The Concept of External Audit
External audit is also known as statutory audit, and this audit of financial statements is a clear example of assurance engagement. In external audit process, auditor evaluates those financial statements of the company which is the responsibility of the third party such as preparation of financial statements are the actual responsibility of the directors of the company. It is necessary that such financial statements and other relevant documents are prepared by third party so that they can provide assurance about that subject matter.
The main aim of external audit is to increase the confidence of users of financial statements, and also reduce the risk related to financial statements. Three concepts of external audit are agency, stewardship, and accountability. Quality of external audit is increased because of professional standards applicable on external audit, and this audit is governed by company law, auditing standards, and codes of professional ethics (AAT, n.d.). In other words, investors are relying on the comments made by external auditors, and they invest their money on the faith that auditors make actual and right comments. There is fiduciary relationship between the auditors and investors, and it is the duty of auditor to maintain this trust.
Companies Act 2006 imposed various responsibilities on external audit, and it is the duty of auditors that they form independent opinion on the truth and fairness of the financial statements. Auditors also checked whether financial statements are prepared as per companies act or not, and auditors also provide statement related to consistency related to information provided by director’s in director’s report with financial statements (Gov.UK, n.d.). Various activities are conducted by the auditors during their process, and while conducting these activities they must adhere the principles of independence and objectivity. Importance of independence and objectivity is defined inn this paper and it must be noted that if comments made by auditor are not complied with these principles then such report is considered as defective report.
Changing business environment increase the importance of independence and objectivity, and this factor is always important for auditors. Increasing importance of independence and objectivity create number of challenges for auditors. Both internal and external stakeholders of the company demands transparency, essential disclosures, expand audit services, professionalism, co-ordination between external and internal auditors, and more responsibilities (Fearnley & Bettie, n.d.).
Usually, term independence and objectivity creates confusion, and there are number of peoples who used these terms interchangeably. These two terms are not same and they have different meaning. Sometimes auditor can be independent but not objective, and on the side auditor can be objective but not independent (IPPF, n.d.). It is necessary to state the difference between two, and also analyze the effects of safeguard and threats on each other. It is easier to implement safeguard and ensure independence rather than ensured objectivity. Safeguards are defined as reporting, segregation of duties, duties and responsibilities, structure related to remuneration, and actions or requirements that avoid conflict of interest and improve the independence. Whereas, objectivity is defined as something for which individual auditor retains accountable for the act, and control.
Principles of Independence and Objectivity
In their profession and business activities, it is necessary that members apply ICAEW’s Code of Ethics, and with other things it also includes being objective. Section 290 of the Code applies on all members in case of absence of national legislation. This section is based on the standards of International Ethics Standards Board for Accountants’ (‘IESBA’) Code of Ethics. This section applies ICAEW’s preferred ethics regulatory ‘framework’ approach of fundamental principles and this framework always apply. It includes analysis of threats for the purpose of compliance, effective safeguards are applied, and application of absolute requirements and prohibitions in case acceptable safeguards are not applied (ICAEW, n.d.).
Section 290 state the requirements related to independence for audit process and review process, especially in external audit under which a person who is accountant by profession and conduct his practice in public state his conclusion on financial statements prepared by third parties. External audit process includes audit process and review process for the purpose of reporting on complete set of financial statements or single financial statement. Those arrangements which does not include audit process or review process are addresses in section 291 (ICAEW, n.d.).
Audit process are prepared for public interest, therefore code of ethics required that members of audit teams, firms and network firms shall be independent of audit clients. This section helps the members of firms and audit teams for applying the approach stated by Section 290 in their audit process for the purpose of achieving independence in their transactions (ICAEW, n.d.).
Independence includes two concepts that are independence of mind and independence in appearance. Both the concepts are stated below:
Independence of mind- it includes that state of mind which provides conclusion which is not affected by any influence and such conclusion must comprise professional judgment. Therefore, it is necessary that individual act with integrity and exercise objectivity while performing their professional activities.
Independence in appearance- it states that professional must avoid such facts and practices which reflect reasonable and informed third party that professional compromise integrity, objectivity or professional behavior. Therefore, it is necessary that members of the firm and audit team avoid activities which challenge the independence of their decision.
This section defines the conceptual framework, and this framework defines various activities for professionals which include identification of threats for the purpose of independence, evaluate the importance of threats identified in first step, apply safeguards wherever necessary for the purpose of removing threats or reduce them up to the level which is acceptable.
