Audit, Controls, and Management Information Systems - Essay Example

External Audit, Internal Controls & Management Information Systems 15 November, 2009 The term audit refers to different types of external checks (Henley, 1989). External audit refers to the examination of accounts and other activities, conducted from outside the organization, by an independent person or body for the purpose of holding the management to account (Hollingsworth & White, 1999). The purpose of an external audit is to provide assurance about the reliability of the published accounts of the particular audited body. It also provides the reassurance regarding the regularity of the fundamental transactions. External audits provide information concerning the efficiency and effectiveness with which a particular organization is performing its functions (Henley, 1989). Most public companies have an internal audit function. The internal auditor generally consists of employees from within the organization, although at times this some or all of this function may be outsourced (ABA, 2007). For companies where internal auditing exists, it is important for the auditing committee to meet with the senior internal auditing executives regularly to discuss problems and issues regarding the internal and external audit programs. Annual audit plans should also be reviewed regularly. Even if the internal audit program has been outsourced the auditing committee should hold regular meetings with theses representatives (American Bar Association, 2007). The fundamental contributor to the failure of an organization is a weak and ineffective internal audit system (Hamilton & Micklethwait, 2006). An internal auditing committee is crucial for assuring that the internal controls are working adequately and to ensure that the company's financial statements provide a true and fair view of the company and its affairs (Hamilton & Micklethwait, 2006). The audit committee is an integral part of corporate governance because it has the oversight responsibility for a public company's financial reporting processes and external controls. Some of the duties and responsibilities of the audit committee are defined by the federal law. It is the core duty of the audit committee, to engage external auditors for the corporation, to serve as a means of communication between the external auditor and the board, review the annual and quarterly financial statements with the external auditor and to review annual reports to shareholders, among many others (American Bar Association, 2007). The audit committee should meet with the corporate external auditor during the planning phase of each annual audit for the purpose of planning, staffing, scope and cost of the audit. Other areas that require special attention or emphasis should also be discussed along with special procedures that may be required during the auditing process. Once the audit is completed, the audit committee along with the external auditor is required to review any problems or difficulties that they external auditors may have encountered. Any significant issues which were highlighted in the audit, debates which took place with management regarding the audit, letters summarizing the audit and observation to management and the management response letter should all also be reviewed and discussed by the audit committee with the external auditor (American Bar Association, 2007). The audit committee should be clear about all significant accounting judgments made in the audit which would impact the company's financial statements. The committee should also discuss the quality of management's accounting decisions with the external auditor. The committee should also discuss deficiencies and weaknesses pointed out in the audit, with the internal auditors (American Bar Association, 2007). The purpose of external audits is to evaluate an organization's accounting procedures and to provide an opinion about the true and fair state of the firm's financial standing. These also verify the organization's compliance to the set rules and standards such as the General Accepted Accounting Principles (GAAP). Materiality, relevance and reliability of the financial information are the main qualities of an audit process. The neutrality and the independence of the auditor become crucial in the value of an external audit (Marnet, 2008). When auditors were first hired for companies, it was common for the auditor to be one of the shareholders in the company, but by the early 1900s it was attempted to ensure that auditors were independent of the company. By 1948 legislative requirements regarding auditors having professional qualifications was introduced. These days efforts are made to ensure that auditors are both competent and independent (Hollingsworth & White, 1999). The auditor acts as an outside body which is independent, and assesses the body in question. Apart from being thorough, audit reports are expected to be impartial, honest, fearless and dispassionate (Henley, 1989). The auditing process should be free form any bias and impartial information. Auditors should be able to counter any bias existing in the client's books (Marnet, 2008). Independence of the auditor is crucial for delivering and performing the role in the accountability process. The auditor should be free from the influence of any interested party so that impartial findings can be presented (Hollingsworth & White, 1999). In order for auditing reports to be credible and have authority it is vital that the auditor is independent (Henley, 1989). Failures of corporations such as Enron and WorldCom show that assumptions regarding auditing as being impartial and unbiased are highly optimistic (Marnet, 2008). The number of reoccurring failures in financial reporting processes has given rise to cynicism with regard to the accounting profession. It has led investor and public lenders to believe that accounting is a crooked profession, incompetent and that the ideal of impartiality and absence of bias are unrealistic (Marnet, 2008). Concerns for long term reputation have been replaced by the emphasis on selling an audit. This is a result of the current existing incentive structures in auditing firms combined with a partnership structure organized along the lines of limited liability partnerships, a perceived commoditization of audits due to increased provision of non-audit services changing the nature of audits from provision of quality audit services to a mere certification (Marnet, 2008). The perceived shortcomings of the auditing processes have influenced the belief that the impartial and nonbiased nature presumptions of auditing processes are unrealistic. Financial incentives are a major source of bias. This could be the reason for a large increase in the provision of auditing services and the magnitude of earning restatements (Marnet, 2008). A close working relationship, even in the absence of financial incentives, makes it difficult for the auditor to remain impartial. This is based on the vulnerability of auditors to