Auditing: Risk, Independence, Threats, and Case Studies Analysis

This report provides a comprehensive overview of auditing, focusing on audit risk, auditor independence, and the threats to independence. It defines audit risk and its components, control risk, component risk of material misstatements and detection risk, as well as discussing auditor independence, including independence of mind and appearance. The report explores various factors affecting auditor independence, such as audit fees and market competition. It details threats to auditor independence including self-interest, self-review, advocacy, familiarity, and intimidation threats, and also explores safeguards to mitigate these threats. The report also presents detailed case studies of major accounting scandals, including WorldCom, Enron, and Lehman Brothers, analyzing their causes and consequences, and the lessons learned from these failures, emphasizing the importance of ethical behavior, independent oversight, and improved auditing practices. The conclusion emphasizes the importance of auditing for organizational growth and the need for addressing threats to auditor independence and managing audit risk.

Auditing

Table of Contents
INTRODUCTION...........................................................................................................................1
MAIN BODY...................................................................................................................................1
CONCLUSION ...............................................................................................................................5
REFERENCES................................................................................................................................6

INTRODUCTION
Auditing is a process under which all the financial records are to check out as per the
certain set of standards, rules and regulations. Audit requires a professional individual who have
expertise in this field. A professional person who possess relevant degree of expertise, could do
audit. Audit is necessary in order to provide the transparency to the firm. Although, various
organisations appoint auditors from the outside who could so auditing on a frequent basis and
then make the report on the basis of findings. An Audit report provides full transparency to the
general public and this would lead to attract various stakeholders. As Audit plan covers the
decision-making process in the organisation (Ng, Chong and Ismail, 2012). The key objective of
the audit report is to confirm whether the organisation is complying all the auditing standards
while applying various accounting entries and financial reporting.
Audit planning includes decision making on the overall audit strategy and developing an
audit plan. The main aim of the project is to discuss the risk and independence in respect to key
audit risk and threats to auditor independence really lie. Under this project various case studies
have been discussed to show and resolve various accounting issue that arise during the audit
process (Sarkar and Sarkar, 2012).
MAIN BODY
Audit Risk, auditor independence and threats to auditor independence.
The audit risk may be defined as misrepresentation of financial reports, that means
business statements of a firm will be issued with material error even though if these reports are
checked by auditor itself (Greiner, Kohlbeck and Smith, 2013). Audit risk have three main
components are control risk, component risk of material misstatements and detection risk.
Detection risk is related to the terror that the auditor will not detect a mistake or misstatements.
Control risk is the warning that error done by auditing will circumferential control. At last
material risk, are those in which accountant intentionally terminate that the financial statements
are mistaken.
Auditor independence refer to the independence of the external auditor. Freedom of
accountant requires two main type of aspects such as independence of mind and independence of
appearance. Independency of mind in general means the state of mind that instrument of a belief
without having any effect of other that might be professional judgement, individual giving
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authority and exercise judgement and professed disbelief (Hicks and Nielsen, 2012). On the
other side it requires independency in appearance which means facts and factors are so
significant that provide a reason and information to the third party, knowledge of all relevant
information. It also includes safeguard applied, integrity, objectivity or vocation disbelief had
been open (Knechel and Salterio, 2016). It is clear that if standard trim metropolis risk slimly but
carry accidental consequences that harm the attribute of financial reportage or capital market
efficiency, they do not suffice the unrestricted curiosity.
Various audit attributes/concepts have been studied recently to determine their effect on
auditor independence. The impact of the proportion of fees received from audit services on
auditor independence has been a thing of concern to auditor during financial year. Brakes and
Urquhart indicates that the dependence on audit fees does not impair auditor independence. But
this could become a problem when a large proportion of the gross audit fee is received from one
client. The help to study and compare the perception of auditing and non-auditing professionals
about the determinants of auditor independence.
Competition present in audit market is consider as one of the major elements of
undermining the auditor independence. According to Beattie, Brandt & Fernery an environment
with a huge competition undermines independence of auditor. However, various studies depict
that market with high competition proves to be a positive event for auditing as it creates a
pressure of providing more effective services to customers.
The threats are present when an auditor shares a close relationship with its client. This
framework identifies threats and safeguard to the auditor independence. These frameworks are
given by the European standard and IFAC uses common approach for threats and safeguard. This
framework describes about five main threats related to objectivity or independence such as, self-
interest threat, which originated from a financial conflict that means an auditor acts in his or her
own financial, emotional or other personal interest. For e.g., an anxiety of losing a client or
having a direct or indirect interest from client. Self-review threat, which arises when an auditor
