Criticism against Statutory Audit, Distortion of Competition for Audit Markets - Coursework Example

Introduction The financial crisis in the year 2008 highlighted and exposed the weakness which the banking sector had and brought forward the manner in which the audit committee didn’t perform their duties. The different reason which can be attributed to the inspection of public concern was the concern regarding the quality of audits which was conducted on the financials of the organization. The financial sector witnessed serious liquidity shortages which were primarily due to the margin calls which took place on derivatives and therefore required that the audits process was properly monitored. The European Commission which was set with the purpose of finding out the weakness which the audit process highlighted the manner in which the role and responsibilities of public entities were not observed. This essay presents the different reasons which raised criticism against the statutory audit and requires development of different reforms and strategies through which the regulators and the audit profession was able to justify their role and ensure that no misappropriation of funds take place. This will thereby help to develop strategies through which steps will be taken through which the chances of such a financial crisis get reduced in the future. Criticism against Statutory Audit The European Commission is of the view that the financial crisis in 2008 highlighted different shortcomings in the European audit system due to which some of the bigger financial institutions were provided clean audit reports despite having serious weakness in the intrinsic health of the institutions (Nanto, 2009). The lack of quality audit by the national supervisor in granting the audit the status of being clear highlighted that the audit process was unclear Improper audit process Bank auditors have a role in ensuring that correct and proper information regarding the financials are provided in the financial statements. Instead, the financial crisis revealed that the banks auditors didn’t provide any such risk about banks failure in the financial statement. This resulted in complete ignorance on the part of the investors which thereby resulted in contributing towards the crisis (Sen, 2010). This factor can be attributed to the fact that the lack of supervision and monitoring on the auditors provided the opportunity through which financials of the banks were modified according to the requirements. The different reports which were audited by different auditors during the financial crisis revealed that there were a lot of deficiencies in the audited report with regard to quality and the auditors didn’t deliver their performance based on the professional standards. This resulted in skepticism and involved the non financial sector as well. The deficiencies which the audit sector highlighted shows that it contributed largely towards the global financial crisis and showed a lack of audit reforms resulted in a crisis. Distortion of Competition for Audit Markets The financial crisis brought forward the manner in which distortion in competition has resulted in increased dependence on the big four audit firms named Deloitte & Touche, Ernst & Young, and Price waterhouse Cooper’s and KPMG. The fact that four of the big firms control around 85% of the market share with regard to audit of different firms it increased in over dependence on the four firms (Böcking, Gros, Wallek & Worret, 2011). This thereby resulted in increased misappropriation of funds and increased the moral hazards for large firms as they ultimately had to pay a higher price for the audited financial statement. This thereby had an impact on the financials and resulted in increasing the chances of a financial crisis. Poor Risk Analysis The audit firms prior to 2010 never looked to identify the housing corporation as ones who were involved in high risk business. The audit firms didn’t have any form of quality measures in their audit which thereby didn’t highlight the risk that housing corporations had to face (Köhler, 2012). This resulted in poor risk analysis and the inability of the audit firms to identify the different factors which resulted in a crisis. This can further be supported by the fact that lack of proper standards which helps to determine that the statement which is provided is correct and fair was lacking. The lack of regular objective assessment which helps to check the validity and reliability of the information was lacking. This provided an opportunity through which the funds were not used in the correct direction and thereby resulted in the misappropriation of funds. Increased Time Pressure The financial crisis also brought forward increased pressure which the audit firms had to undergo. The fact that the majority of the audit i.e. around 85% of the audit work was carried by Deloitte & Touche, Ernst & Young, and Price waterhouse Cooper’s and KPMG it increased the degree of pressure on the auditors. The auditors had to provide audit statement for a large number of organizations which thereby had an impact on the quality of audits. The situation also unfolded in a manner where the auditors were not able to verify the actual information and has to provide clean certificate without looking into the actual situation (Veron, 2009). This increased the misappropriation of funds and resulted in an increase in chances of funds to be misused. Steps to Reduce Criticism This has resulted in the development of proposal from the European Union which requires that the role of the auditors are clearly stated which will be strengthened by developing reforms and rules for the audit sector. This will help to strengthen the role of auditors and will increase greater diversity through which the independence of auditors will increase and will be able to carry out the audit function effectively. Mandatory Rotation The financial crisis showed that audit firms were allowed to continue the audit process for firms continuously. This increased and multiplied the chances of providing clearance to firms even when they were not. Audit firms before the financial crisis were allowed