Auditing Assurance & Compliance Assignment

This report discusses the importance of audit quality and the responsibilities of auditors towards public interest. It also highlights the concepts of whistleblowing and independence in line with APES 110 on Code of Ethics for Professional Accountants. The report also provides insights on the lessons from the Enron Scandal and the steps that are needed to be undertaken by the auditors to address the warning given by Greg Medcraft with respect to the Audit Quality.

AUDITING
ASSURANCE AND
COMPLIANCE
ASSIGNMENT

1
By student name
Professor
University
Date: 25 April 2018.
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Executive Summary
A report has been prepared on the topic of “Auditor’s Public Interest Responsibilities and the Audit
Quality”. The quality of the audit plays a very important and critical role in the decision making and so
the sub-standard audits are not acceptable as it is having a direct consequential risk for the stakeholders
including the auditors’ themselves. The report also highlights the key stakeholder analysis for one of the
Australian listed companies. It also focuses on the concepts of “whistleblowing” and “independence” in
line with APES 110 on Code of Ethics for Professional Accountants. Towards the end, the report
highlights few of learnings from the Enron Scandal and the steps that are needed to be undertaken by
the auditors to address the warning given by Greg Medcraft with respect to the Audit Quality.
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Contents
Introduction.................................................................................................................................................4
Discussion and Analysis...............................................................................................................................4
Key stakeholder analysis for an ASX listed company...............................................................................4
Concepts of whistleblowing and Independence for auditors..................................................................5
Lessons from the Enron Scandal and behaviour of Arthur Anderson, the auditors.................................6
Audit Quality............................................................................................................................................8
Conclusion.................................................................................................................................................10
Bibliography...............................................................................................................................................10
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Introduction
Audit quality plays a very instrumental and monumental role in decision making by the stakeholders. In
case the quality of audits performed is substandard, it is having a serious implication on the decision
making and poses numerous risks for the key stakeholders. Due importance should be given to
independence by the auditors and whistleblowing is the tool which needs to be used by the employees
and the management in case they see any discrepancies in the organization or audit or financial
reporting1. The Chairman of the Australian Securities and Investment Commission (ASIC) Greg Medcraft
did warn that the key of not having to face another Enron like accounting scandal and fraud is to make
sure that auditors do understand their responsibility and do their job honestly such that there is
reasonable assurance that the financial statements are free from frauds, errors and material
misstatements.
Discussion and Analysis
Key stakeholder analysis for an ASX listed company
The company which has been selected here for analysis is BHP Billiton. It is one of listed companies on
the Australian and the New Zealand stock exchange. It is an extensive retail conglomerate with second
largest turnover in Australia and New Zealand as well. It is also the largest takeaway liquor merchant in
Australia. It is one of the largest private employers in Australia with 205000 employees. It primary
operations include the super market chain, hotel, liquor retailing and pubs as part of the hotel and
leisure industry. The company has posted one of the largest losses in the year 2016 since it has been
listed mainly due to the major losses recorded in Big W business and write off of the Masters business
which failed miserably2.
The company has both the internal as well as external stakeholders who are interested in the results of
the company and the audit opinion by the auditors3. The internal stakeholders of the company mainly
include the employees, the board of directors, management, existing shareholders whereas the external
stakeholders include the government authorities, banks and financial institutions, the consumers or the
customers, the prospective investors and the suppliers, etc. All of these stakeholders are interested in
the financial statements and performance of the company for various reasons and if the material
misstatements is not being identified, disclosed or adjusted, the same will lead to various risks for each
of these stakeholders like for the employees, management and board of directors, it will present wrong
and incorrect financial information which will also have an impact on the management decision making
for the future course of action and planning, budgeting and forecasting for the upcoming year. The
1 F.K.Alexander, “The Changing Face of Accountability.” The Journal of Higher Education 71.4
(2016): 411-431.
2 D Arnott, et al., “Patterns of business intelligence systems use in organizations.” Decision
Support Systems 97 (2017): 58-68.
3 P. Belton, Competitive Strategy: Creating and Sustaining Superior Performance. Vol. 2. London:
Macat International ltd, 2017.
