Auditing and Accounting Ethics - Essay Example

Auditing and Accounting Ethics Question 1: It is often argued that the “economic incentives associated with different levels of auditor independence threats and litigation risk influence auditors’ evaluation of information and their subsequent reporting choices”. (Blay) The most important quality an auditor posses is the independent and unbiased approach. In many cases self-interest has been considered as the main hindrance in the independent and fair approach of auditor. Many regulations have been introduced in order to ensure the independence of auditors. The Sarbanes-Oxley Act of 2002 is considered as an important addition to the regulations ensuring auditor’s independence. The act suggests undertaking continuous rotation of audit partners. It also emphasises increased financial reporting and imposes limits on certain non-audit services. The Sarbanes-Oxley act suggests reducing the economic interdependence of auditor and client. The economic rent provided to the auditors can only be gained as a result of long lasting relation ship between the auditor and the client, this condition in turn acts as a hindrance in the way of auditor to act independently. The threat of lawsuits often act as a motivator for the auditors to act independently as inefficient or unfair performance can result in shape of judicial action against auditors. In most of the studies undertaken it has been observed that the higher degree of threat to the auditors independence leads to authentic opinion. Its also found that auditor does not tend to change their decision with the varying degree of independence but change the decision process. The level of threats vary in different countries due to following reasons: i) Difference in the social and cultural values: Standard setting is a crucial process, which includes change. Some societies have open and flexible culture, which keeps on transforming with the time. But on the other hand closed societies have relatively rigid culture. The acceptance level of change in these societies is very low. In the case of the global harmonisation of standards a country adopting the International standards cannot complete the picture. It is equally important for the other countries to accept and implement the same standards in their economic system then only the target of attracting large no. of investors and lowering the financial reporting costs can be achieved. ii) Hindrances due to jurisdictional disputes: “When Power is vested in multiple law-making and standard-setting bodies, jurisdictional disputes may arise in areas where the bodies interests overlap.”(Taylor & Pincus, 2002; p.41) iii) Pressure form the lobbyist and special interest groups: The main aim of the standards is to cater the needs of the information users and creditors but very often the standards are prepared by the group of information preparers. Although the lobbyists group can pose detrimental effects if taken to extremes. These can pose negative impacts on the process of internationally accepted standard setting. (Taylor & Pincus, 2002; p.42) “Recent efforts to improve the independent audit, such as Public Company Accounting Oversight Board Auditing Standard 3, Audit Documentation, focus on extended documentation and review. Other efforts, such as the proposed Ethics and Independence Rules Concerning Independence, Tax Services, and Contingent Fees, adjust the incentive system.” (Blay) Although many steps have been taken to improve the level of auditor’s independence but there is still some room for improvement in order to ensure unbiased and fair auditing practices. References Blay, Allen D. , Independence Threats, Litigation Risk, and the Auditor’s Decision Process, available at http://www.caaa.ca/CAR/CurrentIssue/exeartUKeoVsOTbt.html Taylor, D., W. & Pincus, K. V., (2002). Core Concepts of Accounting Information: A New Introduction to Accounting, Australia, Irwin/McGraw-Hill, p. 39-42. Question 2: “IAS/IFRS are standards for the preparation of general-purpose audit statements, aimed at meeting the needs of a wide range of users, but predicated on the assumption that placing primary emphasis on the needs of shareholders will result in measurement, recognition and disclosure requirements that also meet the needs of other users. However, significant other users of audit statements need not necessarily share this view, and where they have the power and authority to do so, frequently impose different special-purpose audit reporting obligations designed to meet their specific needs (e.g., reporting for taxation purposes, or reporting for prudential and supervisory purposes).” (Hegarty et al., 2004) One common criticism of audit statements is that they lack adequate disclosures about risks and uncertainties (Schrand and Elliott, 1998). Investors must assess risk as part of their investment decision-making process. Because most extant research focuses on effects of risk, not on how investors assess risk, the studies provide little explicit guidance about which disclosures can aid investors in assessing risk. Hence it should be clearly seen from the above stated explanations of the risk from the professionals are scientific. On the other hand the common people see risk in a simple manner relating to their benefits and losses. Risk plays an important role in the investment decisions by the shareholders. In Report to NASD regulation, Inc. (1997), Shareholder assessment of Bond Fund Risk Ratings following facts was found in response of the survey conducted. Mutual fund