Auditors Responsibilities and the Quality of Audit

This assignment discusses the responsibilities of auditors and the importance of quality audit. It includes stakeholder analysis, concepts of whistleblowing and independence, and lessons from the Enron scandal. The role of auditors in financial decision making is emphasized.

AUDITING
ASSIGNMENT

1
By student name
Professor
University
Date: 25 April 2018.
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Executive Summary
The quality of the audit plays a very important role in the modern era as it helps in determining many
financial decisions and therefore it should be understood that the sub-standard quality of the audit will
have a direct impact on the shareholders, other stakeholders and the auditors themselves. Keeping the
above aspect in mind, a report has been prepared on the topic Auditors Responsibilities and the Quality
of Audit. Stakeholder analysis has been done for one of the companies listed on the Australian Stock
exchange and the concepts of whistleblowing and independence has also been highlighted. The
learnings from the Enron scandal have also been enlisted and suggestions and recommendation has also
been given for to address the issues w.r.t. quality of audit.
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Contents
Introduction.................................................................................................................................................4
Discussion and Analysis...............................................................................................................................4
Key stakeholder analysis for an ASX listed company...............................................................................4
Whistleblowing and independence for auditors – concepts and explanation.........................................5
Key Lessons from Enron Scandal and the behaviour of the auditors (Arthur Anderson).........................5
Quality of Audit.......................................................................................................................................7
Conclusion...................................................................................................................................................8
References...................................................................................................................................................9
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Introduction
The auditor’s report serves as a reasonable assurance as to the quality of audit being conducted and
shows that the accounts of the company have been prepared without errors, omissions and material
misstatements. It has direct repercussions on the decision making by the stakeholders and hence it
warrants for due diligence and utmost importance. Greg Medcraft, Chairman of the Australian Securities
and Investment Commission (ASIC) has warned in one of his interviews that the auditors do need to
understand the responsibilities and conduct their jobs honestly and do ensure that the quality is not
being compromised (Bizfluent, 2017). Whistleblowing is one of the ways in which the employees and the
management can report the discrepancies in the organizations, the audit or reporting to one of the
teams in the organization so as to ensure transparency and avoid wrong doing.
Discussion and Analysis
Key stakeholder analysis for an ASX listed company
In the given section, a stakeholder analysis has been conducted for one of the companies listed on the
Australian Stock Exchange named Wesfarmers Limited. The company is a widely known conglomerate
which has its presence in Australia, New Zealand, India, Ireland and United Kingdom (Werner, 2017). The
company deals in chemicals, mining, safety and industrial products, coal mining, fertilizer and retail
sector. The company is the largest in Australia in terms of revenue as well as in terms of employment
giving work to over 220000 employees. The company has a history of over 100 years and is still growing
and has a presence in the lives of almost all the Australians.
In terms of the stakeholders, every company does have a unique set of internal as well as external
stakeholders who are interested in the results and performance of the company and the auditor’s report
serves as the basis of their economic and financial decision making (Visinescu, et al., 2017). The external
stakeholders may be in the form of banks and financial institutions, the government and the tax
authorities, the prospective customer and the shareholders/investors whereas the internal stakeholder
includes the employees, the management, the vendor and the existing customers and shareholders.
Each one of the above stakeholder group is engaged or interested in the set of financial statements for
their own reasons and if the same is materially misstatement and includes errors, frauds and omissions,
all their decisions may be wrong and they might suffer losses. For example, wrong picture of financial
statements and the auditor’s report may lead to wrong planning, budgeting, forecasting and financial
decisions by the Board of Directors, management group and might mislead the employees in terms of
growth and career options. Furthermore, the investors may also suffer losses and negative returns and
thus it may lead to erosion of capital. For the external stakeholders wrong or misstated financial
statements might lead to wrong tax calculation or under reporting of profitability and later on might
result in penalties (Chaudron, 2018). The prospective customers may later on find that the company is
not worth it and this might lead to losing of customers. The banks and financial institutions may not
agree to grant loan and financial assistance to the business once they come to know of the window
dressing as it leads to huge loss in terms of credibility of the company. The prospective investors are also
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on the losing side as they are unaware about the exact and actual situation of the company and thereby
end up on the losing side due to the wrong financial decision made based on the incorrect audit report.
Whistleblowing and independence for auditors – concepts and explanation
As per APES 110 on Code of Ethics for Professional Accountants, independence of the auditor is one of
the very basic requirements of the auditors and it is a pre-requisite which should be met for the quality
of the audit report (Defond & Lennox, 2017). It means independence not only in terms of the mind but
also in terms of the appearance. Independence of mind is a situation whereby the auditor is not
influenced emotionally or by any other means and gives his opinion on the financial statements of the
entity based on integrity, objectivity, professional judgement and applies professional scepticism before
reaching to any conclusion. On the other hand, independence in appearance means taking the decision
and preparation of the audit report based on facts and figures and taking actions which is reasonable
and would have been the same had it been conducted by the 3rd party. As per the conceptual framework
for the auditors, he/she should be independent in his/her approach or else it might lead to frauds,
errors, omission, etc. in the financial statements which might affect the stakeholder directly. The
auditors’ report serves as a guidance and it gives reasonable assurance to the investors that the financial
statements of the company are giving true and fair view of the state of affairs of the company and that it
has been prepared by the independent auditors with any prejudice (Fay & Negangard, 2017). In case the
auditors are involved in window dressing of the financial statements, this might lead to another scandal
like that of Enron.