In case professional accountant found that it is not possible to apply safeguards for the purpose of removing threats or reduce them up to the level which is acceptable or safeguard is not available, then they will eliminate the circumstance which creates such threats or they terminate the audit process.
A professional accountant uses the judgment which is professional in nature for the purpose of applying this conceptual framework (ICAEW, n.d.; ICAEW, n.d.).
Prem Sikka is the professor of accounting at the University of Essex, and in exclusive interview he explains why he thinks that FRC terms of reference for investigations of the BHS audits are not right, and he also explain the reason that why he thinks that UK regulator is not fit for the purpose of conducting investigations because there is lack of independence.
Challenges in Maintaining Independence and Objectivity
Work done by Prem Sikka reflects the characteristics of Laughlin’s, and he is a political activist in accounting. He addressed various issues such as money laundering, independence and objectivity, and other relevant issues (Graffikin, 2006).
Collapse of BHS, largest retailers of UK are investigated by two parliamentary committees and the main attention of this investigation was auditors of the Company that was PricewaterhouseCoopers (PwC). The Financial Reporting Council (FRC) makes declaration on 27th June 2016 that they will investigate the financial statements of BHS limited for the year ended 31/08/2014. FRC is accounting regulator of UK, and declaration made by FRC was not adequate because of the following reasons:
- Investigation conducted by FRC is not adequate because FEC is not the suitable body to conduct that investigation, and this body has close relationship with auditing industry because standards framed by FRC have contributed in the issues of BHS.
- Scope of investigation conducted by FRC was too narrow, and it is not possible to address the accounting and auditing issues of BHS only from the auditing of alleged shortcomings of 2014 only. It is necessary to audit the statements of early years of 2014 and year 2015.
- BHS financial transactions are related to other companies also which are under the control of the green family, and it is necessary for conducting meaningful investigation to include those transactions also. PWC must be audited and advised those companies also which conduct transactions with BHS limited. PWC has close relationship with Green Company and other parts of their business (Economia, 2016).
Why FRC was not fit for the purpose of investigating BHS audit? Answer related to this question is clear that FRC has no independence from the auditing industry. Board of FRC and working committees has been populated by the authorities of big companies and accounting firms. It is their duty that they must be objective and ensure public interest, but truth is little different that their approach towards objectivity and public interest is influenced by their education, income, and business interest. They frame the accounting standards and code of ethics and other process on the basis of their preference, and they will also inform any investigation.
In this article Prem Sikka raise right point because if standards and other processes are framed by FRC then this body is inappropriate for conducting any investigation in which their own standards contribute towards scandals. FRC applying their own accounting and auditing standards while conducting investigation and if corporation complied with all the rules then they give clean chit to the organization. However, this is not right because the rules themselves are faulty in nature and many other issues are identified in these standards. Therefore, it is clear that FRC has no independence and they are not questioning their shortcomings in objective way.
In the case of BHS, auditors stated that accounts are true and fair even cash flow statement was not presented. Cash flow statement is very important document because it provides important information to the readers of account such as appreciate solvency, liquidity and financial dexterity of the company. This lack was identified and permitted by FRC on the basis of note on page 10 of BHS’s 2014 accounts in which company state that they are taking the advantage of exemption provided by Financial Reporting Standard 1 (revised) in which it is not necessary to prepare cash flow statement. Cash flow statements of the BHS are included with the consolidated cash flow statement of Taveta Investments Limited” (The Accountant, 2016).
Comments made by Prem Sikka are right and he provide very strong reasoning for comments but these reasons are not enough for proving that FRC is not an appropriate body to conduct investigation. Allegations made by Prem Sikka on the board and working committees of FRC are not supported by any evidence. There is lack of evidence in this article.
For effective investigation it is necessary that investigation must carry in speedy manner, but in case of FRC it is not possible. FRC announced Investigation for the audit of Presbyterian Mutual Society on august 2009 but they publish the report of investigation in 2016 (Kirton, 2016).
Prem Sikka also stated that possibility of termination of investigation was also high and for this he stated example for this that was, in 2008 and 2009, the FRC stated that they will initiate the investigation of the audits of Equitable Life Assurance Society but in 2012, they further announced that they terminate the investigation because matter related to investigation was too old and there was lack of realistic prospect (The guardian, n.d.).
