership as well as the controlling role (especially that of the shareholders) and the role of the statutory auditors have led the organization into such scandal. The corporate governance structure of the company failed to remain in compliance with the Italian corporate governance standards, such as the existence of independent directors, construction of internal control committee etc., which resulted in such corporate governance failure scandal (Melis, 1999; 2000). The role of the internal control committee as well as the external auditors is responsible in putting Parmalat in global controversy case (Melis, 2004). Bank of America argued that the company did not hold 5 billion liquid assets which were actually reported in the financial statement in September 2003. The bank sends notification to Grant Thornton that no such account exists. Grant Thornton International and Deloitte and Touché failed to detect the fraud. This has been a severe issue which has been marked as one of the major Italian Scandal. Changes in Audit regulations (Sarbanes Oxley Act 2002) The Sarbanes Oxley Act (SOX) has been introduced in the year 2002 in order to protect the rights of the investors by increasing the reliability and accuracy of the corporate disclosures (Rezaee, 2007). This law acts as special protection mainly for the whistleblowers. Sarbanes Oxley Act strengthened the corporate governance by expanding the responsibilities of the auditors. SOX needed the boards of the organizations listed in United States Stock Exchange to introduce audit committees made up of board members who are independent from the management. A large number of audit companies were reconstituted for meeting the independence requirements that have been outlined by United States Stock Exchange and SEC in the latter half of 1990 (Raiborn, Schorg and Massoud, 2006). According to SOX, the companies that do not possess an audit committee member termed as the financial expert, require disclosing the fact in the ‘annual proxy statement’. Such companies also need to mention the reason behind the lack of such member in their committee. SOX have made it mandatory for these executives to always clarify among themselves the following items for every quarterly and annual report: They must review the report. Based on their own knowledge they should ensure that the financial information in the report is fairly presented. Based on their own knowledge they should ensure that the financial report does not have untrue statement which would give a misleading picture of the financial statement. They should acknowledge the responsibility of introducing and maintaining internal control associated with financial reporting or other disclosures. Corporate Governance According to Parmalat (2013a), in order to ensure the fact that Parmalats governing bodies are working transparently and efficiently the management has formulated a robust governance framework that constitutes of a set of rules and activities to be followed by each and every member of the organization. Its governance structure is based on a conventional model which consists of the following governance bodies: Board of directors, shareholders, board of statutory auditors, independent auditors. The company’s governance body consists of Board of Directors comprising 11 Directors, elected by slates of candidates. Shareholders whose number of shares equals to at least 1% of the Company’s shares enjoy the right to vote at Regular Shareholders’ Meetings and are entitled to file slates of candidates. Francesco Tato is the Chairman whereas Yvon Gagarin is the CEO of the company. The main shareholder governing the board of directors is Sofil S.a.s. who owns 81.5% of the company’s shares (1,465,116,500 shares). The auditing committee of Parmalat includes Deloitte & Touche and Grant Thornton (Parmalat, 2013b). Parmalat’s bank, Bank of America released a document that reported the presence of 3.95 billion euro in the bank account of its Cayman Island subsidiary, Bonlat, as a forgery. It was accused of committing massive frauds. It was reported that billion of euro had gone missing from its accounts which were compared to the scale of scandals that happened in Enron (Coso, 2013). The reasons for Parmalat’s scandal can be attributed to the gatekeeper problems with respect to lawyers, auditor, financial intermediaries and political institutions (ECGI, 2005). Conclusion The fairness and transparency in the financial statements is very important for increasing the reliability of the investors, creditors and other stakeholders of the organizations. In order to maintain the transparency and authenticity of all the information, the directors, managers, owners and auditors needs to abide by the strict regulations under corporate governance. The auditors are required to follow all the rules mentioned in Sarbanes Oxley Act 2002 in order to increase the faith of the investors on the accuracy of the information available in the financial statements of the organizations. Moreover, it is very important for all the organizations to have strict corporate governance policies to avoid any kind of fraudulent activities. This would also aid higher accessibility to capital and enable faster growth of the organizations. Reference List Arens, A., Elder, R. and Beasley, M., 2002. Auditing and Assurance Services. 9th ed. Upper Saddle River, NJ: Prentice Hall. Brenkert, G. G., 2004. Corporate integrity and accountability. California: SAGE. CONSOB, 2002. Relazione annuale 2001- Commissione Nazionale per le Società e la Borsa. 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