Effects Of Mistrust Between Auditors And Public Accounting Essay

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The auditors contribute to the public by providing objective opinion and assessing the reliability of an organisation's financial report or the efficiency and effectiveness of various aspects of its performance. Previously, the public got considerable benefits from auditors' opinion and assessment. However, the number of litigations and accusations brought by the public against auditors is increasing in these decades. The relationship between the public and auditors is worsening, and this strained relationship has reached an unprecedented level after Enron's bankruptcy. In the first place, this problem is caused by joint fraud between corporations and auditors. Another reason is that a conflict of interest occurs when auditors provide auditing and non-auditing services for a company at the same time. More important reason is that an "expectation gap" exists between the public and auditors. This essay aims to examine the causes of the public's mistrust of auditors. It will then analyse the effects that have resulted from this troubled relationship, and evaluate some possible solutions.

A review of literature verifies three main causes contributing to the public's mistrust of auditors. The first reason is that auditors do not observe their professional ethics during auditing. There are a lot of cases in which auditors were involved in frauds committed by public companies, and each of those caused considerable loss to investors. For example, Arthur Andersen took part into Enron's financial fraud in 2001. It delivered an auditing report in favour of Enron instead of fulfilling its responsibility. After the exposure of the scandal, Enron's stock price decreased from $90 to nearly $1, costing the public more than $11 billion in this decrease (Benston 2003). The massive loss caused the public to question auditor's ethics and to be less confident about their performance.

The second reason is conflict of interest. Conflict of interest arises from provision of non-audit services by auditing firms for audited clients. It contributes to a great deal of mistrust from the public. In some cases, auditors play multiple roles at the same time: as an independent attester to the public and as an advisor to the management. On one hand, auditors should identify all major problems within financial statements. On the other hand, the management, who pay the substantial consulting fee, expects auditors to ignore financial statements manipulation. In the Enron case, Arthur Andersen received significant auditing fees and consulting fees, about $25 million and $27 million respectively. This amount accounted for roughly 27% of the audit fees of public clients for Arthur Andersen's Houston office (Healy & Palepu 2003, p.18). In this situation, because of the temptation of easy profits auditors may lose their independence. Therefore, when auditors are playing multiple roles, they are widely blamed by the public for negative implication for independence.

As the third reason maintained by Poter (1993), the increase in litigations against and criticism of auditors is owing to the failure of auditors to meet public's expectations.

The failure of living up to the public's expectation is defined as "expectation gap", describing the differences between what the public expect from auditors and what the auditing profession prefers the auditing objectives to be (Chandler & Edwards, 1996). Many studies identify several causes engendering the existence of the expectation gap (Zikmund, 2008).

The critical one is the public's poor understating of the complicated auditing functions.

The public's ignorance about auditing is likely to impose unreasonable expectations on auditors. The public believe that auditors are "infallible supermen", their performance should be perfect, and they should detect all errors of audited companies. The duty of auditors, however, is to make sure that companies' financial statements are true and fair representation of their actual position. In other words, auditors' job is not fraud detection, and they cannot identify all risks of a public company. For instance, Lehman Brothers Holdings Inc., a global financial-services firm, held a perfect auditing report, which was provided by Ernst & Young (one of Big Four). Yet, it collapsed suddenly in September 13, 2008. And its bankruptcy was caused by the sharp deterioration of the global economic environment, which was unpredictable. Thus, Humphrey (1993) had associated that the misconception of the auditing function results in the existence of expectation gap. The gap has led to the increased scale and frequency of litigation against auditors. The detriment of the auditing profession's standing with the public is aggravated by the persistence of a damaging expectation gap.

The mistrust, caused by above factors, has resulted in many adverse impacts on auditors and auditing profession. The most observable one is the negative effect on auditors' reputation, especially when the companies under auditing collapsed in the end (this is definite as "auditing failure" in auditing regulation). If an auditing firm lost its reputation, investors will not trust its auditing reports any more. It would lose business or even shut down. For example, Arthur Andersen, one of the five largest accounting firms in the world before 2001, provided auditing and consultancy for Enron. After the Enron's scandal, Arthur Andersen lost their majority of customers immediately and dissolved in a short period. Reputation is the primary standard of auditing regulation. The damage to auditors' reputation, resulting from the public's mistrust, is a death blow to auditing industry.

Turning to another effect of the mistrust, when the public make great losses in the stock market, they may take legal actions against auditors. Generally, bankrupted companies do not have extra money to compensate the investors. In this situation, if the public feel auditors have not fulfilled their duties, they may put blame on auditors. Then they will sue the auditing firms to pay the loss, because auditing firms have more money to compensate them. KPMG, another "big four" firm, had to offer one billion dollars as compensation to the public because of involving in bankruptcy of New Century Financial, (The Reuters 2009). Therefore the lawsuits caused by mistrust can be highly influential to the auditors. Even with the compensation, the relationship between the public and auditors is still strained

In order to regain the public's trust, some actions have been taken by auditors and auditing profession. In the first place, individual auditors should do more to recover the public's trust, such as keeping auditing report easy to read and exercising self-discipline to obey the professional ethics. All of these measures have positive impacts on both the public and auditors. For auditors, both the misunderstanding from the public and the number of litigations will be reduced. For the public, better understanding of the reports prepared by auditors can assist them to make the right decision on investment. With the efforts of individual auditors, the mistrust can be eased to a large extent.

In addition, government regulation is another effective solution to reduce public's mistrust. As a reaction of a number of major corporate and accounting scandals, which cost investors billions of dollars loss, some countries regulate auditors' behaviour by legislation. The most famous action is the actualization of Sarbanes Oxley Act. This act aims at protecting the public's interests and regulating the accounting profession. The act creates a new agency, the Public Company Accounting Oversight Board, to supervise, regulate, inspect and discipline auditing firms. Furthermore, this act also covers issues such as auditor independence. Consequently, the act plays a significant role in combating fraud, improving the reliability of financial statements and restoring investors' confidence in auditors.

The auditing profession believes that the increase in litigation against and criticism of auditors can be traced to the public's mistrust of auditors. The mistrust is detrimental to auditing profession as it has negative influences on the value of auditing and the reputation of auditors in modern society. It is found that the existence of the mistrust is by virtue of auditors' unprofessional behaviour, conflict of interest, and the expectation gap. To reduce the negative effects coming from the mistrust, such as unsavoury reputation and a great number of litigation, auditors need to obey the professional ethics and keep their independence from clients. Although auditors are endeavouring to recover the public's trust, their efforts alone are insufficient. The government also has taken part into remodelling auditors' image. The most famous action performed by government is the promulgation of Sarbanes Oxley Act. To conclude, researchers and auditors have responded, in one way or another, to the mistrust. However, given the current situation, it is likely that the mistrust of auditors will continue to be a major concern for years.