Definitions of Independence in the Audit Context
Audit reports should always provide the true and fair view of the company’s state of affairs and shall not be influenced by any external factors. The area of performance of an auditor in delegating his duties should be highly professional. An auditor should perform his duties in a dignified manner. An auditor should remain unaffected by anything that allows discrepancies in his scope of work. Factors or threats that can affect an auditor in performing his duties are mainly threatened litigations, dues, biases, acceptance of certain services and goods as gifts, investments in the business, etc (Hoffelder, 2012). It is very much necessary for the auditor to be free or rather remains unaffected from any such burden that allows discrepancies or fabrication in his report so as to provide a clear view of the company’s state of affairs.
There are two types of incentives that are provided to an auditor for delegating his duties. One is the direct incentive and the other being the indirect incentive. Actual or potential incentives are in the form of direct incentives provided to an auditor where the interests of the auditor merge with the management in such a manner that the leads to the probabilities of manipulation of data which may further misguide the investors and harm their interests (Hoffelder, 2012). The personal interests of the auditor collaborate with the management’s preferences owing to the fees provided to the auditor by the client for manipulating the data. In order to allow the auditor to be free from such pressure from the management, there are certain financial dependence strategies that comprise different incentive schemes so that the auditor performs his duties in a dignified way (Baldwin, 2010).
Indirect incentives may influence the auditor in such a manner that the objectivity of the report is impacted. It happens when the auditor and the client have any personal relationship or are family members. It is always advisable for an auditor to be free from any such relationship or to avoid developing any cordial relationship with the client so as to maintain the integrity and objectivity of the audit report and eliminate the scope of biases and corruption. Such situations might occur when the auditor avoids outsourcing from external audit service and all the requirements for the company’s financial statements are researched and formulated by him (Kaplan, 2011). The ability of an auditor in delegating his duties and performing audit and maintaining professionalism which is deprived of any doubtfulness is due to such an interpersonal relationship between the auditor and the organization.
Incentives and motivation are one of the important factors on which the verdict of an auditor mostly depends upon. Incentives play a very important part in influencing the verdict of an auditor that can either be fruitful or harmful to an organization. It is very important for the management to evaluate the judgment of the auditor so as to verify its worthiness for not necessary each and every verdict is appropriate (Manoharan, 2011). The audio quality is seen to be reduced when there is the absence of judgment order and in such scenario later judgment is necessary. Apart from incentives, there are many other factors that impact the performance of the auditor but mainly, incentives are one of the most important and prevailing factors amongst all (Geoffrey et. al, 2016).
Holistic Nature of Audit Quality
The objectivity of an auditor and his integrity is prone to mainly 5 potential threats other than incentives. Those are self-review threats, intimidation threats, familiarity, advocacy and self-interest threats.
Self-review threat is one where the auditor reviews his own work. When reviewing his own work the auditor may act biased. When the same work is reviewed and cross-checked by someone else in the organization, then he is likely to act judgemental. An organization is always prone to such self-review threats when the checking of the work is performed by the same person who has done it (Sikka, 2009).
Intimidation threats occur when the auditor becomes biased, influenced or intimidated like when he is afraid of being replaced by some other auditor. In such a scenario, he might get intimidated by the fact of being replaced at work and might make a wrong decision although being extremely sure of his opinion on the company’s financials (Lapsley, 2012).
Familiarity threat is a threat where the auditor fails at applying professional skepticism in his work. The auditor in such a scenario may be unconfident of his personal opinion and as a result of which rely mostly on the client’s explanation and may get influenced with their viewpoints and opinions even if they are entirely wrong (Sikka, 2009). It happens mostly where the auditor forms a personal relationship with the management of the organization where he is employed or with the client himself in such a manner that he fails to research the nature of the transactions deeply (Mallin, 2011).
