Audit Independence, Quality, and Credibility - Essay Example

(Assignment) Case Study AUDITING Introduction E-Commerce and other rapid developments in technology are making the modern businesses too complex. In a big business firm, a large number of financial transactions are performed every day. Therefore, it is necessary for shareholders and concerned parties such as bankers and creditors to ensure the authenticity and accuracy of overall business operations. Auditing is the only alternative for a firm to interpret the outcomes of its previous year’s operations and to assess the current status of affairs. The given case reflects the auditing operations in Cheaphol plc by Winters & Co. The Cheaphol plc is a tour operator, who had been performing its business excellently until a fire at a foreign hotel killed their ten guests on 28th May, 2010. The Winters & Co audited the firm during May 2010 and auditor’s unqualified report was signed on 5th June 2010. The submitted report was clean audit report which did not contain any references to the financial difficulties. This report has been drafted for the senior partner of Winters & Co with intent to analyse the issues associated with the threatened litigation. Duties and responsibilities performed by Winters & Co. The ISA has framed certain duties and responsibilities for auditors. According to Sharma, the most important duty of an auditor is that he/she should do his/her work with “due diligence, intelligence and dedication” (Sharma, 165). In the case of Winters & Co. they could complete their audit work successfully by disclosing all material facts till the date of audit report. It is necessary to note that the disaster occurred on 28th May 2010 and Winters & Co. signed the unqualified report on 5th June 2010. It clearly reflects that there was only a time gap of six days in between occurrence of the disaster and report submission. Similarly, it must also remember that the company did not release any report out of the press until they were questioned by officials. The case study precisely points out that this news leakage and subsequent holiday cancellations led the company to huge financial crises. Therefore, it is identified that Cheaphol’s financial position was safe till the date of audit report submission. In other words, Cheaphol’s financial crises began after the course of audit work of Winters & Co. Although some of the audit staff came to hear the catastrophes regarding the company, they could not corroborate the matter. In addition, the audit team had no sufficient time for conducting a detailed investigation regarding the newly acquired information since they were needed to submit the audit report immediately in order to assist the Cheaphol plc to make negotiations with Alltan’s bankers. It is one of the primary responsibilities of the auditor to complete the audit work in time (Advantages of final audit). In order to carry out this responsibility accurately, the Winters & Co. handed over the signed audit report to the Cheaphol plc without further enquiries. In this case, the fraud was committed by the persons at the helm of affairs who the assigned the task of audit work. Gupta (2005, p.499) tells that auditors receive various certificates and documents of the company with the management officials’ attestation; and it is believed that management would not commit fraud. Delaney and Whittington (86) reflect that in order to reveal such types of fraud, the auditor must possess reasonable care and skill. The ‘reasonable care and skill’ cannot be defined since it varies form situation to situation and from company to company; hence it helps the auditor to defend himself/herself against legal suits. However, it will be very difficult for the auditor to bring out a cleverly committed fraud by the director board executives. According to AICPA auditing standards (as cited in Rittenberg et al), “it is not reasonable for auditors to detect all frauds because frauds can be cleverly manipulated by management” (Johnstone et al, 410). Liabilities of an auditor International Standards on Auditing (ISA) has defined a wide range of situations under which an auditor will be held legally liable. According to ISA, the liabilities of an auditor are mainly categorized into three such as civil liabilities, criminal liabilities and other liabilities. 1. Civil liabilities The civil liabilities of an auditor are subcategorized into two such as liability for negligence and liability for misfeasance (Better legal research). The client can file a suit against auditor if the auditor has acted against the interest of the client by acting negligently or by breaching the position of trust. According to Marnet (138), the auditor acts as an agent to his client so that he/she must take all possible efforts to perform his duties sincerely and effectively. Sometimes, the clients may suffer losses on the account of auditor’s negligence and hence the auditor may be called upon to compensate the damages occurred. When an auditor fails to disclose the frauds in his final report, it does not mean that he/she will surely be held liable. Some types of frauds cannot be disclosed by an annual audit or even by a detailed audit; in such conditions, auditors may not be sued. Anyhow, the level of care and skill taken by the auditor during the course of his/her audit will determine whether he/she is liable or not. Similarly, it is found that auditor uses the personal business information of the client in order to make personal gain (Goliath; Business knowledge on demand). In such situations, the auditor can be sued for breaching the contracts of trust and confidentiality. 2. Criminal liabilities Quinn (1996) indicates that the auditor will be held responsible if he/she willfully makes a false representation in the financial statements or any other documents of the client with intent to deceive and mislead. It is identified that auditors sometimes falsify the financial reports of the client in order to save the interests of the competing firms. In such circumstances, the audited financial statements may not show a true and fair view of the state of affairs of the company. Therefore it would hurt the interests of the shareholders and third parties. At the time of the winding up of a company, court may ask the concerned auditor to return all the necessary documents related to the company; and if the auditor fails to do so, he will be criminally liable. 