Ethics Principles and Audit Failures - Example

ETHICAL PRINCIPLES AND AUDIT FAILURES Name Institution Professor Course Date Introduction Effective auditing must adhere to ethical standards that hold fundamental principles and important procedures. Ethics entails the components crucial to human beings and proposes standards that are applicable as guiding principles for formulating an ethical culture. Auditors must follow ethical standards in their auditing process. They must adhere to specific guidance, standards and rules. According to Dennis (2015, p.62), the incidence of a positive image linked to the audit process is expressed by the trust it formulates. This is because the audit’s credibility to clients and stakeholders depend on the trust that users confer on the financial statements that got an audit authentication. Moeller (2008, p.322) confirms that every profession needs a set of standards to govern its practices, ethics and general procedures. The major standards for auditors are referenced as IIA’s (International Standards for the Professional Practice of Internal Auditing). Good audit means are linked to audit quality. Audit quality is build on several ethical principles that include independence, integrity, objectivity, professional competence and due care, confidentiality and professional behaviour (Dennis 2015, p.49). These basic principles set out the qualities that auditors should demonstrate in their professional roles. This paper critically evaluates which ethical principle tends to be responsible for the most audit failures and what changes to the regulations aimed at reducing audit failures. Independence/Objectivity Independence is a key ethical principle that governs the professional responsibilities of auditors. Auditor’s independence entails the autonomy of the external auditor from parties that may hold a financial interest in the firm being audited. Independence calls for an objective perspective and integrity to the process of auditing. Independence helps in preventing conflicts of interest besides ensuring the integrity of the auditing procedure. Independent auditors protect potential investors and shareholders from unrepresentative and fraudulent financial claims. According to Loughran (2010, p.38), an auditor must be independent in both appearance and fact. Being independent implies that one hold no financial interests or special relation with the client that may cause the auditor to disregard facts and evidence. In the event of conflict of interest and personal relations, audit failures occur. Objectivity refers to the unbiased mental mindset that enables internal auditors to conduct their professional responsibilities in a way that prevents compromise to quality. Objectivity principle requires that financial reporting and accounting information be independent and supported with unprejudiced evidence. This suggests that accounting data must be founded on facts and research and not simply an auditor’s opinion. The principle of objectivity makes financial statements more reliable and relevant. According to Dennis (2015, p.49), the basic principle of objectivity necessitates being independent of clients’ assurance. According to GAO (2007, p.196), objective implies that the presentation of an audit report is balanced in tone and content. The objectivity of audit reports is promoted when the report explicitly states the origin of evidence and the assumptions applied in the analysis. Integrity Although it is hard to define the term integrity, it refers to incorruptibility, virtue and the condition of being unimpaired. The integrity of auditors formulates trust thereby offering a foundation for dependence on their judgment. It involves numerous factors that are all essential in the auditing process. When there is integrity in auditing, the upshot of an audit demonstrates honesty, completeness and accuracy. Integrity is essential in auditing because sound auditing is based on integrity and other ethical standards indispensable to effective oversight and accountability. According To Loughran (2010, p.37), in the world of auditing and accounting, integrity implies acting according to a standard or code of values. An auditor demonstrates integrity when he does the right thing irrespective of whether doing so is the best one can do personally (Mahmoodi & Hanifeh 2014, p.375). To demonstrate integrity, an auditor must follow both the spirit and form of ethical and technical standards failure to which leads to audit failure. Professional Competence and Due care According to Tidrick and Prentice (2010, p.357), professional competence implies undertaking only those professional services that an auditor or client can practically expect to be completed with professional competence. The principle of due care and professional competence requires professional accountants to uphold professional skills and knowledge at all the level needed to guarantee that employers and clients receive proficient professional services. This principle also requires professional accountants to act conscientiously with respect to applicable professional and technical standards when conducting their professional activities. An auditor’s services must be based on latest advancement in legislation, techniques and practice. With respect to this principle, professional accountants must not carry out activities that they hold no skills in unless under guidance or assistance from an expert. When auditors perform roles that they are not skilled in, audit failure may happen. Due care