Whistleblowing is one of the ways of reporting the wrongdoing in the company to a dedicated team
which helps in identifying the wrong doing and thereby reducing the chances of the fraud. It is a
situation whereby any employee, contractor, management personnel or supplier goes beyond the
normal course and channels of communication to report something unusual and suspicious to the
whistleblowing committee in the interest of the organization (Fukukawa & Mock, 2011). Normally, many
companies in the modern era set up the whistleblowing committee or else set up the processes to
report these kind of inefficiencies. In some cases, auditors do make the public disclosure as well as the
same highlights the possibility of fraud and errors in the organization and the lack of internal control as
well. The Code of Professional Ethics gives due importance to this fact and mentions that in case any of
the auditors do find that their fellow colleagues are involved in any such wrong doing, then the same
should be immediately highlighted to the audit committee or directly to the head of the audit
committee as the same is in public interest and it would help in avoiding frauds and mismanagement
(Kaufmann, 2017).
Key Lessons from Enron Scandal and the behaviour of the auditors (Arthur
Anderson)
Enron Scandal is still one of the biggest accounting scandal that has materialised till now and it led to the
erosion of $ 60 billion worth of shareholder’s wealth. The company was the one dealing in the energy,
commodities and services in USA. It was founded in 1985 and was bankrupt in 2001. It was the 7 th
largest company in USA at the time of its liquidation and employed nearly 30000 employees and has
reported a revenue of $ 101 Billion in the year 2000 (Linden & Freeman, 2017). In the year 2001, it was
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identified that the reported profits of the company were over and above the actual and the same was
effected by systematic and preconceived accounting and the then auditors Authur Anderson, one of the
reputed big 4 accounting and consulting firms failed to highlight these points in the auditors’ report.
Since then, both these entities have become infamous for audacious corporate fraud and corruption.
This is the only reason which put a question mark on the integrity and the accounting practices of many
big companies in USA and thereby leading to the emergence of Sarbanes Oxley Act, 2002. The shares of
Enron Company dwindled from $ 90.75 to $ 1 in the wake of this corruption as the company along with
the auditors Arthur Anderson inflated the profits as well as the assets in the books, ultimately leading to
the downfall of the company. Some of the major learnings from this entire episode are as follows:
1. Not to invest in anything which is not understandable or manageable: The Company Enron was
in the business of energy and utility sector but it made a huge investment in the derivatives as
well as commodity market. The investors clearly did not understand the business model of the
company and went just by the motion of the markets. The financial statements of the company
were complex and scandalous so much so that even world’s most successful investor Warren
Buffett was not able to understand and interpret the same. The company also used a number of
non GAAP entries in the financial books in a bid to hide the actual expenses and thereby
showing excessive and supernormal growth forecasts (Marques, 2018).
2. Understanding and taking appropriate measures to avoid counterparty risks: It was not only the
company Enron which suffered massively due to its liquidation but even the counterparties were
adversely affected as they not foresee the same earlier. The counterparty risk may be defined as
the risk to both the parties to the contract that the other party will not be able to meet the
obligations (Mubako & O'Donnell, 2018). Some of the most affected counter parties include the
creditors, banks and financial institutions and derivative counterparties who did not receive the
funds rendered as loan to Enron. Even the auditor, Arthur Anderson was one of the most deadly
affected counterparty as one of the 5 biggest consulting firms in US known for risk management
and high quality audits had to close down its operations due to the involvement in the Enron
Accounting Fraud.
3. Over use of the Debt in the capital structure can be risky: The use of excessive leveraging in the
capital structure of the company can act just like 2 sides of the coin. It can help in multiplying
the gains of the company if the value of assets is rising. Similarly, it can also lead to the erosion
of the wealth if the asset values are declining. The biggest concern with the use of the debt
capital is the fixed interest burden which has to be paid irrespective of the profitability of the
company and therefore the same should be used with utmost care (Appelbaum, et al., 2018). It
has been seen in the past that many companies like liquidation of Lehmann Brothers, WorldCom
and even the US housing loan bubble in 2007, all of which occurred due to excessive use of the
debt capital.
4. The investor should always avoid investing in the companies which employ fancy derivatives:
Enron was hugely dependent on the speculative income and had huge investments in the
derivative contracts which are quite uncertain in nature. Warren Buffett has mentioned these
instruments to be quite risky in nature which may even lead to the downfall of the company.