shareholders assess risk when making investment decisions. Shareholders who assess fund risk conduct a comprehensive evaluation. Mutual fund shareholders differ in how they define risk of mutual fund investing. Mutual fund shareholders tend to assess mutual fund risk over an intermediate or long term horizon. Experience with bond fund investing varies for shareholders as does their understanding of bond fund investing. The improvement in public scrutiny and controlled market discipline is largely dependent upon the meaningful and accurate disclosure of information. This not only helps the shareholders but also helps the organisation to conduct business in a safe and efficient manner by achieving their targets through improving their risk management processes. The researchers find many gaps in the appropriate disclosure of risk by the organisations. Many surveys have been conducted, a wide variety of studies and interviews from the information users and shareholders have pointed out towards gaps in the currently disclosed information. The demand of provision of accurate and timely information is increasing. Business reporting effect people from every work of life an effective allocation of resources strengthens an economy by promoting productivity, innovations and an efficient and liquid market. Adequate information plays an important role in reporting the risks and opportunities of investing in business venture. To make effective decisions people need accurate information. The completeness and timeliness of information enhances the probability of taking the most appropriate decisions by the investors. (AICPA, 2005) describes the following uses of the business reports. Promote a common understanding of terms and alternatives that facilitate negotiations between users and companies about the (Murphy, 1999) sees Audit reporting and audit statements in particular can be thought of as a less through which one can view a business. Audit reporting provides a broader view of the business than that provided by audit statements only. In other words, audit reporting encompassed audit statements, but it is not limited to audit statements. Externally reported audit information is largely historical in nature. It looks back in time and reports the results of events and transaction that already have occurred. While historical information is very useful in assessing the future, the information itself is more about the past than it is about the future. A comparison of the historical trends with the future trends can be found helpful in better understanding of the information by the shareholders and other related people. (Audit Economists Roundtable, 1996) Inexact and Approximate Measures: Externally reported audit information may have a look of great precision, but in fact much of it is based on estimates, judgements, and assumption that must be made about both the past and the future. The fact that a great deal of judgement underlies most accounting information is a limitation that is sometimes misunderstood (Schrand and Elliott, 1998). Users of Audit Statements: Shareholders to Stakeholders According to (AICPA, 2005) An investor's primary objective is to form opinions about the absolute and relative value of companies and their equity securities. Adams (1995) states that every person has expertise to analyse risk, the expertise of a common man depends upon his daily life experience and to learn from those experiences. On the other hand the professionals present a scientific perception. There is a difference between the scientific and professional perception. The scientific perception is quantitative measurement of risk. On the other hand the non-scientific perception rely on the past experience. Although the introduction of the International Auditing standards has not covered this perception gap but has narrowed it. References Adams, J., 1995. Risk. UCL Press AICPA, 2005. Introduction: Chapter 1, available from http://www.csus.edu/indiv/o/ogilbysm/course1/ch1.pdf Murphy, A. B., 1999. Firm Characteristics of Swiss Companies that Utilise International Accounting Standards Metropolitan State College of Denver, The International Journal of Accounting, Volume 34, Number 1. Report to NASD Regulation, Inc. 1997. Shareholder Assessment of Bond Fund Risk Ratings, available from Schrand, C. M., and Elliott, J. A., (1997). Risk and audit reporting: A summary of the discussion at the 1997 AAA/FASB Conference. Accounting Horizons. 12 (3) 271-283. Question 3: (Shah, 2002) states that some Trans-national corporations make more in sales than the GDPs (Gross Domestic Product) of many countries. In fact, of the 100 hundred wealthiest bodies, 51 percent are owned by corporations. While this can be seen as a success story from some viewpoints, others suggest that these and other large corporations are largely unaccountable for the many social and environmental problems that they leave in their wake, and that their size means that their effects are considerable. The multinational corporations who naturally have vested interests in international development and trade policies (like any group) are able to deploy enormous financial resources in an attempt to get favourable outcomes. The political power that is therefore held by such a small number of people impacts the planet significantly. As a result a few of these corporations make up some of the most influential sources of political and economic power. Naturally, with such influence it is not clear ‘who’ the regulator is. Profit supersedes safety and power supersedes