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existing shareholders would also get the distorted view and thus, it may result in wrong investment
decision and thus lower or even negative ROI4. From the perspective of the market and the external
stakeholders, the less tax may be paid to the government and the tax authorities if the window dressing
of the financials is being done to show less profit. The debtors as well as the creditors may be in the
wrong impression of the current affairs of the company and may later come to know that the same is
not worth it. The banks and financial institutions may also suffer a set-back as the collectability of the
funds becomes a major issue when the accounts is materially misstated as there are high chances that
the amount lent may be spilled over in case of liquidation. It also affects the future investors’ big time as
it may lead to wrong investment decision and they may suffer a loss5.
Concepts of whistleblowing and Independence for auditors
From the perspective of the audit and the auditors, independence means Independence of mind and
independence in appearance. Independence of mind means the state of mind not being influenced by
anything while giving an opinion on the financial statements. As per this, the auditor should apply the
professional judgement, act with integrity and objectivity and apply professional scepticism while giving
an opinion on the financial statements. Independence in appearance means taking relative and
appropriate action which is so reasonable that even the third party would have considered it in the
circumstances of the case6. As per conceptual framework as well as the Code of Ethics, the auditors
should remain independent in their conduct in the public interest and in case the same is being
compromised with anytime then it may lead to frauds, errors and omission in the financial statements
which may then lead to wrong decision making by the shareholders. The auditor should issue the audit
report accordingly as per the circumstances of the case as their actions and report provide reasonable
assurance to the investors on the financial situation of the company. If they are involved in fraud and
window dressing or crafting of the financial statements, it would result in the scandal like those of Enron
and WorldCom.
On the other hand, the term “whistleblowing” has become very popular in the corporate world off late
post the number of accounting scandals which have taken place. Whistle blowing is when the employee,
contractor, supplier or any person in the organization goes beyond the normal channels of
communication and to report any suspected wrongdoing at work and does speaks it in a confidential
manner in the interests of the organization. This can be done through the internal processes in the
organization or through setting up an external whistleblowing committee. Disclosure made in public is
also considered to be of interest to the auditors as it shows the possibility of lack in the internal control
of the organization and thus the possibility of fraud and errors. As per the Code of Ethics for Professional
Accountants this is of utmost importance and should be taken care off in the public interest and in case
4 H. Fukukawa, and T.J. Mock. “Audit risk assessments using belief versus probability.” Auditing:
A Journal of Practice & Theory 30.1 (2011): 75-99.
5 F.I. Lessambo, “Audit Risks: Identification and Procedures.” Auditing, Assurance Services, and
Forensics 3.1 (2018): 183-202.
6 Y. K. Choy, “Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview
Analysis.” Ecological Economics (2018): 145. <https://doi.org/10.1016/j.ecolecon.2017.08.005>.
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if any of the auditors do find it that the fellow colleagues are involved in fraud, mismanagement or
window dressing, the same should be reported to the audit committee or the head of the audit
department such that it is in the public interest7.
Lessons from the Enron Scandal and behaviour of Arthur Anderson, the
auditors
Enron scandal is one of the biggest accounting scandals and fraud that has taken place in all times. Its
impact has been magnanimous and it destroyed more than $ 60 Bn of the shareholder’s wealth. It was
the 7th largest company in USA at the point of its liquidation. It was also the largest bankruptcy in terms
of assets until then and has clearly been a poor investment as its shares declined from $ 90.75 to almost
$18. The auditors Arthur Anderson played a very major and instrumental role in the downfall of the
company as the wrong accounting techniques were being used to inflate the revenue as well as the
assets in the balance sheet and later on when the same was disclosed to the market, it led to the
downfall of the company. Few of the major learnings from this scandal are listed below:
1. Excessive leveraging in the company can be highly risky: Financial leverage is the use of the
borrowed funds to do the business and it is generally a two sided sword as it can multiply the
gains to the company if the assets values are going up and reduce the wealth of the company if
the asset values are going down9. On top of that, there is always a fixed burden to pay the
interest and therefore the same should be used amicably. There are numerous instances which
has led to bankruptcy for the companies due to use of excessive debt capital like that the
Lehmann Brothers, the WorldCom, US housing loan bubble and burst in 2007 and therefore the
lesson is to make use of the leverage adequately and that it is prudent to have the backing of
equity while asset purchase.
