Ethical Dimensions of Business Decision-Making - Assignment Example

Ethical Dimensions of Business Decision-making

Introduction

The debate on auditor rotation provides different perspectives on the prospective gains or losses that stakeholders may incur. Auditing firms, managers, businesses, specific industries, and even entire countries, have offered different views regarding the effectiveness of the approach. This paper will further elaborate this debate, reviewing the implications of the dilemma from an ethical perspective. It will understand the individual stakeholders, and the potential outcomes that the use of auditor rotation may present. The review forms the basis for establishing alternative ways for reinforcing auditor independence, and the selection of the most appropriate approach to use.

• From an ethical point of view, comprehensively describe and explain the debate (or dilemma) above and its implications for auditors’ independence and the impact on the credibility and reliability of financial reporting.

The Financial Reporting Council has the basic role to promote high standards in audit and thus ensure high quality of corporate governance. As a consequence they provide basic guidelines on what is expected of auditors in terms of ethics. Auditors require the maintenance of ethical standards of competence, integrity, independence, confidentiality, and objectivity (Livne, 2012). As such, the perspectives to the debate seek indication that the application of rotation would improve individual auditor’s application of these standards.

The support for auditor rotation implies that long-term relationships between the auditors and the businesses infringe on auditor independence. As auditors stay longer in relationships with one business, their relationship may lose its independence and the auditor adopt the advisory role excessively (Institute of Chartered Accountants, 2014). As such, objectivity in reporting may be compromised, as the auditor’s interests in the client firm compel their release of largely positive results.

Nevertheless, arguments against the rotation note that it does not necessarily enforce the adoption of auditing ethics. Audit partners are rotated every five years in the USA, and there already exists the requirement to put out an audit tender once every ten years (Livne, 2012). Further, there is little evidence to support the fact that relationships for lower time periods will increase auditor independence and objectivity (Amir, Guan, & Livne, 2010).

Alternative ethical requirements in auditing include competence and integrity (Institute of Chartered Accountants). Professional scepticism is crucial in the development and delivery of audit reports among all business entities (Harris & Whisenant, 2012). As such, rotation of auditing firms on an annual basis is expected to improve such scepticism, and thus result in more accurate audit reports. The longevity of audit-client relationships may infringe on the auditor’s integrity, reducing critical analysis of the performance of the firms (Harris & Whisenant, 2012).

However, the debate also highlights the fact that the rotation may actually reduce the degree of competency and the quality of audit reports. Auditing as a process requires sufficient time to study all pertinent information pertaining to a company’s business Rotation gives auditors minimal time to familiarize with the client firms, implying they rely on a shallow set of data for effectiveness (Institute of Chartered Accountants, 2014). This greatly compromises the quality and reliability of the reports generated by the rotating auditors. Consequently, the FRC believes that the firm that is best able to undertake an audit should be retained by the clients (DeFond, 2010). Firms such as Ernest and Young believe that the rotation would also highly compromise the quality of audits (Livne, 2012).

As such, the debate offers alternative perspectives on the ethical implication of auditor rotation. While rotation appears to promote objectivity and independence, the effect is difficult to substantiate. Further, auditor competence may be reduced due to diminished firm knowledge at the point of reporting. However, support for rotation suggests increased integrity, and thus efficient reporting due to objectivity.

• Determine the various stakeholders who may be affected by the debate (or dilemma) above 


The debate above affects various stakeholders, albeit from different perspectives. One of the major stakeholders is the auditing firms. The Big Four auditing firms are strongly against the rotation requirement, due to the impact such an approach has on relations and costs of operations (Livne, 2012). For instance, the auditing firms would have to incur new costs in acquiring resources to get up to speed with the operations of the client (Institute of Chartered Accountants, 2014). This task would be difficult, especially for smaller auditing firms, whose resources are less and have minimal economies of scale (Institute of Chartered Accountants, 2014).

Other stakeholders affected by this change include the clients of auditing firms, which features every business in the UK that is listed for tax filing and auditing. Many companies could be compelled to seek the services of larger audit firms, as they have the ability to quickly transform and get up to speed with the activities of the entity (Cameran & Prencipe, 2013). The implication here, is that these businesses may be unable to retain the auditor it believes is best to undertake the audit (Livne, 2012). Further, due to the constant rotation, the firms they would prefer may fail to tender, resulting in the adoption of lower quality auditing firms (Institute of Chartered Accountants, 2014).

Another group of stakeholders in this debate are the shareholders. Under the current arrangement, shareholders usually detect disputes or progress hindrances in case of a change in auditors (Institute of Chartered Accountants, 2014). However, under the rotation, it will be difficult for changes in auditors to signal such disputes to the shareholders. The role of shareholders in corporate governance will also reduce significantly (Li, 2010). Some shareholders form part of the audit committees, and the compulsory rotation limits the freedom to appoint the best-suited auditor. The involvement of shareholders also makes it impossible to have impartial reports as they may control the agenda.

