Current Issues in External Auditing - Coursework Example

Current Issues in External Auditing Introduction Auditing is the investigative process intended to verify the reliability and accuracy of company operations for the last accounting period. An efficiently prepared audit report adds value to the shareholders of the company as it enables them to verify whether their interests are preserved or not. According to the stance of IFAC, third parties to the company such as creditors, bankers, other financial institutions and investors take business decisions on the basis of company’s annual audited report (Audit quality and international standards of auditing, IFAC). Although audit work can ensure the authenticity of company’s performance, it needs great care to maintain the quality of the process. The decline in audit quality reduces the public confidence in companies and thus it becomes a major crisis as it has happened in the global market. Professional work standards such as International Standard on Quality Control (ISQC) 1 and International Standard on Auditing (ISA) 220 were introduced in order to keep the quality of audit work. Likewise, the decrease in the number of audit firms leads to another market difficulty called audit market concentration. This paper has been drafted with intent to explore the current issues in external auditing and difficulties associated with audit market concentration. Need of Audit work Although a systematically conducted audit programme is useful to both third parties and public, the company management is the prime beneficiary. The timely suggestions of auditor regarding strategic amendments help the company to carry out its operations more smoothly. Auditing is the only effective technique to find out frauds and errors in the company accounts which might hurt the ultimate business objectives. In other words, auditing mainly verifies the arithmetical accuracy of accounting works; it implies that audit begins where accountancy ends. According to The British Joint Stock Companies Act 1844, the audit of public companies is a statutory requirement in UK. Characteristics of a good audit work According to the guidelines of the Contact Committee of the Heads of the SAIs of the European Union (2004), it is necessary to ensure that certain characteristic elements are scrutinized in order to prepare an authentic audit report. These special features are described below. Significance: the auditor must consider the size of the firm and their business strategies before commencing an audit work. He/she has to clearly understand the effect of the company’s audit report on public in order to make necessary changes with the professional code of conduct. Reliability: the auditor must ensure whether his findings match with actual state of affairs of the company. In addition, all the vouchers and receipts must support the respective transactions in order to increase the accuracy of business operations Objectivity: the aim of the audit must be to get a fair and true view of the performance of the company. The auditor should conduct an independent analysis based on his assessments and the results obtained must be highlighted in his final report. Scope: the audit programme must be prepared in such a way that it reveals all the elements required for an efficient audit report. Similarly, it must be clear and accurate as it determines the strategy formulation of many individuals. Timeliness: the auditor must be careful to submit the audit report before the deadline since it is a necessary document for future managerial decisions. Likewise, the auditor must provide timely guidelines to the directors in order to strengthen the weaker areas of managerial operations. Clarity: the audit report must contain all the merits and demerits regarding company deeds; it must also provide proper suggestions and better improvement techniques in order to conduct the business in a more efficient way. Moreover, his/her findings and suggestions must be recorded in such a way that it can be easily understood by busy business executives and even non experts. Efficiency: the result must include risks and opportunities to the business which others do not see. For this purpose, the auditor must exploit all available possibilities. Effectiveness: an audit report becomes effective when it gets good responses from auditee, investors and government (Contact Committee of the Heads of the SAIs of the European Union, 2004 p.5). The quality of an audit work is determined by the mode of execution of the above described eight factors. If any of those elements are ignored, it will weaken the authenticity of the audit results. Causes of failures Normally, the main cause of failure is the decline in audit quality which occurs as a result of various reasons. The Audit Inspection Unit (AIU) recommends that certain areas of audit work have to be improved in order to enhance the audit quality (Corporate Law and Governance, 2009). The decline in audit quality is mainly attributed to the weakness of audit programme which is the process of creating a lay out for the alignment of audit work. The audit programme includes the act of distribution of audit work among the audit staff according to their skill, qualification and experience. The inefficient allocation of audit work among the employees would affect the quality of audit work as it needs greater potential to find out cleverly committed frauds. Similarly, the audit work would be a mere drama, if the auditor does not get sincere cooperation from the part of client’s staff. In the opinion of Guruswami (2008), ‘increased complexity of both accounting standards and financial instruments, the challenges associated with fair value estimation processes’ intensifies the issues related with audit quality. Similarly, the accounting procedures adopted by various firms may be different and thus it becomes a cumbersome task for the inexperienced audit staff. Sometimes, the auditor may falsify his/her findings in order to satisfy some of the cunning objectives of the directors. The auditor may inflate the company’s actual profit with intent to attract more shareholders, investors and bankers. On the other hand, a deflated profit may show in the final audit report so as to