Audit Risk, Independence and Case Studies of Enron, WorldCom and Lehman Brothers

Auditing
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Table of Contents
Part 1................................................................................................................................................3
Audit risk.........................................................................................................................................3
Constitution of audit risk.................................................................................................................3
Auditor Independence......................................................................................................................3
Actual forces which losses independence of auditor.......................................................................4
Factors undermines the weakness of an auditor..............................................................................5
Part 2................................................................................................................................................5
Case of Enron...............................................................................................................................5
Case of WorldCom.......................................................................................................................6
Case of Lehman...........................................................................................................................8
References......................................................................................................................................10
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Part 1
Audit risk
Audit risk is the risk in relation to the fraud and material misstatement of the financial
statement of the corporations. This is a risk when the financial statement is materially
incorrect(Knechel, & Salterio, 2016).
Constitution of audit risk
Audit risk includes inherent risk, detection risk, and control risk. The equation of audit
risk is AR= IR*CR*DR.
Here, IR is an inherent risk refers to the risk of material misstatement takes place due to
error, omission and failure of controls. This risk is a result of factors which are not due to failure
of controls.
CR is control risk refers to the risk where misstatement may be occurred due to failure
and absence of effective control at place.
DR is detection risk under which auditor is not able to detect the material misstatement in
the financial statements.
Audit risk is a product of various risks which is encountered at the time of conducting
audit and need to be assessed the level of risk in relation to composition of audit to keep the
overall risk below the acceptable level. Each risk need to be managed effectively in order reduce
the overall risk.
Auditor Independence
Independence of an auditor is an external and internal auditor independence from the
parties of entity having financial interest in the business for which audit is conducted. Hence,
independence of an auditor is loose when the auditor has a financial interest in the business.
Independence of an auditor requires proper integrity and objectivity and carrying the work freely.
An auditor need to be independent so that true and fair picture of the financial affairs of
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Company can be revealed for the users and other interested parties. Independence of auditor is
also required to prevent any influence from relationship whether financial or non financial.
Auditor must provide unbiased and honest professional advice on financial statements.
Actual forces which losses independence of auditor
There are areas of risk which forces auditor to lose independence such as when Company
is undue dependent on audit client, when auditor directly or indirectly make loan to its client, or
involved in guarantees and overdue fees. If an auditor or any other member from its firm
receives benefit in the form of goods and services then it forces auditor to lose independence.
When auditor participate in the affairs and there is any litigation involved and any mutual
business interest is there then it forces auditor to lose independence.
The auditor may prepare some accounting for the fund to fulfil its personal fund
requirement. Hence it is always preferred to separate the work of audit and accounting
independently between two different partners or firm. When the auditor has large business
dealing from its one client then the independence of auditor is threatened as the auditor may not
provide a qualified opinion on the significant portion of the business (Jones, 2011). Issuing a
qualified report can also impact negatively on their referrals relationship. There is also ex-staff
and partners threat where the auditor leaves to start its own business and perform the function of
audit for the former client. This requires Company to carefully check the independence of the
audit firm by looking at every aspect and also on the familiarity between the audit and
accounting firm (Koch, Weber, & Wüstemann, 2012). The threat can also be there from advising
where auditor provides financial advice. The auditor can be distinguished in three level of ethical
recognition where it can lose its independence:-
Pre-conventional- When an auditor places its self-interest above the interest of society
and penalty attributes.
Conventional- When an auditor matches the rules of society and also sensitive to the
penalties attributes, it undertakes small or ignorable activities to earn some profits above the
salary.
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