7 D.A. Appelbaum et al. “Analytical procedures in external auditing: A comprehensive literature
survey and framework for external audit analytics. .” Journal of Accounting Literature 40.1
(2018): 83-101.
8 C. Raiborn et al. “The internal audit function: A prerequisite for Good Governance.” Journal of
Corporate Accounting and Finance 28.2 (2016): 10-21.
9 S. Kangarluie and A Aalizadeh, “'The expectation gap in auditing.” Accounting 3.1 (2017): 19-22.
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2. Adequate liquidity is always the good thing: this is a very significant part of the corporates and in
case of Enron, this was the case when it was not able to meet the short term obligations on time
and hence had to liquidate. The primary reason for the same was lower levels of the working
capital and inadequate liquid assets to meet the short term obligations10.
3. Don’t invest in anything which is not understandable by you: Most of the investors in Enron did
not understand the model of business which the company employed into as it was into a lot of
commodity and derivative trading. The financial statements of Enron were scandalous and
ambiguous to such a high extent that even Warren Buffett was unable to understand the same.
The company also used a lot of non GAAP financial metrics in order to hide the actual expenses
of the company coupled with the excessive growth forecasting contributed to its fall.
4. Avoid investing in the companies which employ fancy derivatives: The Company was using
excessive derivative contracts and was hugely reliant on the speculative income from these
contracts which were quite uncertain in nature. Warren Buffett describes these financial
instruments as the “time bomb” as he assumes them to be quite risky in nature. Furthermore,
the company was also involved in the mark to market accounting scheme where they were
recording the profit from the derivatives even before they were earned and accrued. This could
10 M.L. Defond and C.S. Lennox, “Do PCAOB Inspections Improve the Quality of Internal Control
Audits?” Journal of Accounting Research 55.3 (2017): 591-627.
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have played a very major role had the profit not been realised11. All said and done, Enron was
the only company in the energy sector at that point of time to declare the bankruptcy and the
major reason for the same was excessive use of the derivative instruments.
5. Understand and access the risks from the counterparty: It were not only the shareholders of the
company which suffered the losses but the counterparty as well as they did not access the
counterparty risk when they were entering into the contract with Enron. It is defined as the risk
to both the parties of the contract that the opposite party will not meet the contractual
obligations. Some of the counterparties who suffered the most are derivative counterparties,
creditors of the business, the banks and the financial institutions which have rendered loans to
the group12. One of them was also Arthur Anderson, the auditor of the company which was one
of the 5 largest firms in USA at that time and had high reputation for risk management and high
quality operating standards. Its involvement in the accounting fraud is undisputed and it is for
this reason that the firm has to close its operations within 6 months of the Enron Scandal.
6. The Importance of Management Integrity Cannot Be Understated: It is pertinent and very
important to have a quality management at the helm of the business. Good managers with good
capital allocation skills can contribute a great deal to the success of the organization, on the
other hand, the bad management can lead to bad results. Enron does proves this. It is difficult
for the investors to check in and meet the management officials directly and so there are 3
techniques to examine them and monitor their performance13. The first of it the quarterly
investor conference call where they should be willing to answer any and every question, the
next is assessment of the insider trading transaction and the last tool is to monitor the
executives of the investees in the broader media level.
From the above episode it was also very much clear that how important and bigger the role the auditors
play as it is the reputation and report of the auditors on which the investors as well as the other
stakeholders rely on when they are unable to understand the financial reporting and its constituents 14. It
is therefore their responsibility to not get involved in any corrupt practices and do actual reporting.
Audit Quality
Audit quality may be defined as the systematic examination of the books of accounts which may be
carried out by the internal or the external auditor. It is the requirement of the quality management
system and is one of the key elements of the ISO quality system standards. The very objective of the
11 R. P. F. Marques, “Continuous Assurance and the Use of Technology for Business Compliance.”
Encyclopedia of Information Science and Technology (2018): 820-830.
12 B. Guragai, “Accounting Information Systems and Ethics Research: Review, Synthesis, and the
Future.” Journal of Information Systems: Summer 2017 31.2 (2017): 65-81.
13 I.D. Dichev, “On the conceptual foundations of financial reporting.” Accounting and Business
Research 47.6 (2017): 617-632.
14 F. Saeidi, “Audit expectations gap and corporate fraud: Empirical evidence from Iran.” African
Journal of Business Management 6.23 (2012): 7031-41.