justify the less payment of dividend. These malpractices reduce the quality of audit work as it is against the interests of the stakeholders and general public. Moreover, if the auditor does not possess some creative skills, he/she will certainly fail while dealing with the frauds committed by persons at the helm of affairs. The collapse of the corporate giant Enron was the result of failure of an efficient audit. The audit market concentration is the ongoing problem which plays a crucial role in the decline of the quality of audit work. In the view of Beattie and Fearnley (1994), ‘the voluntary realignment, changes in the set of consumers, and changes in the set of suppliers’ are the some of the reasons of audit market concentration. They say on the strength of Structure-Conduct-Performance view that higher audit market concentration causes to reduce the market competition and thereby it badly affects the ultimate consumers. In addition, the excessive audit concentration is a threat to smaller audit firms since it questions their existence. The increase in audit prices is one of the major consequences of higher concentration and as a result, audit cost becomes unaffordable to smaller companies. The auditor may tend to complete the work with unnecessary rapidity in order to maximise his/her income on the strength of increased audit cost; it would result the submission of a poor quality audit work. Similarly, it is clear that audit market concentration would decrease the auditor’s autonomy which would adversely affect the quality of the audit report. In short, audit quality and audit market concentration are interrelated in which latter intensifies the former. Suggestions for the improving audit quality In order to improve the quality of audit work, the auditor must penetrate into the company’s managerial operations and observe all the things under suspicion. It is said that an auditor is a watch dog but not a blood hound. That means, the purpose of an auditor is to safeguard the assets of his/her master (shareholders). Therefore an auditor should not harass the client staff during the course of his audit; on the other hand he must maintain a healthy relation with them which would make his programme easy. Similarly, the auditor must examine each end every invoice of the company if there is not a well established internal check system in operation. The auditor should not take any biased decisions and all his/her acts must be independent. The auditor should also ensure to rotate the work among his staff regularly in order to prevent the work becoming monotonous. As Dubaere (2007) notifies, the breakup of the Big Four would be an effective solution to the audit market concentration as it will broaden the options available to the largest companies. However, it is practicable if and only the world wide audit regulators mutually accept the proposed suggestion. Similarly improved regulation on Big Four also reduces the intensity of audit market concentration. The Financial Reporting Council can prevent excessive concentration by raising awareness of audit firm’s capabilities. Likewise, merger between mid-tier firms is another suggestible solution to trim down the problem of concentration and thereby issues associated with audit quality. Moreover, the perceptions of the non-Big Four must be changed; it is the only ultimate solution to the problem. Factors influencing independence of audit (Source: Oxera Survey and Calculations, 2007, p.77) The chart illustrates the scores obtained for each factors in turning the audit independent. Majority of people think that audit becomes ineffective if the audit firm has any financial interest in the audited company; 220 is scored for this element. From the diagram, it is clear that audit performs successfully while the auditors involved are suitably qualified. It is also a fact that regular change of the audit firms can improve the independence of the audit and this factor scored as 150. Similarly, a score of 190 is given if the structure of audit firm is single and integrated rather than a net work of independent practices in different countries. Conclusion Although a variety of initiatives are taken toward the objective of better audit quality, the problem still persists across the globe. The positive change in ideologies must begin from the part of auditor in order to keep the expected audit standards in every firm. Anyhow, better audit practices can minimize the failures of concerns because failures always point out weaker areas of managerial operations. Since audit market concentration also intensifies the problems related to audit quality, averting excessive concentration would increases the quality of audit work to a great extent. References Audit quality and international standards of auditing, (n.d.) International Federation of Accountants (IFAC)[Online] [Accessed 4th Jan 2011 http://web.ifac.org/download/Audit_Quality_Fact_Sheet.pdf Beattie, V., Goodacre, A & Fearnley, S. (2003). ‘And then there were four: A study of UK audit market concentration – causes, consequences and the scope for market adjustment’. Journal Financial Regulation and Compliance. Vol.11,no.3, pp. 250-265. Dubaere, C. (2007-2008) Concentration on the audit market, Faculty of economics and business administration, Academic Year 2007-2008, GHENT University. [Online][Accessed 4th Jan 2011] http://lib.ugent.be/fulltxt/RUG01/001/309/435/RUG01-001309435_2010_0001_AC.pdf Guidelines on audit quality. (2004). Contact Committee of the SAIs of the European Union. [Online][Accessed 4th Jan 2011] http://www.eurosai.org/docs/AQGuidelines.pdf Guruswami, R. (2008). ‘The need to audit our auditors’. Business. Siliconindia.com. [Accessed 4th Jan 2011] http://blogs.siliconindia.com/guru_raghavan/The_need_to_audit_our_auditors-bid-rhF4230a30935114.html Ownership rules of audit firms and their consequences for audit market concentration. (Oct 2007). OXERA. [Online][Accessed 4th Jan 2011] http://ec.europa.eu/internal_market/auditing/docs/market/oxera_report_en.pdf UK: AIU publishes overview of audit quality inspections. (10 Dec 2009). Corporate Law and Governance. [Online][Accessed, 4th Jan 2011] http://corporatelawandgovernance.blogspot.com/2009/12/uk-aiu-publishes-overview-of-audit.html Read More