Besides this, the company was also involved in accounting practices like that of mark to market
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such that the profit from the derivatives was being accounted for even before they were being
accrued or realised (Raiborn, et al., 2016). Enron, being one of the major energy giants all over
the world at that of time, it can only be said that the excessive use of the derivative instruments
can also led to a massive downfall.
5. Management integrity is a must: For any organization to prosper and flourish, it is very
important that the proper and skilled management is a work. The best part about having a
quality management team is that it leads to proper allocation of the capital, minimising of risk
and multiplication of wealth (Lu, et al., 2017). Enron proves to a classic example for the same as
the investors cannot directly meet and check with the management about the operations of the
company and therefore they rely on the operations report of the company, the quarterly
investors’ conference, the insider trading transaction assessment, etc. and Enron failed in all
these aspects.
Thus, from all the points mentioned above, it is clear as to how big a role the auditors play in financial
decision making as it is their reputation and the audit report based on which the stakeholders take risks
and invest in companies. It thus becomes very important that they understand their responsibility and
not get involved in fraudulent practices.
Quality of Audit
The quality of audit plays a very crucial and important role as in the modern era all the economic,
financial and investment decision regarding any company is based on the opinion by the auditors. It may
be defined as the systematic examination of the books of accounts either by the internal or the external
auditor. It is also one of the basic requirements of the quality management system and is a major
constituent of the ISO quality standards (Vieira, et al., 2017). Audit are conducted with the objective that
the auditors after duly examining the books of accounts, will arrange for sufficient and appropriate audit
evidences based on which they will express and opinion on the financial statements and the same is
being used by the stakeholders for economic and investment decision making. The auditors are
responsible for giving reasonable assurance to the investors that the company is quite stable and that
the financial statements are free from errors and misstatements and are showing a true and fair view of
the affairs. For those who do not understand the financial statements, it is the auditor’s report based on
which the decision making is done. Therefore, it is very important to maintain the quality of the audit
and it will help in fostering the element of trust in the stakeholders. Some of the major objectives of
framework on the quality of audit are:
1. Encouraging the awareness of the stakeholders to suggest ways to improve the quality of audit.
2. Encouraging greater dialogue by the key stakeholders (Sonu, et al., 2017).
3. Increasing awareness on key topics of audit quality and its overall impact.
It was seen in the recent interview with Greg Medcraft, Chairman, Australian Securities and Investment
Commission (ASIC), that he warned the accounting and the auditing fraternity as a whole that in order to
avoid the accounting scandals like that of Enron and WorldCom, it is high time that the auditors do
understand their responsibility and the give a true and fair view on the audits conducted by them. It is
important to have professional scepticism all throughout the audit and give opinion based on sufficient
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and appropriate evidences only (Knechel & Salterio, 2016). They should highlight all the material
misstatements as well as the inefficiencies in the system such that there is an improvement in the
transparency of information. It has been mentioned in APES110 on Code of Ethics for Professional
Accountant that the most distinguishing feature of the accountant is to work in a responsible manner in
the public interest. Some of ways to improve the quality of audit are as follows:
1. Provision of useful and timely information to all the stakeholders.
2. Interaction and enquiry with the relevant stakeholders.
3. Exhibition of proper values, ethics and attitude at work as there is a huge responsibility towards
all the stakeholders and that they rely on the professional skills and judgement of the auditors.
4. Have sufficient knowledgeable and skilled people at work with experience so that they are able
to do the sufficient analytical review and then come to the conclusions thereof.
5. Application of the different audit procedures and the quality checks to ensure that the financial
statements have been prepared in accordance with the applicable financial framework and
requisite laws (Erik & Jan, 2017).
6. The auditors should be in continuous discussion with those charged with governance and should
be highlighting all the doubts and issues which they come across during the course of the audit
for proper justification and explanation.
7. They should practice professional scepticism and should have a questioning mind all throughout
the course of the audit and must check the management assertions, estimates and judgements
for any foreseeable risks.
8. There should be an audit planning and procedure phase well before the start of the audit such
that no critical and significant area of audit is being missed out. They should also be ready to
make the requisite changes in the audit plan, if required (Gerlach, et al., 2018).
Along with the above mentioned points, it should also be ensured that the proper support is rendered
by the management and the directors of the company to the auditors so as to improve the level of
transparency and audit as a whole.
Conclusion
From the above discussion, viewpoints and analysis of the various aspects of audit, we can conclude that
it is not only the auditors who are responsible for ensuring the quality of the financial statements but
even the management and accountants of the company should not involve in the fraudulent
malpractices and creative accounting techniques as it hampers the quality of information and ultimately
leads to the downfall of the company. From the perspective of the auditors, it is very importance to
practice professional ethics and be independent in their approach only then the quality of work and
audit report would improve.
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References
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