means completing the audit in a timely fashion and within the budgeted audit figure (Williams 2002, p.166). Confidentiality Confidentiality entails ensuring that information is available to only authorised people and is safeguarded in the best way possible. Confidentiality is a crucial principle in auditing as it imposes a limit on the amount of data and information that can be revealed without consent. The temperament of auditing necessitate that to the degree allowed by law, auditors hold unrestricted access to employers or clients data and information. According to Rittenberg, Johnstone and Gramling (2011, p.113), the rule on confidentiality acknowledges a basic public trust amid the auditor and client and mirrors the way in which all professional conduct themselves. Nonetheless, in certain incidences, the auditor may be needed to communicate confidential information. Afyouni (2005, p.10) confirms that confidentiality handles two aspects of security that hold slight disparities. The first aspect is the prevention of unauthorised people from accessing or knowing secret information. The second aspect of confidentiality is the procedure for safeguarding confidential information and revealing secret information only to authorised people by means of categorising information. When either of the two aspects is contravened, the confidentiality principle is violated, and information security jeopardised. Auditors must disclose confidential information only when they have a professional or legal duty to do so. Professional Behaviour ACCA code of ethics requires all members to conform to pertinent regulations and laws, and avoid any action that can discredit the accounting profession. GTG (2008, p, 5) asserts that professional behaviour necessitates that a professional accountant should stick to all applicable regulations and laws. In this perspective, professional accountants should adhere to all regulations and rules set out by the governing body to which they are linked to and the code of ethics prescribed by the governing body. With respect to the principle of professional behaviour, professional accountants must avoid actions that will make people disrepute the profession. How Ethical Practices Cause of Audit Failures According to Gul and Fung (2014, p.127), the aim of ethical pronouncements is to promote a blueprint of conduct in professional persons besides providing an enforceable and practical test of the suitability of individuals’ conduct. Despite the fact that the above ethical principles are meant to ensure ethical conducts in professional accounting, most incidences of audit failures are caused by unethical practices and conducts. There are many ways in which audit failure can occur. Some of these ways include misapplication of GAAS, contravention of the principle of integrity and objectivity by accepting bribes and giving into threats and intimidation, and personnel and business relationship that affect the independence and objectivity of the auditing process. According to Dodaro (2013, p.415), integrity in the auditing process promotes transparency. Ethics and integrity are the bases of auditing because they help in disclosing and speaking out hard truths. The code of professional conduct for accountants state that in the performance of any professional service, auditors and accountants must uphold integrity and objectivity; must be free of conflicts of interests and must not knowingly misrepresent facts or subordinate their judgement to others. The code of conducts of professional auditors, therefore, prohibits auditors from knowingly misrepresenting facts or subordinating judgment when conducting professional services. According to Mintz (2014, p.56), integrity is a basic character trait that allows certified public accountants to prevail in their superior’s or client’s influence. Lack of integrity can lead to subordination of individual judgement. A person of integrity acts out of moral standards and rejects acting for the sake of convenience. While refusing to suborn one’s judgment could lead to loss of a client, employment or promotion, a CPA should always consider public interest while providing professional services. An auditor must uphold public interests and act on principle. Goethals (2014, p.49) asserts that auditors who want to continue working with their clients and who want to sell other services to the same clients cannot ignore their own self-interest. With these enticements, even the most honest auditors act with bias and hence, audit failures takes place. Considering the scandals at WorldCom, Enron Cendant, Subeam Halliburton and Global Crossing to mention but a few, evidence point to that most auditors are good individuals who failure to act independently because of conflict of interest inherent in their created institutions. Failure to adhere to GAAP is also a major cause of audit failure. For instance, Arthur Andersen failure to adhere to GAAP caused the downward spiral of Enron and Andersen LLP became the first accounting firm to convicted of a felony. The ethical principles governing the accounting profession are threatened by conflict of self-interest, self-review, advocacy, familiarity and intimidation. This is well demonstrated by the case of Arthur Andersen and the collapse of Enron. According to Loughran (2015, p.38), audit failures occur because auditors fail to be impartial where they are required to be unbiased and neutral in all decision-making process. They fail to base their report and opinion only on the facts instead of