unconscious bias in their assessment, due to their close working relations with their clients. Distorted assessments and may not always be based on financial interests or the intent of fraud on the auditor's part (Marnet, 2008). Arthur Anderson created one of the most infamous cases regarding auditing fraud. It is believed that the firm, which was at one point a Big 5 accounting firm, routinely succumbed to the demands of Enron management (Marnet, 2008). Independence of an external auditor is vital in allowing the auditor to perform its function effectively (Hollingsworth & White, 1999). As many companies came crashing down various failings came into view. This included many practices, such as inadequate audit (both external and internal), boards' inability to monitor and control the activities of executives, accounting frauds and greed of executives, lawyers, banks and auditors; to name a few (Hamilton & Micklethwait, 2006). An example of lack of independence is the case with Arthur Andersen. Enron was the biggest client of the Arthur Andersen Huston Office. They supplied both audit and non-audit services to the firm which included internal audit, tax avoidance schemes, off balance sheet financing schemes and designing internal controls. In 2000 Arthur Anderson received $25 million in fees for audit services whereas it gained $27 million for non-audit services. Since the Huston Office was getting fee for both audit and consulting they did were not willing to lose the non-audit fees earned from Enron. The two firms maintained a close relationship which influenced the independence of the audit firm (Gray & Manson, 2007). The internal audit committee at Enron failed to perform its functions of internal control and monitoring the external audit functions (Solomon, 2006). The outside monitors failed in executing their responsibilities by neglecting their responsibilities or being co-opted by the Enron management to lose objectivity (Gadossy & Sonnenffeld, 2004). The audit committee is responsible for the authenticating the accounts activities of an organization and to identify any wrongdoings in the organization (Ahmed & Annam, 2006). Anderson was working as the company's external auditor as well as a consultant this relations was getting criticism for leading to compromised audits. The audit firm was also functioning as Enron's internal auditor, the combination of both activities raised criticism since it was felt that this led to compromising and inefficiency of both internal and external auditing (Gadossy & Sonnenffeld, 2004). There was also inaccurate representation of accounts at Xerox which misled and betrayed the investors. The company's actual financial performance was concealed by creative accounting showing operating results which were substantially better than the company's actual performance. Xerox used many accounting actions to manage the quality of its reported earnings. In 2002 a complaint was filed by the Securities Exchange Commission against Xerox for civil fraud. this was a result of the evidence uncovered in the SEC led investigations which revealed that the profits at Xerox had been overstated by $3 billion and the profit by $1.5 billion in the four year period starting in 1997 (Newquiest& Russell, 2003). In June 2002 WorldCom announced that its earnings for 2001 had been overstated. The company had manipulated the financial statements by stating their period expenses as capital expenditures, thereby inflating the net income for the current period. At the time of the scandal Arthur Andersen was the company's auditor. Andersen representatives later stated that they were not aware of the scandal since the details leading to the accounting fraud had been withheld from them by WorldCom (Hilton, 2002). Both Sullivan and Andersen auditors violated their professional codes as auditors. Andersen placed the demands of its client WorldCom before their own independent professional obligations (Gundry, Posig & Werhane, 2007). There was a time when audit firms had a strong professional audit culture. This changed towards the 1980s when they began to grow in terms of size and the services they were offering. This increases concerns that audit firms since them have become more concerned with satisfying management as compared to meeting shareholder needs and delivering credible financial statements. The meaning of the term "professional" has also changed over a period of time. It used to refer to acting with honesty and integrity, but with the changing times it has come to mean satisfying the management with minimum problems and disagreements (Gray & Manson, 2007). It is the duty of external auditors to ensure that their job is done responsibly, objectively and with integrity. Auditors should stay clear of any influences when conducting audits so that the outcomes are fair and real. This is however, not always the case. There have been many instances in the past where poor corporate governance and fraudulent practices based on personal interests, gains and greed have led to acting without honesty on the auditors' part. The consulting nature of auditing firms has given them a reason to guard their commercial interests. The loss of independence in accounting can be associated with the business risk approach. As accounting firms view it the business risk approach is a more effective way of adding value to the audit. As a result of this approach audit firms aid the client firms in management by assisting them in their duties rather than serving the needs of the stakeholders. Business risk approach blurs the difference between accounting and consulting. Audit firms sell their expertise to improve business and to aid management, using auditing only as a means of selling further services to the client (Gray & Manson, 2007). References Ahmed H & Najam A 2006,How corporate governance affects the strategy of organizations: Lessons from Enron Corporation.Viewed 30 May, 2009. American Bar Association. Committee on Corporate Laws (2007) Corporate director's guidebook. American Bar Association Gandossy, RP & Sonnenfeld, JA 2004,Leadership and governance from the inside out.Published by John Wiley and Sons Gray I & Manson S (2007) The Audit Process: Principles, Practice and Case. Cengage Learning EMEA Gundry L, Posig M & Werhane P (2007) Women in business: the changing face of leadership. Greenwood Publishing Group Hamilton S & Micklethwait A (2006) Greed and corporate failure: the lessons from recent disasters. Palgrave Macmillan Henely D (1989) Public sector accounting and financial control. Taylor & Francis Hilton (2002) Managerial Accounting. Tata McGraw-Hill Hollingsworth K & White F (1999) Audit, accountability and government. Oxford University Press Marnet O (2008) Behaviour and Rationality in Corporate Governance. Routledge Newquist, S & Russell M 2003,Putting investors first: real solutions for better corporate governance.Published by Bloomberg Press Solomon, J 2007,CorporateGovernance and Accountability.Published by John Wiley and Sons Read More