regulation hence there stood the conflict of interests, for the victims of corporate crime. These are for the most part neither wealthy nor powerful although, when they are liability is certainly applied copiously. For example in the case of Enron the former chief accounting officer, Richard Causey was indicted on charges of ‘ fraud, conspiracy, insider trading, lying to auditors and money laundering for allegedly knowing about or participating in a series of schemes to fool investors into believing Enron was financially healthy’ (findlaw.com). The ‘victims’ in this case were the investors who were identifiable and influential. In case of Enron as mentioned by Vinten the governing bodies broke all the rules. The management of the corporation resolutely focused on maximising profits and a ‘legal obligation to act in the best interests of its shareholders. By and large, this excluded the corporation to act ethically or socially responsibly…’(Slapper and Tombs, 1999). Violations, which impact on financial systems, are subject to more scrupulous legislative administration, compared with social infringements (snider 1991 cited in Slapper and Tombs 1999:89). Increased attention to corporate crime would mean relating to large companies as ‘criminals’ (Slapper and Tombs, 1999). An issue, (Sullivan, 1995 cited in Clarkson, 1998) renders impossible on the basis that ‘crimes can only be committed by human, moral agents’. Media attention should focus on financial aspects of corporate crime due to its impact on a political scale and the sensational-factor that is the ‘respectable’ figures committing crime as well a the belief/knowledge that ‘scandal sells’. Scandal, is common reference for this financial aspect but noting the influence of language Slapper and Tombs (1999) note that this sets a’ scale’ for perceptions, rendering it uncommon/unusual. Another scale, which has been set in the last few decades, is the increasing complains of the least risk disclosure by the companies in their annual reports and financial statements. This is also accompanied by the misuse of the accounting techniques by the executive officers and managers of the corporations. As in case of Enron the technique of off balance sheet reporting was used in negative manner. Investors are often aware of the risks they take and in itself, off-balance-sheet financing is no vice. Companies can use it in perfectly legitimate ways that carry little risk to shareholders. The trouble is that while more companies are relying on off-balance-sheet methods to finance their operations, investors are usually unaware that a company with a clean balance sheet may be loaded with debt — until it is too late (Morgenson, 2001). A change is required in the regulations. The accounting firm should not perform the consulting and auditing services both. The Companies should be required by the Government to increase their degrees of disclosure. The top-level management should be held more responsible by tightening up the regulations. They should also be held responsible in case of any frauds and regulatory violations of their subordinates. This in turn will give rise to the sense of responsibility in the people related at all levels. (Hanson, 2002) The Directors of the companies must understand that the transparency and clear disclosure of risk related information can positively effect the image of the company and attract more investors rather than traditional investors. Since most of the people find it difficult to make judgements about the financial companies risk portfolio due to the complex nature of the information provided and non understandable terminology. It is also concluded that despite the advantages attached to the voluntary information disclosure the directors of most of the companies are reluctant to follow the trend of fair and transparent disclosure. It is due to the traditional fear regarding the disclosure of risk information and lack of confidence in the directors to deal with the pressure resulting in shape of accountability from stakeholders and shareholders. The directors of most of the companies use under the carpet approach to keep information regarding the risk hidden till the last moment. This trend has given rise to the importance of the role of legislative authorities which should make it compulsory for the companies to disclosure all the risk related information with out any provision of exclusion of sensitive information. Although a large amount of research has been undertaken which has resulted in shape of valuable suggestions such as Jenkins report, value reporting, GRI, & Turnbull report But it is evident from the research that most of the financial companies are not applying these suggestions voluntarily in order to modify and enhance the risk disclosure and management practices. It is suggested that in order to make most of the previous research it is important to find out ways to implement previously suggested applicable methods of risk reporting rather than finding new methods. References Clarkson, Max (Editor), The Corporation and Its Stakeholders: Classic and Contemporary Readings, University of Toronto Press, 1998. Hanson, K., (2002). Lessons from the Enron Scandal, interview about Enron by Atsushi Nakayama, a reporter for the Japanese newspaper Nikkei, March 5, 2002, Retrieved 03/04/08 from http://www.scu.edu/ethics/publications/ethicalperspectives/enronlessons.html Moregenson, G., (2001). Are New Woes Lurking in Financial Nether World? The Associated Press, December 23, 2001, Retrieved 03/04/08 from