to continue with their operations of verifying the financials of the company continuously without any checks (Cameran, Vincenzo & Merlotti, 2005). This provided the required space and room through which the audit companies manipulated the financials and thereby had a role in financial crisis. The commission has brought about changes in it and states that audit firms has to be rotated continuously and can be engaged for a maximum period of six years which can be extended for a maximum period of nine years depending on different situations. Once an engagement comes to an end than the same audit committee cannot be engaged for the next four years (Cameran, Vincenzo & Merlotti, 2005). This thereby helps to provide a check through which the performance of an audit committee will be measured and will help to reduce the chances of acting in an unfair manner. The process will also help to ensure that audit firms carry out the duties and responsibilities that have been entrusted on them and carry out all the different functions which they have been entrusted with. This process entails towards the development of a process which reduces the risk of any potential threat which might arise due to familiarity threat. This will bring the required chances which the auditors have to undergo and will help to reflect and bring the changes through which the process of audit improves. Development of Public Interest Entities This has to be matched by the fact that public interest entities will have to undergo an open and transparent tender process while selecting a new auditor and the entire activities have to be monitored by the audit committee. This will ensure fair and transparent selection of the auditor and will reduce the chances of misappropriation of funds or financial statement in the future (Veron, 2009). On the global level to deal with such conflicts and crisis an audit network has to be developed which will look at improving coordination and cooperation to monitor the working of the auditors. This will help to increase the level of supervision and will control the different activities through which the working of the auditors is monitored. This will help to enhance the quality of audits and develop the required confidence which will help to provide correct and complete financial statement to the different stakeholders. The global crisis where the role of auditors to provide clear certificates to financial institutions was high shows that the current audit practice is not fundamentally flawed, but could be improved by increasing the scope and expanding the role of the auditors by developing relationship between auditors, internal auditors, audit committee and shareholders which includes regulators. This will help to verify the authenticity of the financial statement and will provide the required directives through which flexibility is ensured and the process of audit gains prominence. Correct Risk Estimates The lack of proper risk analysis measures were highlighted during the financial crisis which can be reduced by increasing the role of both the internal and external auditors. Increasing their role and using different quality measures to find out the degree of risk will help to understand the manner in which different factors contribute towards risk. This will help to develop the risk profile which can be provided to the stakeholders so that the decisions which are taken are based on it. This will help to provide complete and clear information which will thereby reduce the magnitude and impact of crisis and increase the dependency on financial reports (Barth, Gerard and Levine, 2006). This will also guide the investors and reduce the chances through which the investments are made in different directions. Compliance with Internal Guidelines The auditors have to comply with the different requirements which have been prescribed by the audit firms with regard to the guidelines which will help to ensure complete and correct information is provided to the stakeholders. To ensure proper compliance supervision along with increased role of internal and external auditors will have to be observed (Ryuhei, 2009). This will help to track the work of one auditor by the other and will improve the overall reliance on the audit process. This will also help to follow the different guidelines and reforms which have been provided for the audit committee and will ensure stronger reforms. Conclusion The essay shows the manner in which the auditors were unable to carry out their roles and responsibilities due to which they are being criticized as they contributed immensely towards the global crisis. This further resulted in creating a situation where organizations were able to take advantage and ensure that the funds were misused. Developing stricter reforms which look towards increased monitoring and supervision along with widening the role of the auditors will help to bring the required check on auditors and ensure that the auditors carry out the duties and responsibilities which have been entrusted on them. References Böcking, H., Gros, M., Wallek, C., Worret, D. 2011. Analysis of the EU Consultation of the Green Paper "Audit Policy: Lessons from the Crisis", Goethe University, Frankfurt/Main Barth, J., Gerard C. and Levine, R. 2006. Rethinking Bank Supervision and Regulation: Until Angels Govern. Cambridge, UK: Cambridge University Press Cameran, M., Vincenzo, D. & Merlotti, E. 2005. The audit firm rotation rule: a review of the literature. Bocconi University Köhler, A. 2012. Mandatory rotation in the German Audit Market – A Scenario Analysis University of Duisburg-Essen Nanto, D. 2009. The Global Financial Crisis. Congressional research report, Questia Journals Ryuhei, W. 2009. International trade during the financial crisis: WTO supervisory functions should be enhanced. Research Institute of Economy, Trade & Industry, IAA Sen, S. 2010. The Global Crisis and Remedial Actions: a nonmainstream perspective. Working Paper 677. Annandale-on-Hudson, NY: Levy Economics Institute of Bard College Veron, S. 2009. Impact of Financial Crisis on Investment & Trade. Japan Center for Industrial Cooperation, Seminar Report Read More