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audit of the financial statements is that the auditor will arrange for sufficient and appropriate audit
evidences so as to express an opinion thereof on which the investors and the other stakeholders would
rely upon and take decisions accordingly15. The role of the auditors is very crucial and critical with
respect to the credibility of the financial statements as it ensures financial stability and for those who do
not understand or are unsure on what has been reported in the annual report of the company, it is the
auditor’s report which forms the basis of the decision making and it is therefore very important to
maintain the quality of the audit. As per the accounting bodies over the world, audits can help foster the
trust in the quality of the audits as it raises some of the pertinent questions which are relevant in the
circumstances of the case. Some of the major objectives of the framework on audit quality are:
1. Raising awareness on the key elements that contribute to the audit quality
2. Encouraging the key stakeholders to come out with the ways that would aid in improving the
quality of the audit.
3. Facilitation of the greater dialogue by the key stakeholders on this topic16.
We have seen that the former Chairman of the Australian Securities and Investment Commission (ASIC)
Greg Medcraft warned that in order to have no more Enron like accounting scandals the auditors need
to understand their responsibility and ensure that they are doing their jobs responsibly and give a
reason able assurance on the financial statements audited by them based on the sufficient and
appropriate audit evidences collected by them17. They also need to highlight the material misstatements
and inefficiencies in the system, if any so that the informed decision can be taken by the investors and
the other stakeholders. The Accounting Professional and Ethics Standards Board (APESB) mentions in
APES110 on Code of Ethics for Professional Accountants that the most distinguishing feature of an
accountant is to accept the fact that they need to work responsibly in the public interest. Some of the
ways to ensure the quality of the audit by the engagement team is as follows:
1. Exhibit the appropriate values, professional ethics and the attitude which is required at work as
they have a huge responsibility towards all the stakeholders who rely on their professional skills
and judgement.
2. Providing the useful and timely reports and information18.
3. Have sufficiently knowledgeable, skilled and experienced people at work and give them
sufficient time to do the analytical review and come to the conclusion thereon.
15 V. Trieu, “Getting value from Business Intelligence systems: A review and research agenda.”
Decision Support Systems 93.1 (2017): 111-124.
16 S. Sithole, “Benefits of guided self-management of attention on learning accounting.” Journal of
Educational Psychology 109.2 (2017): 220. <http://psycnet.apa.org/buy/2016-21263-001>.
17 F.T. DeZoort and P.D Harrison. “Understanding Auditors sense of Responsibility for detecting
fraud within organization.” Journal of Business Ethics (2016): 1-18.
18 A.L. Meroño-Cerdán at al. “Risk aversion, innovation and performance in family firms.”
Economics of Innovation and new technology (2017): 1-15.
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4. Application of the rigorous audit procedures and checks and apply quality control procedure
which are in line with the applicable financial framework, the laws and the regulations.
5. Interact and enquire with the relevant stakeholders.
6. They should be engaging with those charged with governance for any and every doubts and
highlight them to the forum for proper justification19.
7. They should critically access the financial statements and must have a questioning mind and
thus professional scepticism in order to check and validate the appropriateness of the
accounting estimates and management judgements. They should not readily accepting the
explanation and representations from the management without challenging the issues.
8. They should have effective audit planning and implement the same thereon to address the
findings. They should also be ready to revising it from time to time to ensure that they are
effective20.
Furthermore, it is not only the auditors who are responsible for ensuring the quality of the audit but the
management as well as the directors of the company as well who should be supporting the audit
process by providing appropriate and sufficient support to the auditors on a timely basis21.
Some of the very important and critical aspects to be taken care of for ensuring the quality of audit are
sustainability of the reviewers of the audit findings and supporting, the coverage of the review, how the
review and reporting is being done and the audit working papers are being prepared, are there any
remedial action which has been suggested and are they being taken into consideration. All this should
be signed off.
Conclusion
From the above discussion and analysis, we can conclude that it is not only the malpractices of the
company and the management and the creative accounting practices that lead to the downfall of the
companies like Enron and WorldCom but the involvement and non-adherence to the professional ethics
and practice by the concerned auditors which lead to the bankruptcy and liquidation. The auditor report
being one of the most critical decision making document, should be prepared with utmost accuracy and
that the quality of the audits should be ensured. Whistleblowing committee can one of the most
effective ways in which such malpractices can be highlighted.