http://pages.stern.nyu.edu/~adamodar/New_Home_Page/articles/isthisdebt.htm Slapper, G., & Tombs, S., Longman, (1999). Getting Away with Murder, Corporate Crime, Reviewed by Chris Moore, Issue 47, May 2000 Shah, A., (2002). Corporations and the Environment, Page Last Updated Saturday, May 25, 2002, Retrieved 03/04/08 from Viten, G., (2008). The Corporate Governance lessons of Enron, Corporate Governance 2,4 2002, pp. 4-9, available at www.prdatta.com/Documents/DBA/Globalisation/Articles/Corporate%20governance%20at%20Enron.pdf Question 4: Last few decades have seen tremendous improvement in the fields of accounting and auditing. In a capitalist economy, financing is fundamental to the viability of the companies and to the persistence of the capitalism. The availability of funds depends on the efficient allocation of resources by the economic agents from financial markets to productive investments, e.g. for the creation of new ventures or to finance the growth process of established companies. An efficient allocation depends on the investors expected return, but also, on the investor’s belief that the firm will be managed in order to maximise the investment and that the cash flows promised in exchange for the investment will effectively be returned. The economic viability of investment projects can be assessed through capital budgeting techniques and risk-return trade-off analysis for asset allocation decisions. Nevertheless, investors trust depends on a broad set of factors as the legal, institutional and regulatory environment that guarantees the investor protection. In this sense, auditing surges to mitigate the problems related with agency problems. “The main responsibility of accountants and auditors is to ensure that the firms are run efficiently, its public records kept accurately, and its taxes paid properly and on time. They analyse and communicate financial information for various entities such as companies, individual clients, and government. Beyond carrying out the fundamental tasks of the occupation—preparing, analysing, and verifying financial documents in order to provide information to clients—many accountants also offer budget analysis, financial and investment planning, information technology consulting, and limited legal services. Specific job duties vary widely among the four major fields of accounting and auditing: public, management, government accounting, and internal auditing.” (U.S Department of Labour, 2007) In order to keep on delivering profits the business must keep on investing in different projects in order to improve their organisational capabilities. These investments improve the capabilities of the business to respond to the customer demands, the external contacts of business reduces the risks attached to the products, internal integration improve the productivity of organisation continuous experimenting not only improve the value creation but also enhance the image of the organisation in business. Internal auditors These investments are very important for the businesses to survive it is necessary to measure the cost, inventory, space and quality savings measured by traditional capital budgeting systems. Most of the traditional accounting techniques measure the future flow of income by undertaking an investment which is not easy to calculate since the stream of income is expected to increase in future and the managers are cannot decide to assign the right value to the future benefit. Rather than that it is easier to the investment. This is due to the difficulty the future organisation face in calculating the future benefits; most organisations normally do not undertake new investments. These judgements can be undertaken if the assets are quantifiable. The internal auditor of the organisations can only judge the benefits attached to the intangibles and investments in such projects can be made on the basis of the beliefs of the organisation heads. The investments in these projects should be formally budgeted on the other hand it is strongly recommended to undertake periodic reviews of the outcomes and benefits attached to these projects. With investment in value delivering projects it is also important to invest in organisational skills, and system since they affect the value. “Management accounting is the design and use of accounting information systems to achieve the organisation’s objectives by supporting decision-makers inside the enterprise. Internal decision-makers are employed by the enterprise. These internal decision-makers create and use internal accounting information not only for exclusive use inside the organisation but also with the purpose of sharing some of it with external decision-makers.” (Meigs, Williams, Haka & Bettner, 1999) The development of effective internal auditing systems has played an important part in dealing with the problems discussed above. Internal auditors have strong responsibility of ensuring the effectiveness of internal control with in the organisations and to provide services of fraud detection. Through the introduction of audit regulations at domestic and international levels although these aims are not completely met but the many gaps in the process have been covered. References Meigs, F.R., Williams, J. R., Haka, S. F. & Bettner, M. S., (2001). Accounting, Eleventh edition, Irwin McGraw Hill, United States of America, ISBN0-07-289709, pp.12 U.S department of Labour, Bureau of Labour Statistics, Occupational Outlook Handbook, Page last modified: December 18, 2007, available at http://www.bls.gov/oco/ocos001.htm Read More