Example of: Lehman Brothers Audit regulation and organization Example of: APC,APB Claim for alteration of company law
Example of: PWC bid Prudential Corporation Plc
Discuss what major criticisms are made of auditors
Briefly explain two aspects of audit independence and describe the negative influence of audit independence caused by non-audit services.
Example of: PWC's financial Position and Enron events
Explain why the profession accused of acting is in a self interested way
Describe auditors' responds to these criticisms including non-audit services and audit failure
Support by: ICAEW chief's opinion
Criticisms of Audit Profession
The future of audit profession. Discuss the changes of accounting standards and arts and the revolution of auditing
Support by: the Sarbanes- Oxley Art of 2002 and SFAS 140-3
Before the discussion of the audit profession's self interested, it needs to be understood that The audit profession always described a defender of shareholder's interest. The auditor is created to provide true and fair views and accurate, real and complete figure to the shareholders, board director, lenders, pensioners and others. Those information guarantees by auditor's good professional skill and a high moral standard. The audit profession generally regards as to stand for public interest.
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Unfortunately, more and more evidence indicates that the auditors do not always show its good performances of their responsibility and duty, such as the auditor in these companies, Peter Cardillo, Maxwell and Anderson. Indeed, an audit firm is such a special type of business that provided their services on the basis of knowledge, expertise and effective suggestions. However, when audit failure exposed, the audit profession always acts to evade responsibility such as claims that the audit option is not a guaranteed and refused to admit their mistakes. So this could be described of a factor that the audit profession has been accused of acting in a self interested way.
Moreover, according to Gray & Manson (2008, p.763-764), the auditor claim for alteration of company law connect to professional negligence. There are two main reasons to support this claim. One is that the cost of obtaining indemnity insurance is higher than the audit incomes, the other one consider about the risks of accountant company's bankruptcy. However, there is no annual financial report provide by audit firms to support's their claims and the failure of companies seems to be a normal incident under business markets. So, critics assess their proposals as a pretext that auditor's intent to reduce their own responsibility, which could treat as a self interested behavior.
Then, moving to the audit regulations, APC(Auditing Practices Committee) and APB(Auditing practices Board) were criticized that its foundation is in order to protect individual in the audit profession rather than the public interest. At the time of that background, Auditing standards were constituted by those institutional members who came from major accounting firms and large company and the important information were not public. So the audit profession is self interested way.
Focus on the last main factor is that vicious industry competition which leads to the audit firms have to accept its audit revenue less than audit cost in order to win the bid. For example, when PWC bid Prudential Corporation plc, the audit fee provided by PWC was unreasonable lower than its cost. The competition directly resulted to audit firms will expand non-audit business in order to make up for audit business losses and the increasing of non-audit revenue would threat audit independence.
It is obviously to find that the criticisms made by public are always focus on three main aspects that are audit independence, auditors' duty and performance of auditing activity. My opinions are following.
Audit independence is a hot topic always published in an academic newspaper and magazine. It is an important issue that contains two aspects. One is that there must not have any interest relationship between company and audit firms. Another issue is that auditors required to following the principles of programming independence, investigative independence and reporting independence when they implement the audit procedure. However, public always accused auditor falls to fulfill audit independence since of the external factors like attractive non-audit profit. Significant non-audit revenue may somehow prevents audit firm to provide true and fair opinions to the company because auditor would pay more attention to the non-audit services which may decline audit quality. Indeed, if audit firm's non-audit revenue is bigger than the audit income, this would cause a bad influence of audit independence since audit firm may compromise in order to keep its client. As the new SEC revealed in the year 2000, virtually all public companies (96 percent) purchased non-audit services from their auditors. Furthermore, these non-audit services typically presented material amounts with 51 percent of companies paying more for non-audit services than audit services (Brandon, Crabtree and Maher, 2004, p.2). Such as PWC, 'The bank's annual report disclosed that PwC was paid £500,000 in 2006 for its audit work compared to £700,000 in 'non-audit fees', specifically 'in respect of securitisation transactions and the raising of wholesale funding'(Accountancy Age, 2007).
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Furthermore, if the audit firms provided a lot of non-audit services to the company, the audit firm would expect their clients operate successfully which would cause a good profits. However, as famous as Enron events, $2700m non-audit fee was given by Enron comparing with $2500m audit fee which made Andersen conceal Enron's financial position on purpose. Moreover, the close relationship between company and audit firm will also give a motivation to auditors to mislead investors in invest this company. This motivation came true on 24 Nov 2010 that Lords accuse auditors of deceiving investor in UK since the auditors conceal the true state of company (Accountancy Age, 2010).
The second main criticism of the audit profession is whether auditor undertakes the appropriate obligations to the public. Lehman Brothers is a good example to analysis what faults were made by auditors.
Lehman Brothers bankruptcy causes can be attributed to the internal and external parts. External reasons were the aggravated sub-prime crisis and defects of U.S. Financial Accounting Standards; internal factor was Lehman finance by 'Repo 105' which was described by Robert Pozen (2011) 'Lehman would swap some of its assets for cash with a third party, which would sell these assets back to the Lehman subsidiary for cash just after the end of the same quarter. To reduce the amount of debt on its balance sheet, Lehman booked these swaps as asset sales rather than borrowings.'
This financing method led Lehman has to undertake more and more liabilities, however this is not presented by its annual financial report.
As Lehman's audit firms, Ernst and Young provided an unqualified audit opinion for the Lehman's performance. Ernst and Young did not mention any information about 'Ropo 105', although in the annual continuously audit work and in the context of the financial crisis. The reason is Ernst and Young's self-confident of Lehman's credibility and integrity instead of audit evidence. So Ernst and Young should accept their audit fault.
Auditor's incompetent professional skill and moral defects, inadequate understanding of the customer's operations, defects of audit process and the auditor's fraud will all cause a bad influence of audit quality which would be result in audit failure directly. So there factors were always concerned and accused by critic.
The following point of views gathered from the audit profession to response the criticisms. According to Gray & Manson (2008, p.759) the criticisms could not just focus on the case of audit failure, most of them are successful, and business failure do not equal to audit failure. In fact, it is very difficult to identify what is audit failure, because the defective accounting standard and subjective audit regulations. Furthermore, reasonable expectations gap should be accept and it is difficult to judge what public interest is. ICAEW chief Michael Izza said that there is no direct evidences state that non-audit business will inflect audit independence. APC,APB's establish had an undeniable improvement for audit regulation and the number of auditors in APB was less than 50% which implied that APB could stand for audit independence in a sense.
In short, although the most of criticism are made by academic institutions rather than auditors, but it is objective. These criticisms inspired and promote the development of the audit profession. After Enron event, the United States president signed 'the Sarbanes - Oxley Art of 2002' which built up A Security And Exchange Commission (SEC) to supervise and manage the audit profession. After Lehman events, Financial Accounting Standards Board (FASB) released SFAS 140-3 in order to limit transfer and repurchase of financial assets. In general, more and more people begin to think about the audit's future, lots of new perspectives and revolutions came to be adopted, such as, established an independent organization to monitor audit firms and the result publish regularly; Audit firm change to carry out limited liability partnership; The reformation of accountant institutions consisting of representatives of all interested parties. According to Priddy (nd) company's audit services as well as non-audit services could not taken by the same audit firm etc. All in all, the audit profession trend to be more information transparency, professional judgment and independence in the future.