19 M. Jefferson, “Energy, Complexity and Wealth Maximization, R. Ayres. Springer, Switzerland .”
Technological Forecasting and Social Change (2017): 353-354.
20 G. Mubako and E. O'Donnell. “Effect of fraud risk assessments on auditor skepticism:
Unintended consequences on evidence evaluation.” International Journal of Auditing 22.1
(2018): 55-64.
21 J.M. Heminway, “Shareholder Wealth Maximization as a Function of Statutes, Decisional Law,
and Organic Documents.” SSRN (2017): 1-35.
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Bibliography
Alexander, F.K. “The Changing Face of Accountability.” The Journal of Higher Education 71.4 (2016): 411-
431.
Appelbaum, D.A., A. Kogan and M.A. Vasarhelyi. “Analytical procedures in external auditing: A
comprehensive literature survey and framework for external audit analytics. .” Journal of
Accounting Literature 40.1 (2018): 83-101.
Arnott, D, F Lizama and Y Song. “Patterns of business intelligence systems use in organizations.” Decision
Support Systems 97 (2017): 58-68.
Belton, P. Competitive Strategy: Creating and Sustaining Superior Performance. Vol. 2. London: Macat
International ltd, 2017.
Choy, Y. K. “Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview Analysis.”
Ecological Economics (2018): 145. <https://doi.org/10.1016/j.ecolecon.2017.08.005>.
Defond, M.L and C.S Lennox. “Do PCAOB Inspections Improve the Quality of Internal Control Audits?”
Journal of Accounting Research 55.3 (2017): 591-627.
DeZoort, F.T and P.D Harrison. “Understanding Auditors sense of Responsibility for detecting fraud
within organization.” Journal of Business Ethics (2016): 1-18.
Dichev, I.D. “On the conceptual foundations of financial reporting.” Accounting and Business Research
47.6 (2017): 617-632.
Fukukawa, H. and T.J. Mock. “Audit risk assessments using belief versus probability.” Auditing: A Journal
of Practice & Theory 30.1 (2011): 75-99.
Guragai, B, “Accounting Information Systems and Ethics Research: Review, Synthesis, and the Future.”
Journal of Information Systems: Summer 2017 31.2 (2017): 65-81.
Heminway, J.M. “Shareholder Wealth Maximization as a Function of Statutes, Decisional Law, and
Organic Documents.” SSRN (2017): 1-35.
Jefferson, M. “Energy, Complexity and Wealth Maximization, R. Ayres. Springer, Switzerland .”
Technological Forecasting and Social Change (2017): 353-354.
Kangarluie, S and A Aalizadeh. “'The expectation gap in auditing.” Accounting 3.1 (2017): 19-22.
Lessambo, F.I. “Audit Risks: Identification and Procedures.” Auditing, Assurance Services, and Forensics
3.1 (2018): 183-202.
Marques, R. P. F. “Continuous Assurance and the Use of Technology for Business Compliance.”
Encyclopedia of Information Science and Technology (2018): 820-830.
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Meroño-Cerdán, A.L., C Lopez-Nicolas and F.J. Molina-Castillo. “Risk aversion, innovation and
performance in family firms.” Economics of Innovation and new technology (2017): 1-15.
Mubako, G. and E. O'Donnell. “Effect of fraud risk assessments on auditor skepticism: Unintended
consequences on evidence evaluation.” International Journal of Auditing 22.1 (2018): 55-64.
Raiborn, C, J.B Butler and K Martin. “The internal audit function: A prerequisite for Good Governance.”
Journal of Corporate Accounting and Finance 28.2 (2016): 10-21.
Saeidi, F. “Audit expectations gap and corporate fraud: Empirical evidence from Iran.” African Journal of
Business Management 6.23 (2012): 7031-41.
Sithole, S., “Benefits of guided self-management of attention on learning accounting.” Journal of
Educational Psychology 109.2 (2017): 220. <http://psycnet.apa.org/buy/2016-21263-001>.
Trieu, V. “Getting value from Business Intelligence systems: A review and research agenda.” Decision
Support Systems 93.1 (2017): 111-124.
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