3. Other liabilities Although the auditors have no contractual obligations to third parties like bankers, creditors, and other financial institutions, they (auditors) may be held liable under certain circumstances. If any fraud committed by the auditor causes damages to third parties, the auditor may be liable to compensate the losses (Commission by Thieffry & Associates). Sometimes, unlawful acts of the client may also make the auditor legally liable. Is Winters & Co. liable? Currently the Winter & Co. is facing litigation from two classes of Cheaphol customers such as those who were customers by the end of May and those who became new customers after May. The old customers continued their dealings with the Cheaphol plc on the strength of unqualified report submitted by the company. Similarly, new customers were also attracted to the company on the basis of unqualified audit report. An unqualified audit report or a clean audit report is an unconditional opinion of the auditor, which the auditor issues when he/she has no doubts regarding the matters contained in the financial statements. According to Ainapure and Ainapure (574), an unqualified report indicates that the financial statements of the company give a true and fair view of state of affairs of the company and it reflects the actual profit and account for the period. Generally, an auditor’s liability is secured and he/she is justified under the following circumstances. The financial statements and other documents are prepared on the basis of generally accepted accounting policies and procedures The financial information complies with governmental regulations and other statutory provisions The final report discloses all material facts and other facts relating to the presented financial statements Since the Winters & Co. submitted an unqualified audit report; naturally, those two classes of customers might have lost their money at the time of attribution so that they have the right to file a suit against the auditing firm. Though, the auditor is not liable to the customers since he/she has not entered into a contract with them. From the point of view of Basu (241), it is stated that the auditor would be liable if his deeds amounts to be fraud and it has hurt the interests of the customers. We have just discussed the criteria for issuing an unqualified audit report. It is clear that the Winters & Co. has met the first two criteria. At the same time, they failed to disclose all relevant material matters related to the presented financial statements. Therefore, the auditing firm’s unqualified report cannot be justified. Although Winters & Co has flawed in preparing the audit report, they can defend the customers in a legal suit since disclosure of all relevant matters of Cheaphol plc was beyond their capacity. The Winters & Co can argue that they had applied reasonable care and skill in practicing the audit procedures. In addition, they can also argue that Cheaphol’s financial position was safe till the date of signing of audit report. The auditing firm can give lot of evidences for clearing their side. The Chepahol’s disaster news leaked on July 2010 and it caused their financial collapse; a lot of media reports will be available regarding this failure of 2010 June. The Winters & Co can precisely state the court that this news leakage was the starting point of financial crises and subsequent fall of Cheaphol plc. In addition, the Cheaphol plc were trying to recover from the disaster on the base of the Alltan’s (its own bank) loans; but a national television programme questioned the safety standards of the firm and it led to an unprecedented cancellations with customers demanding their money back. It clearly indicates that Cheaphol’s decline started one month after the signing of audit report so that Winters & Co can successfully defend the customers’ negligence suits. Similarly, the Winters & Co. can also defend the negligence suits from Cheaphol’s bank, Alltan’s bank, and the Administrators of Alltan. Out of these three parties, Cheaphol’ bank and Alltan’s bank are the third parties to the audit firm, who have no contractual relationship with Winters & Co. However, these bankers have suffered huge losses since they had sanctioned big loans to the Cheaphol plc on the strength of clean audit report of Winters & Co. Hence, these bankers have the right to file negligence suits against the auditing company on account of provision of Misstatement in Prospectus stated under civil liability section (Auditor’s liabilities). These bankers’ rights are similar to that of the customers’ rights; therefore the auditing firm can successfully defend these suits as it had not issued the unqualified report with intent to deceive the bankers. In case of administrators of Alltan, the Winters & Co have contractual obligation to them since they are the ultimate beneficiaries of the audit report. The civil liability acts permit the administrators to file suit against the audit firm since they also have experienced huge losses due to the absence of warning or suggestions from the part of auditors. The Winters & Co would have submitted a qualified report with additional suggestions for improvement if the junior audit team member had reported the acquired information to the senior auditor. Anyhow, the administrators of Alltan do not have any indication regarding this matter so that they cannot prove audit firm’s negligence in the court. Even if the audit firm had acquired proper information about the unlawful acts of the client, it would not have reported it as it would adversely affect the client’s trust on the firm. In the view of Basu, in such circumstances, the auditor “must not act in such a way that it unnecessarily injures the confidence of his client on him” (Basu, 241). Conclusion From the detailed discussion, it is clear that Winters & Co would not get hurt by the negligence suits of any of the parties. The losses incurred on customers, bankers, and administrators cannot be attributed to negligence of Winters & Co since the Cheaphol’s financial position was safe till the date of audit report submission. In addition, they did not get adequate time to investigate on the fire disaster since they were compelled to submit the report in time. However, Winters & Co could have skipped from the troublesome difficulties of negligence suits if the audit junior team member had passed the acquired information to his superiors. Works Cited Ainapure, Varsha and Ainapure, Mukund. Auditing and Assurance. New Delhi. PHI Learning Pvt. Ltd, 2009. Print. “Auditor’s Liabilities, Liabilities of an Auditor: B-com part 2 auditing notes.” Friends Mania: A place for friends. (2010). 13 Feb 2011 “Auditor’s Liability.” Better Legal Research. (n.d). web 13 Feb 2011 “Advantages of Final Audit.” Guess Papers. (2010). Web 13 Feb 2011. “Audit Independence, quality, and Credibility: Effects on reputation and sustainable success of CPAs in Thailand.” Goliath: Business Knowledge on Demand. (2009). Web 13 Feb 2011 Basu, S.K. Auditing: Principles and Techniques. India. Dorling Kindersely (India) Pvt. Ltd., 2006. Print. Earnestine, S Quinn. “Auditors beware: key factors can lead to law suits.” All Business. (1996). Web 13 Feb 2011 Gupta, Kamal. 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