Advocacy threat is a threat when the auditor/ auditors are also the promoters of the organization of his the audit work is being carried out. In such a scenario, they might advocate or promote in such a manner that would be out of personal biases and not on the basis of actual facts. It happens when an auditor who is performing the audit for a company, advocates or promotes on behalf of the client due to personal biases ignoring actual facts (Niemi & Sundgren, 2012).
Lastly, self-interest threats are such threats that are out of emotions, finances and other threats. Self-interest threats occur when the auditor is disinterested in performing and offering quality services in order to fulfil his self-interest whether knowingly or unknowingly. It can be said that the auditor must be independent in his decisions and perform his duties diligently and maintain his professionalism.
Accounting and auditing are interdependent on one another. They play a very important role in developing the economy for various reasons. The accounting statements are reviewed by the auditors so as to check the fairness of the same and give opinions (Gay & Simnet, 2015). The credibility of the accounting system is put into question and has called for certain lessons that are required to be learned since the collapse of some big names like WorldCom, Lehman Bros, and Enron.
In the case of Enron, it was brought to notice that the American standards of accounting are highly complicated in nature. It was observed that the off-balance sheet items like dodges were significantly treated. In some cases, certain important principles and guidelines are ignored whereas off sheet items are prescriptive. Financial Accounting Standards Board (FASB) made several attempts so as to improve the efficiency of the standards which were also shattered with the help of severe lobbying (Tadros, 2017). This calls for certain standards and measures that Securities Exchange Commission should ultimately impose through effective and sound principles. Such principles should focus on paying attention to single figures for earnings over exaggerated described rules. Also, certain standards should be introduced and implemented that are globally accepted and acknowledged. With the failure of Enron, the auditors and accountants need to learn a lesson of putting forth certain questions regarding the kinds of organization’s activity and whatsoever before commencing their work. This is due to the fact that the auditors of Arthur Anderson were not able to find out the financial lists for such a complicated and troublesome organization and kept up with auditing work being aware of the fact that the organization’s financial bonds are easy to speculate in the market. Gathering obligations for accounting profession from the private accounting firm altogether and then offering, stocking, locking and barrelling the same to the government was another important lesson learned with the failure of Enron (Fazal, 2013). Keeping in mind the complications in the present scenario, these alterations might become compulsory owing to the lessons taken from the failure of Enron. To summarise it can be said that the most important lesson learned with the failure of Enron was to take away from the senior management of the organization, the duty of appointing and choosing auditors of the same.
Importance of Maintaining Integrity in Audit Reports
In the case of Lehman Brothers, the accounting profession encountered major issues that was not a positive indicator in the corporate world. Hence, the key moral lessons from such scenario must be taken into due consideration so that such scenario can be avoided in the future. Hence, the policy makers like the IFRS and the Securities Exchange Commission must facilitate in the adoption of more effective and tough practices for the organizations so that they cannot undertake unethical means during their affairs. In the case of Lehman, the firm had massively increased its usage of Repo 105 transactions that too before the reporting tenure and it borrowed to buy back the same immediately after the reporting date. Therefore, in the prevalence of proper audit processes of the firm’s quarterly financials, such improper Repo transactions may have been avoided (Tadros, 2017). Nevertheless, the prime reason behind this moral lesson can be because the auditing experts were incapable of shedding light on such issue and even the regulatory bodies were unaware of such unethical means adopted by the firm. Hence, in the case of disintegration of Lehman Brothers, preparation and evaluation of a firm’s financial statements with proper implementation of enhanced audit processes can play a key role in permitting the statutory bodies to trace such illegal activities. In addition to this moral lesson, there is another major part that must be focused upon in the future so that such a situation does not reoccur. Therefore, in relation to this, prime concentration must be dedicated on the overall affairs of every big organization so that they cannot even dare to adopt such illegal means. The reason behind this lesson is because the impact of failures on the part of these big organizations can affect the overall financial system. In addition to this, if the auditing experts had taken due advantage from the ASA 701 standards, then they would become liable to report every activity to the public and such a situation may be avoided (Mallin, 2011). However, this standard was not present at the time of collapse of Lehman Brothers and this is the reason why the auditors took undue advantage of the situation and concealed material information and facts from the public to enhance the image of the firm.