After analyzing all the comments and fact stated by Prem Sikka in the article, it is clear that FRC is not the appropriate authority to conduct investigation, but he does not provide any strong evidence which support the comments and fact stated by him. Therefore, after evaluating this article it is clear that FRC can conduct the investigations but it is necessary that they consider other aspects also while conducting the investigation, and not only the aspect of standards framed by FRC. Therefore, I am agreeing with the comments made by Prem Sikka on the independency of external auditors in case of BHS. As stated by Prem sikka, PwC depends on BHS for its fee and this is the only reason that it easily went along with the myth of financial support for BHS. This comment is true because it is not possible for any auditor to loose such a big client just because of being robust and sceptical.
On other hand, authorities like Financial Reporting council (FRC) who are investigating such issues has no independency in case of big firms and they took time in resolving issues. All the comments made by prem sikka on the case of BHS are right and he cover all the relevant issues related to this case.
References:
AAT. External audit. Available at: https://www.aat-interactive.org.uk/elearning/level4/External%20audit%20-%20framework%20and%20regulation.pdf. Accessed on 20th March 2017.
Economia, (2016). FRC to investigate PwC’s BHS audit. Available at: https://economia.icaew.com/news/june-2016/frc-to-investigate-pwcs-bhs-audit. Accessed on 20th March 2017.
Fearnley, S & Bettie, V. . Auditor Independence and Non-Audit Services: A Literature Review. Available at: https://www.icjce.es/images/pdfs/TECNICA/C06%20-%20Normativa%20UK/C.06.040%20-%20Estudios%20y%20otros/Auditor%20Independence%20and%20Non-audit%20Services%20-%20A%20Literature%20Review.pdf. Accessed on 20th March 2017.
Gov.UK. Audit, accounting and reporting. Available at: https://www.gov.uk/guidance/audit-accounting-and-reporting-guidance-for-uk-companies. Accessed on 20th March 2017.
Graffikin, M. (2006). The Critique of Accounting Theory. Available at: https://ro.uow.edu.au/cgi/viewcontent.cgi?article=1040&context=accfinwp. Accessed on 20th March 2017.
ICAEW. Auditor independence approach. Available at: https://www.icaew.com/en/technical/ethics/auditor-independence/auditor-independence-approach. Accessed on 20th March 2017.
ICAEW. Code of Ethics B section 290. Available at: https://www.icaew.com/en/membership/regulations-standards-and-guidance/ethics/code-of-ethics-b/part-b-290. Accessed on 20th March 2017.
ICAEW. ICAEW Code of Ethics. Available at: https://www.icaew.com/en/technical/ethics/icaew-code-of-ethics/icaew-code-of-ethics. Accessed on 20th March 2017.
ICAEW. Regulation of Auditor Independence. Available at: https://www.icaew.com/en/technical/ethics/auditor-independence/regulation-of-auditor-independence. Accessed on 20th March 2017.
ICAEW. Section 290 Independence – Assurance engagements. Available at: https://www.icaew.com/-/media/corporate/files/members/regulations-standards-and-guidance/ethics/code_of_ethics_prof_account_in_public_practice_part_b_290_1_sep_2006.ashx?la=en. Accessed on 20th March 2017.
IPPF. Independence and Objectivity. Available at: https://www.iia.org.uk/media/57156/independence_and_objectivity.pdf. Accessed on 20th March 2017.
Kirton, H. (2016). Accountancy watchdog cannot follow up on BHS inquiry as requested because it’s being asked to investigate people who aren’t actually accountants. Available at: https://www.cityam.com/242772/accountancy-watchdog-cannot-follow-up-on-bhs-inquiry-as-requested-because-its-being-asked-to-investigate-people-who-arent-actually-accountants. Accessed on 20th March 2017.
The accountant, (2016). Comment: The UK Financial Reporting Council can’t investigate BHS audits. Available at: https://www.theaccountant-online.com/features/comment-the-uk-financial-reporting-council-cant-investigate-bhs-audits-4944726/. Accessed on 20th March 2017.
The guardian. Called to account Prem Sikka. Available at: https://www.theguardian.com/commentisfree/2008/dec/14/credit-crunch-auditing. Accessed on 20th March 2017.
Order an Essay Now & Get These Features For Free:
Turnitin Report
Formatting
Title Page
Citation
Outline
