Factors Involved in Fraud Cases with External Auditors - Essay Example

Factors Involved in Fraud Cases with External Auditors Introduction The auditors play a very significant role in the decision making procedures. They perform the responsibility of measuring the accuracy of financial statements of an organization. These financial statements are then utilised by owners of the companies for evaluating the management stewardship. It is utilised by investors for the decision making associated with the buying or selling of securities. The auditors provide guidance to the owners as well as investors for assisting them in their decision making procedure. The appropriate use of financial statements needs proper understanding of the responsibilities of auditors. As financial statements represent the functioning of the management, it is essential to maintain authenticity and reliability for avoiding fraudulent actions, while preparing such reports. The auditors express their views associated with the maintenance of authenticity and transparency by the management. They have been given the authority to assess these financial statements of organizations in order to judge the transparency of such information. They gather evidences in order to assure that the figures appearing in financial statements do not include material misstatement. The credibility of such reports is incremented by means of the audit process carried out by the auditors. These reports audited by auditors have huge impact on the decisions of investors, bankers, creditors and other stakeholders. The economy is struggling hard for recovering from a tumultuous situation which is infested with severe corporate scandals associated with misconduct of the auditors which have resulted in losing investor’s confidence. Presently, greater emphasis is given on improving the credibility, accountability, transparency and trust associated with the information provided in financial statements (Romero, 2010). The present structure involved in the audit process seems to be very problematic. Most of the big organizations generally pay their auditors by means of a third party known as the ‘audit system’. There are cases where clients make these payments directly to the auditors. In such cases, there is an added incentive paid by the clients to the auditors for delivering favourable news. Now the question which arises is whether such actions affect the real performance of auditors or influence them to lose their independence (Cooper & Neu, 2006). Actually, it does affect the real performance of auditors, thereby reducing the transparency and authenticity of the information in their audit reports. The auditors manipulate the figures in these financial statements in order to earn high incentives. This has become one of the most remarkable issues requiring urgent attention in the present scenario. The thesis would be conducted on the topic, ‘Factors involved in fraud cases with external Auditors’. It would be done by dividing the entire analysis into three segments. The study would highlight that the auditors are influenced in three different ways: conflict in interest, double positioning threat and finally, the familiarity threat. Analysis Conflict in Interest The auditor’s independence is the major area of concern in this study. It is known that the managers have an interest in misrepresenting, exaggerating or manipulating the information provided in the financial statements of organizations. It is expected that an independent audit report must provide unbiased and credible appraisal related to the financial status of an organization. The significance of the auditor’s independence has been shown in American Institute of Certified Public Accountants’ (AICPA’s) Code of Professional Ethics. It has been made mandatory by various legal decisions, which are provided by the Supreme Court of United States, in their opening quote. Recently, there was a series of events which has raised questions regarding the independence involved in the present practices related to accounting. The United States Securities and Exchange Commission has conducted a series of hearings related to the auditor’s independence in 2000, after a number of occurrences of accounting scandals. SEC has included modest changes in the disclosure rules after the hearings in 2000. However, these issues gradually moved away from public agenda, but the accounting scandal associated with Enron Corporation, where the functioning of the auditor, Arthur Andersen, had lacked independency, resulted in the arousal of issues related to the auditor’s independence again. Several evidences claim that if there is a close relationship between the client and auditor, chances of the auditor getting influenced is higher (Lee, Mande & Ortman, 2004). Double Position Threat Double positioning is where the audit firm provides audit as well as non-audit services to the organization. There are arguments which claim that by providing both types of services, the audit firms reduce their independence level. According to Guz & Francis (2000), if a particular audit firm provides audit as well as non-audit services to a particular organization, then they are basically serving two types of clients in same organization. One set of clients includes shareholders, audit committee and other users of the financial statements, whereas the other set is the management itself. The audit firm provides audit services to the first set of clients and non-audit services to the second set. Ye, Carson, & Simnett (2011) have argued that these non-audit service functioning promote public interest as well as audit effectiveness. However, this argument is not correct as inclusion of both the services will allow auditors to conduct fraudulent activities, thereby reducing their independence. Familiarity Threat This threat features if the client is familiar with the audit firm. It is due to this reason that it is necessary to hide the auditor’s identification from the client, so that even if there is a close association between the auditor and client, it would not result in loss of independence of the auditors. Moore, Tetlock, Tanlu & Barzerman (2006) have stated that generally audit companies hide the identification of auditors in order to increase their independence. This means that with more familiarity between an auditor and his client, the lesser would be the former’s independence. Thus, familiarity possesses high threat towards the independence of auditors. The new auditing leaders should protect or hide the results of their previous engagements. According to Romero (2010), if an audit company audits an organization more than once, the former would gain far more expertise. However, a review on this topic by these scholars has helped in concluding that the more familiarity an auditor breeds with his clients, more would be the independence experienced by him. Conclusion The auditors play a very vital role in the decision making procedures. They perform the responsibility of measuring the accuracy of financial statements of an organization. In recent days, there are issues arising related to the independence of auditors, which has become a major reason of concern. The study here analyses this topic. The entire analysis was segmented into three parts. It has been found that closer is the relationship between the client and auditor, higher are the chances of auditor getting influenced. However, the analysis has helped in proving that including dual position in the same organization will allow the auditors to conduct fraudulent activities, thereby reducing their independence level. In case of familiarity of auditors with the client, there have been contradictory discussions, where one set of researchers claim that higher familiarity would reduce the independence and another set of researchers claim the opposite, that is higher familiarity would rather increase the independence. Total Word Count: 1188. References Guz, F., & Francis, J. (2000). The demand for NAS from auditors. Working paper, University of Tasmania. Lee, H., Mande, V., & Ortman, R. (2004). The effect of audit committee and board of director independence on auditor resignation. Auditing: A Journal of Practice and Theory, 23(2), 131-46. Moore, A., Tetlock, E., Tanlu, L., & Barzerman, H. (2006). Conflicts of interest and the case of auditor independence: moral seduction and strategic issue cycling. Academy of Management Review, 31(1), 10-29. Romero, S. (2010). Auditor independence: Third party hiring and paying auditors. EuroMed Journal of Business, 5(3), 298-314. Ye, P., Carson, E., & Simnett, R. (2011). Threats to auditor independence: The impact of relationship and economic bonds. Auditing, 30(1), 121-148. Read More