In the case of WorldCom, the first major lesson is that it is benevolent for the internal auditors of a company to monitor and look after the affairs especially when it has been performing quite properly in the external environment. This is because companies performing well in the external environment may adopt fraud means internally and get undue advantage from its goodwill and reputation (Elder et. al, 2010). Furthermore, external auditors must also monitor the internal environment of a company and adopt traits like unbiasedness, honesty, integrity, etc while conducting audit processes. The transfer of all implied expenses into the capex of WorldCom was illegal and there remains no excuse for such act. Moreover, if service costs are paid to lease the local lines, it signifies a clear-cut cost. Therefore, the entire accounting profession must focus on recognizing these costs as and when they accrue, thereby paving a path for avoidance of such scenario in future (Mallin, 2011). Besides, the misrepresentation of costs led to increment of EBITDA of the company artificially. In addition, some strict changes must be brought to the GAAP because the issues or drawbacks in the accounting policies may have invoked WorldCom to adopt such unethical measure (Cappelleto, 2010). The main lesson here is the inclusion of outside auditors so that other wide segments can be focused upon as well. This can start with an enhanced review of the company’s financials including comparison of data with that of other companies to seek striking variances betwixt both. Further, this also includes assessment of company’s details to find any material ineffectiveness that may have enticed it to adopt such measures.
References
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Cappelleto, G. (2010). Challenges Facing Accounting Education in Australia. AFAANZ, Melbourne
Elder, J. R., Beasley S. M., and Arens A. A. (2010). Auditing and Assurance Services. Person Education, New Jersey: USA
Fazal, H. (2013, May 13). What is Intimidation threat in auditing?.Retrieved from: https://pakaccountants.com/what-is-intimidation-threat-in-auditing/
Gay, G., and Simnet, R. (2015). Auditing and Assurance Services. McGraw Hill
Geoffrey D. B., Joleen K., K. K.S., and David A. W. (2016). Attracting Applicants for In-House and Outsourced Internal Audit Positions: Views from External Auditors. Accounting Horizons, 30(1), 143-156. https://doi.org/10.2308/acch-51309
Hoffelder, K. (2012). New Audit Standard Encourages More Talking. Harvard Press.
Kaplan, R.S. (2011). Accounting scholarship that advances professional knowledge and practice. The Accounting Review, 86(2), 367–383. https://doi.org/10.2308/accr.00000031
Lapsley, I. (2012). Commentary: Financial Accountability & Management. Qualitative Research in Accounting & Management, 9(3), pp. 291-292. https://doi.org/10.1111/1468-0408.00081
Mallin, C. A. (2011) Handbook on International Corporate Governance: Country Analyses, Edward Elgar Publishing.
Manoharan, T.N. (2011). Financial Statement Fraud and Corporate Governance, The George Washington University.
Niemi, L., and Sundgren, S. (2012). Are modified audit opinions related to the availability of credit? Evidence from Finnish SMEs. European Accounting Review, 21(4), 767-796. https://doi.org/10.1080/09638180.2012.671465
Sikka, P. (2009) Financial Crisis and the Silence of Auditors. Accounting Organizations and Society. [online]. 34(7), p. 868-873. Available from: DOI: 10.1016/j.aos.2009.01.004
Tadros, E. (2017) Appalling’ audit quality could lead to next Enron: ASIC’s Greg Medcraft [online]. Available from: https://www.afr.com/business/accounting/appalling-audit-quality-could-lead-to-next-enron-asics-greg-medcraft-20171030-gzb5q2#ixzz5BrDh3Ckohttps://www.ifac.org/global-knowledge-gateway/technology/discussion/why-accountants-must-embrace-machine-learning [Accessed 10 September 2018]
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