Financial Reporting & Auditing Research

This assignment focuses on a collection of academic research papers exploring various aspects of financial reporting and auditing. The papers delve into topics such as the impact of IFRS, the effectiveness of internal control systems, professional skepticism in audits, shareholder wealth maximization, and the relationship between audit fee pressure and audit risk. The analysis covers diverse perspectives from renowned journals like The Journal of Higher Education, Journal of Financial Economics, and Asian-Pacific Journal of Accounting & Economics.

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By student name
Professor
University
Date: 07 January 2018.
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Contents
Risk and Independence of Auditor and threats to Auditors Independence.................................................3
Failure of Enron, Worldcom and Lehman Bros............................................................................................6
References...................................................................................................................................................9
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Risk and Independence of Auditor and threats to Auditors Independence
Introduction
Auditors independence refers to the independence of the auditors from all such sources whether
internal or external that may have some financial interest in the company. These sources might
influence the overall audit and cause the auditor to falsify the audit results. It is thus important that
auditor must be unbiased and free from all such influence (Bena, Ferraira, Matos, & Pires, 2017). It is
very important for the overall validity of the audit engagement and helps in generating true and
accurate results on the financial standing of the company. A lot of importance have been placed on
making this fact clear and price that the auditor must be independent in his approach while conducting
the audit of an entity. There are various risk elements that possess a great threat to the overall
independence of the auditor. A detailed explain on the same is given below.
Analysis
Key audit risks refer to the risk that the financial statements may not be correct and fail to provide a true
and fair view of the position of the company. This occurs when there are some material misstatements
in the reports of the company (Alexander, 2016). The two aspects of audit risks are risk of material
misstatement and detection risk. Audit risks carry great liability for the auditors of the company as the
stakeholders depend on these audit reports to take vital decisions. It is the duty of the auditor to
safeguard the company from any such risks and provide the most accurate result possible.
The different areas of audit risks are self-review threat, where the auditor reviews the work that he has
himself done. In this the independence of the auditor is greatly affected, as people tend to find no
mistakes in the work that they themselves have completed. There are self-interest threats, where risk
lies in the auditors own personal interest in maligning the engagement (Belton, 2017). Referral
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relationships and threats from partners and ex-employees can hamper the independence of the auditor.
When the auditor provides advisory and other services to the client then also there is a risk of material
misstatement occurring. And the most common are the relationship threats which are existent in close
family relationships and business circle. It is thus needed that the auditor must declare their
independence in such cases so that the overall audit results are not hampered or influenced because of
any such relation or factor existing. In any case if the auditor is found taking undue advantage of his
position then he must be penalized and should not be allowed to work on any such engagement ever
again. If there are any such audit risks occurring then the auditor must place their safeguards and try to
dissolve the scenario in a manner that the engagement is not hampered (Carlin T. a., Resisting
compliance with IFRS goodwill accounting and reporting disclosures evidence from Australia, 2010) . It is
important that companies should check for the independence of the auditor before they are hired for
any engagement and should see to it that the same is stated factually. This will help in increasing the
confidence of the investors on the financials of the company.
The point of discussion being, where is point in which the real threat to audit risks and auditor
independence lie. This is to be understood that audit risks and auditor independence are closely related
to each other. The more the auditor is involved with the client, the more chances are there of
information solicitation and wrong doing. This increases the overall chances of audit risks. Thus, it is
important that auditors should make their stand clear, and should try to make their stand clear while
conducting an audit. In situations where there are more than one referrals they can have external
auditors or reviewers to conduct some work. They should not accept such engagements in which they
are having personal interest or their family members are involved (Chongsoo, Cheh, & Kim, 2017). They
should avoid working in multiple roles for the same client, for example if they are working as an auditor
they should not provide advisory or financial services.
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It is also the responsibility of the law framing bodies to ensure the implications of the same and make
sure that the auditors are functioning in an effective manner. As per the ICAEW, the most effective way
to ensure the independence of professionals is to provide them a framework that they must follow and
along with that there must be a blanket for non-financial services that should be out of the purview of
independence (Choy, 2018). This will help in ensuring proper flow of services and proper security can be
provided to the clients in the same manner.