preconceived ideas or prejudices. Audit failures also occur because auditors fail to remain intellectually honest whereby they fail to interpret policies and rules in a sincere and truthful manner. Most audits fail because auditors perform services for clients with whom they hold a non-audit-related or personal business relationship (Imhoff 2003, p.118). Conflict of interest was evidenced in the case of Enron, WorldCom and other firms. According to Campbell and Houghton (2005, p.124), Arthur Andersen owed a fiduciary duty to Enron’s management, which undermined their role as independent auditors and made them complicit, by relationship if not by direct participation in doubtful accounting practices that had the impact of disclosing debt and escalating earnings. In this regard, Arthur Andersen contravened the principle of independence and integrity. More so, Arthur Anderson failed to uphold the principle of professional competence and due care. It is difficult to envisage that the level of corruption at Enron was not recognized to the auditors and that their ethical failure was simply one of laxity. Nevertheless, whether Enron collapse was as a result of inattention to care or involvement in corruption, the role of the auditors with regard to Enron case underscores one of the major problems regarding conflict of interest. According to Meade (2010, p.8), Arthur Andersen advised Enron against utilising the term nonrecurring and recorded its objections internally during ligation. However, Arthur Andersen had failed to report the objections of the term initially to cure Enron’s public statement. Andersen also failed to uphold the principle of integrity. Apparently, the auditors failed to present the true financial condition of the company. According to Mintz (2014, p.57), a prevalent challenge to integrity happens when accountants are pressured by a superior or client to concur with potentially materially misstated financial statements. General explanations for such pressure include attaining financial analysts earning anticipation and exceeding or meeting budgeted amounts the rationalization that it is one-time appeal is basically given to convince an auditor to go along with fraud. Once a firm begins to manipulate its earnings, it states the slide down the well-known ethical slippery slope. A misstatement of earning in a given period establishes pressure to uphold the illusion of increased earnings in the period to come until the bubble explodes. The WorldCom fraud depicts a case in point of financial fraud of a superior subordinating professional judgement resulting in contravention of the integrity rule. In the WorldCom case, Betty Vinson was a midlevel internal accountant who was pressured by her superiors to document expenditure for yearly costs to access telecommunications ability from other providers as capital costs to repay them over several years instead of expensing them annually an aspect that would have lowered earning in full every year. SEC in its investigation established that Betty Vinson and other WorldCom employees made the firm to overstate materially its earnings thereby violating GAAP. The principle of integrity can also be compromised when offering nonattest services and when auditors allow for the subordination of judgement. When a professional accountant or auditor loses sight of the integrity principle or allows pressure to compromise objective judgement, failures in auditing can occur. Another major cause of audit failures is unprofessional behaviour. For instance, in their role as auditors, Arthur Andersen participated in and stomached the suppression and destruction of proof that disclosed misleading and illusory accounting practices and policies in the financial reporting of Enron’s account. The auditors’ failure to uphold accounting standard and failure to conform to pertinent regulations and laws discredited the accounting profession. The behaviour of Arthur Andersen’s is a case point that shows how the breach of the principles of professional behaviour and independence causes audit failures. KPMG also attracted a show of disapproval from SEC for involvement in improper professional practice (Fernando 2009, p.231). Dealing With Audit Failures, Changes To Regulation The most apparent way to address audit failures is to prevent them at all costs. Potential role conflicts can be prevented by including strict division of responsibilities and duties that do not permit the opposing roles to mount undue pressure over the other. For instance, the division of accounting roles amid banking and cashiering functions, and the account receivable and payable lowers the risk of a conflict of interest amid the two functions that may otherwise promote potential corruption. A further way of lowering conflict interests emanating from roles obligations is to establish a strict separation and division of responsibilities amid members of professions that owe fiduciary duties to different stakeholder groups with potentially conflicting interests. For instance, conflict of interests in accounting can be prevented by strict separation and division of the financial consultancy functions and auditing. If a conflict of interests cannot be prevented, then it can be disclosed. A main ingredient of corruption is secrecy and concealment. Measures that would ensure disclosure of conflict of interests should be added in the accounting regulations to promote disclosure by the professionals. Other safeguards that can help in ensuring strict adherence to ethical principles in efforts