Regulators are also largely affected by a prospect change in requirements to accommodate rotation. Currently, regulators can monitor auditing activities of one auditor and the client firm consistently over relatively long periods (Institute of Chartered Accountants, 2014). However, monitoring the firms after the rotation requirements implies more costs for regulators, requiring new records and set-ups after the transition (Institute of Chartered Accountants, 2014). This feature may also limit the effectiveness of regulators towards transparent accounting and auditing.

• Suggest/offer courses of actions or effective ways to reinforce auditor independence, objectivity and professionalism together with a comprehensive analysis of the several impacts on the various parties involved.

The proposal to impose the rotation requirement may prove ineffective for the stakeholders in business and auditing firms. As such, there are alternatives to this approach in improving the independence of auditors, as well as they objectivity and professionalism.

One approach features the application of various corporate governance mechanisms. Here, businesses should ensure the presence of strong and independent audit committees as part of their boards (Mayhew & Pike, 2004). The committees will ensure the auditor interacts exclusively with them, and has minimal contact with the manager. This approach will limit the auditors being beholden to the managers, limiting managerial oversight and boosting independence and objectivity (Institute of Chartered Accountants, 2014). Nevertheless, the alternative may not be effective in entities where the company is under the strong control of their CEO. The situation would imply that the board is selected among allies of the manager, compounding the threat to auditor independence (Livne, 2012).

Auditor professionalism and objectivity could also be enforced through the prohibition of non-audit service provision by the auditor simultaneously with the audit (Amir, Guan, & Livne, 2010). Such services include bookkeeping and appraisal services, as well as internal audits and investment advice (Livne, 2012). The enforcement of such prohibition ensures that the auditor does not audit their own accounting, nor serve in an advocacy role for their client (Livne, 2012). The separation of these roles would ensure the objectivity of the auditor, and more efficient reporting. While the business may lose some quality accounting services, the shareholder gets accurate reports regarding their business. However, the approach fails to eliminate the problem of the auditor still receiving fees from the entities they seek to scrutinize objectively (Livne, 2012).

The objectivity and professionalism could also be enforced using the adoption of better disclosure procedures. Most of the information regarding the relationship between auditors and the companies they audit is private. This often permits fraudulent activities to take place and also influence the outcome of the audit reports. Public companies should be required to disclose the fees paid to the auditors, elaborating the amounts used as auditing and non-auditing fees (Cameran & Prencipe, 2013). The transparent disclosure will enable investor and shareholder understanding the extent to which economic dependence is a factor in the reports given by the auditors (Livne, 2012). However, the extent of transparency may be limited for some entities, which limits the extent to which an investor can determine the value of the business.

Regulating auditors is also a viable alternative to the accomplishment of effective independent and objective auditing. While auditors scrutinize the businesses, independent bodies require assessing the activities of the auditors (Harris & Whisenant, 2012). Consequently, bodies such as the Audit Inspection Unit in the UK take charge of ensuring that auditors maintain the required ethical practice standards (DeFond, 2010). If auditors operate with supervision, it is likely they will be less willing to engage in unethical practices. Businesses, on the other hand, will be able to get the value for their fees and avoid future regulatory charges.

• Suggest and select the most appropriate course of action and provide valid conclusions to your discussion.

The most viable alternative from the choices available is the strengthening of corporate governance. Business regulations should grant sufficient power to the shareholders, enabling their taking over corporate governance solutions (Mayhew & Pike, 2004). With a strong corporate governance, it will mean that the audit committee is responsible for auditor selection, and that the auditors will report to the committee. In this case, the manager would have minimal overview and consequently exert less influence over the review and reporting activities of the auditors (Mayhew & Pike, 2004).

The approach ensures that managerial overview and influence does not interfere with the independence and objectivity of the auditors. The choice recognizes some setbacks, such as boards comprised entirely of the CEO’s allies. Nevertheless, regulation could extend to defining the extent of director composition that comes from shareholders (Harris & Whisenant, 2012). Despite the possibility of some entities having CEO’s that influence the composition of the board of governors, most entities will likely comply with the requirements to avert imposition of rotation.

Conclusion

Ethical practice among auditors is key to the financial reporting of companies, which in turn, ensures effective capital market operation. Inefficient reporting on the part of the auditor violates ethical standards such as independence, objectivity, and competence. However, the debate on enforcing rotation suggests that, despite the possible positive outcomes, there are chances of the shift imposing unnecessary costs and proving ineffective. As such, alternatives such as strong corporate governance, more transparent reporting, tighter auditor regulation, and the limitation of non-audit roles may be viable. The comparison of these alternatives indicates that strong corporate governance may be the most comprehensive. The approach will grant the shareholder more power over the choice auditor and limit managerial influence. Consequently, the manager will exert less overview and enable accurate reporting by the auditor, devoid of influence and exercising more independence and objectivity.