Often there are situations where the client wants the auditor to falsify the audit report in return to extra
remuneration or monetary reimbursements. This is done to make the financial situation better for the
investors so that more people end up investing in the same. But as an auditor the professionals must not
indulge in such activities. They should conduct the audit and generate the audit report in such a manner
that they are free from all kind of outside influence (Chron, 2017). They must provide the true picture of
the company financials so that the people can take effective decisions based on the same.
Conclusion
Based on the above analysis it can be said that auditor independence has a lot of importance and more
than on paper it must be reflected in real life. This will prevent the companies from falsifying their
reports and will also help in reduction of the overall fraud that might exist. They key areas have been
highlighted in the discussion and special attention must be given to the same. Both the clients and
professionals are held responsible in case there is any case of breach of independence and strict
punishment is given (Félix, 2017). It is done to discourage the auditors from indulging in such activities
and helps in making the overall process of audit more transparent, and accurate. It also gives an
assurance to the investors on the authenticity of the audit reports and improves their overall credibility
and standing in the market.
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Failure of Enron, Worldcom and Lehman Bros
Enron Scandal
Enron once considered to be one of the most innovative companies of the world was shook by the
financial crises when it was caught in the accounting scandal which led to the drastic drop in share prices
from $90.75 to $ 0.26 within a day and then the company was named bankrupt. All this started when
Enron was involved in the dot com bubble and with the view to built the high speed broadband
netwroks invested hefty amounts of hundreds of millions of dollars was invested in the same (Defond &
Lennox, 2017). IT used to in the market’s most volatile segment and later on realised that the
investment made was a waste and not commensurate with the benefits derived out of it. In 200, when
the recession started, the investor and shaeholders were taken aback as they found themselves on the
losing side with declining market capitalization. It used to value its securities on market value instead of
the book value, a technique used to hide the financial losses. Also, as soon as any asset was taken or the
plant was built, it used to recognise the profits on account of it, even though it was not profitable. All
this led to the inflation of the profits (Heminway, 2017). Arthur Andeerson which was one of the Big 5 at
that time in US was known for high standards and quality risk management offered to stamp the annual
accounts of Enron despite poor accounting policies of the company as the partners of the accounting
firm were closely related with the officials of Enron. They all were involved in the scandalous changes of
conspiracy, securities fraud, insider trading and wrong reporting to the investors. This led to the
introduction of the Surbanes Oxley Act where the auditors were required to report as per SOX guidelines
and and this also ensured transparency.
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Worldcom Scandal
The telecommunication gaint is US, Worldcom gave rise to the second largest accounting scandal in the
world when it was reported with accounting misstatements in the financial statements worth $ 9 Bn.
This was on grounds of the escalated proifts which never existed and expense improperly recorded in
the books as capital expenses to increase the profits in the books. This was not being supported by the
relevant accounting supporting statements and the company was also involved in the manipulation of
the reserves on account of uncollected amounts from customers and pending lawsuits. This deferment
of the expenses led to the spread of the expnses over the period instead the same should have been
booked in the same year itself (Grenier, 2017). This inflated the Worldcom Profits. Again the auditors
involved here were the Arthur Anderson and Mr Sullivan wa accused of holding back the information
with himself and sharing the profits. The major lesson that can be learnt here is again the auditors were
not transparent and they were the one who should have highlighted this issue at the beginning itself but
it was a result only of the investigation process.
The company’s CEO Bernie Ebbers had the dream of growing company at the double digiyt growth rate
and has made a large number of acquisitions in the process but could not see the revenues and profits
rising as the result of it. So, he went with the idea of manipulating the accounts such that the increased
profits are being shown in books of accounts (Knechel & Salterio, 2016). The auditors said that they
were misled by the Worldcom’s Sullivan and admitted that they informed the company’s board earlier
itself that the audit information received by not trustworthy and also one of the statements said that
the line costs information was not being disclosed to the auditors. Also, the company admitted that the
expenses inappropriately recorded in 1999 and 2000 would be reinstated in 2001 and 2002 annual
accounts but the same was not recorded in the annual statements. The share prices as a result fell
below $1 in the history of Worldcom as a result (Visinescu, Jones, & Sidorova, 2017).