of preventing audit failures include experience and education entry requirements, constant professional development and regulatory and professional monitoring and disciplinary procedures. Strict disciplinary measures should be implemented to ensure that auditors stick to the provided standards or principles. Provision for ensuring rotation of senior personnel and auditors should be included in the regulations. For instance, the United Kingdom has recently necessitated audit partners’ names to be revealed in audit reports. The PCAOB is contemplating introducing similar requirements in the United States (Hay, Knechel & Willlekens 2014, and p.104). A capable advantage is that researchers would be in a position to control audit partner rotation when evaluating whether mandatory audit company rotation hold an incremental impact on audit quality ( Hay, Knechel & Willlekens 2014, p.104). Rotation of auditors would help to promote objectivity and independence that in turn would help in preventing audit failures. More so, independent mentor and third party consulting should be encouraged. Other safeguards would include ensuring that auditors provide only auditing services to their clients other than providing other services such as accounting and consulting services. Changes should be made to ensure that that auditing firms provide auditing services only. In addition, a regular change of auditors should be allowed in the regulations in order to prevent conflict of interests. For instance, besides performing a statutory audit for Enron, Arthur Andersen provided consulting services (Rockness & Rockness 2005, p, 33). The conflict of interest and business relationships between Arthur Andersen and Enron instigated audit failures. According to Fernando (2014, p.230), Arthur Andersen collected 25 million dollars as audit fees and another 27 million dollars for consultancy services in fiscal 2000. Arthur Andersen had to face crippling damages, a slew of litigations, tarnished reputation and regulatory action by SEC for the breach of integrity, independence, objectivity, due care and professional behaviour. To prevent audit failures, it is important that the accounting regulations be improved to include assessment of a person’s character alongside professional qualification. The honesty and behaviours of auditors must be stressed. Besides code of ethics, the regulations must include quality assurance code aimed at ensuring maintenance of the integrity, objectivity and independence standards. The regulations should ensure that the quality of the audit is maintained. Standards should be established to ensure quality control procedures and policies. According to Goethals (2014, p,49), auditing firms create powerful conflicts of interests through asking auditors to offer unbiased evaluations of their clients books while they carry their customer’s favour and seek to extend their business. Audit failure is viewed as a resultant of corruption, but intentional fraud is only the most tremendous sign of a far more malicious and insidious problem in auditing. Evidence shows that when individuals are inspired to attain a certain conclusion, they are incapable of independence and objectivity. Objectivity and integrity go hand in hand. Auditors lose their objectivity when they permit threats imposed by superiors to go along with financial and accounting treatments that do not conform to GAAP. Objectivity and integrity represent the bloodstream of auditors’ ethical value systems. In this regard, the accounting regulations should include feasible channels and measures that would promote reporting of threats to objectivity and integrity. Safeguards to eradicate such threats should be included in the regulations. Appropriate supervision and training should also be stressed in the auditing rules and regulations. Conclusion Auditing is an independent, objective assurance and consulting practice established to add value and enhance a firm’s operations. It helps a firm to attain its objectives through bringing a systematic, disciplined perspective to assess and enhance the efficiency of risk management, governance and control processes. The collapse of Enron and the criminal condemnation for Arthur Andersen for mishandling Enron Audit is a clear definition of audit failures. The conduct of Anderson cast doubt on the quality of auditing services offered by big international accounting companies. With respect to Enron, KPMG and other cases, audit failure occurs mainly because of the breach of integrity, independence, professional behaviour, due care and objectivity. Auditors’ failure to adhere to GAAP and conflict of interest are the major causes of audit failures in the contemporary world. The paper concludes that among the ethical principles that govern auditing, integrity and objectivity/independence failures are the key causes of audit failures. To address audit failures, standards should be established to ensure quality control procedures and policies. Auditor rotation and provisions requiring auditing firms to offer only auditing services should be included in the rules and regulations governing the accounting profession. Reference List Afyouni, H 2005, Database security and auditing: Protecting data integrity and accessibility, UK, Cengage Learning. Campell, T 2005, Ethics and Auditing, USA, ANU E Press. Dennis, I 2015, Auditing theory, UK: Routledge. Dodaro, G 2013, ‘ Ethics and integrity in auditing’, Public Integrity, vol.15, no.4, pp. 415-422. 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