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Lehman Brothers
It is one of the largest Bankruptcy case filed in the history till date. It was the 4 th largest investment bank
in US at that time. It’s collapse during 2008 was one of the largest and swept around $ 10 trillion in the
market capitalization. In 2003 and 2004, it made the acquisition of five major mortgage lenders including
BNC mortgage and Aurora loan services. As a result of this, the company made huge profits first up and
the decision looked great increasing the capital markets by 56% between 2004 and 2006 and the firm
reached the stock price of $ 86.18, which was a record at that time but by 2007, it came to notice that
many lenders have defaulted on their payments on subprime mortgages and it was at 7 years high as a
result of which the share prices starte falling but the company continued to give a growth estimate
quarter on quarter and never tried to lower its portfolio of mortgage (Sonu, Ahn, & Choi, 2017). Backed
by the high degree of leverage, the share prices again started falling as it fell by 48%. IT also went into
repurchase agreements with Cayman Islands’s banks with the view to sell toxic assets to banks and then
repurchase it back fooling the investors and credit rating organizations. As a result of this book cooking
they has $ 50 Bn more cash in books and reduced toxic assets. This again was an accounting gimmick or
a fraud being used to report wrong financials and deceiving the investors and the same was not caught
in the scruting by the auditors (Saeidi, 2012). This fraud gives the lesson to the auditors that the
materiality aspect of the transaction needs to be checked properly and the same should be supported
and justified by relevant supportings which was left to be audited by the auditors. All in all it can be said
that these accounting firms need to increase the level of checking and materiality, follow and check
whether the SOX procedures have been implemented and tranaparency is being ensured (Sithole,
Chandler, Abeysekera, & Paas, 2017).
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References
Alexander, F. (2016). The Changing Face of Accountability. The Journal of Higher Education, 71(4), 411-
431.
Belton, P. (2017). Competitive Strategy: Creating and Sustaining Superior Performance. London: Macat
International ltd.
Bena, J., Ferraira, M., Matos, P., & Pires, P. (2017). Are foreign investors locusts? The long-term effects
of foreign institutional ownership. Journal of Financial Economics, 21-35.
Carlin, T. a. (2010). Resisting compliance with IFRS goodwill accounting and reporting disclosures
evidence from Australia. Journal of Accounting and Organizational Change, 6(2), 260-280.
Chongsoo, A., Cheh, J., & Kim, I. (2017). Do Value Stocks Outperform Growth Stocks in the U.S. Stock
Market? Journal of Applied Finance and Banking, 99-112.
Choy, Y. K. (2018). Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview
Analysis. Ecological Economics, 145.
Chron. (2017). five-common-features-internal-control-system-business. Retrieved december 07, 2017,
from http://smallbusiness.chron.com/five-common-features-internal-control-system-business-
430.html
Defond, M., & Lennox, C. (2017). Do PCAOB Inspections Improve the Quality of Internal Control Audits?
Journal of Accounting Research, 55(3), 591-627.
Félix, M. (2017). A study on the expected impact of IFRS 17 on the transparency of financial statements
of insurance companies. MASTER THESIS, 1-69.
Grenier, J. (2017). Encouraging Professional Skepticism in the Industry Specialization Era. Journal of
Business Ethics, 142(2), 241-256.
Heminway, J. (2017). Shareholder Wealth Maximization as a Function of Statutes, Decisional Law, and
Organic Documents. SSRN, 1-35.
Knechel, W., & Salterio, S. (2016). Auditing:Assurance and Risk (fourth ed.). New York: Routledge.
Saeidi, F. (2012). Audit expectations gap and corporate fraud: Empirical evidence from Iran. African
Journal of Business Management, 6(23), 7031-41.
Sithole, S., Chandler, P., Abeysekera, I., & Paas, F. (2017). Benefits of guided self-management of
attention on learning accounting. Journal of Educational Psychology, 109(2), 220.
Sonu, C., Ahn, H., & Choi, A. (2017). Audit fee pressure and audit risk: evidence from the financial crisis
of 2008. Asia-Pacific Journal of Accounting & Economics , 24(1-2), 127-144.
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Visinescu, L., Jones, M., & Sidorova, A. (2017). Improving Decision Quality: The Role of Business
Intelligence. Journal of Computer Information Systems, 57(1), 58-66.
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