views an audit that is previously performed by them. It means when an auditor challenged his or
her work in order to reach audit conclusion. Advocacy threat arises when an auditor acts to be an
advocate against or in favour of client. This threat may seem to be contradictory with the
independence or objectivity (Jones, 2017).
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Familiarity or trust threat, it generally assumed when an auditor is affected by a
relationship that they have with their client. Or else, when auditor may blindly trust over the
management representation so as to be inappropriately stringent in investigating them.
Intimidation threat, it generated from an assumption that the auditor may get intimated by actual
threat or feared, either by a manger or director.
So, when an auditor finds out such threat as well as evaluate their importance, they
should analyse potential safeguard. These includes procedures firm which a firm must execute
for protecting auditor's independence, such as assessed through a consultant with designed
professional in a company or presented in front of audit committee. Safeguard includes
restriction over auditor's relationship with their customers, like a s ban on purchasing the client's
stock or assigning to firm of client whose family member are working at the client firm. Standard
setter should analyse the importance of threat as well as importance of actual safeguard to make
sure that their standard deducts the auditor risk of independence. If these any threats occur to an
auditor, its does’ mean they are not able to complete audit. Rather, safeguard is required to keep
at place for removing the threat and each safeguard should be written in the audit report. While
doing this it is very essential to consider a single circumstance which creates more than one
threat which are required to be addressed (Fiolleau, and et. al., 2013).
Failure of WorldCom, Enron and Lehman Bros.
WorldCom is said to be not about the biggest accounting scandal in the global level, but
also one of the major bankruptcies. It became the second largest telecommunication provider in
the united states that provide internet services and long-distance phone services. In July 2002, the
company faces one of the largest scandals at the international level. It was total worth of $41-
dollar liabilities increase and almost $107 in the assets. Total of $11 billion accounting fraud
over 3-year period and this is because of accounting misstatements of financial report,
managerial issue after the merges with sixty companies, and the failure of board to director
(WorldCom, 2018).
The accounting scandal was occurring in mainly two basic manners such as
understatements those are associated with the operating expenditure through proper capitalisation
cost recorded into the company’s overall financial statements. Secondly, WorldCom has earned
sufficient amount of profit in the last couple of 3 years. After the merge of management,
company not been able to examine how to operate and control revenues and credit limits during
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that particular time. It has been found that only one month after the auditors, Andersen was
found guilty in fraudulent of law for shredding matter those are associated with the audit of
Enron (Greiner, Kohlbeck and Smith, 2013). At the time, when the techs boom moves to bust
and most of the companies slashed into overall spending on Telecom sectors, WorldCom used to
resort to various accounting rules in order to maintain proper appearance of growing profitability
for the company. It is said to be the utmost essential part of the investment with total amount of
$3.3bn which is irregularity consistent during the manipulation of specific reserves. Companies
used to set aside various reserves that used to cover estimated losses which are uncollected
during from various kinds of customers those are involves as primary part of WorldCom.
It is essential for the WorldCom to considered long term aims and profitability rather than
the sort period of months while formulating the accounting reports. The board of directors was
the audit committee that had the obligation to communicate with the internal and external
auditor. In addition, the external auditor must come in with an objective, unbiased mind set and
audit the company with integrity, honesty and independence.
Enron was formed in 1932 by Omaha and operate in Houston Based energy product
trading and distribution. Company began tweaking the number in their financial statements with
accounting techniques to hide their losses. Enron created partnership and then passed the assets
(losses) to these partners which eliminated the losses from their balance sheet. Rather to face and
resolve the write-offs the company tries to hide them with various accounting techniques. Many
off-balance sheet loans collaborated by Enron stock and restatement, correction and new
disclosure, collapse of confidence in reporting and integrity of management this let to downfall
of company (Nicolăescu, 2013). Major reason of bankruptcy in Enron is a substantial fraction of
company reported profit over a 4-year period that had been the result of accounting
manipulation. It also let to misleading of accounts as management stated that company has
established SPEs to move assets and debts off its balance sheet and to increase cash flow. Once
SPEs It will borrow debts from banks and Enron would Guarantee that debt. There were many
reasons for bankruptcy in Enron like managers led to build empires and scarify profit, directors
fail to control management and there is lack of independence of board.
There were many lessons to be learned from Enron collapse, like expert panel have
assembled today on auditing and accounting practice. It helps an auditing professional to have an
independent oversight and strengthens auditing process within an organisation. Secondly, it helps
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in learning that audit quality can usually best be improved providing incentives, rather than
threatening punishment. The improve the internal control auditing reporting requirement and
grows the auditor-audit committee relationship is also important in fair and accurate financial
disclosure.
The failure of Lehman Bros. as the biggest bankruptcy case in the US history with $639
billion in assets and $619 billion in debt. It was the largest in history as its assets far surpassed
those of previous bankrupt giants such as WorldCom and Enron. The major causes to the crisis,
the market for credit default swaps(CODs), falsity of financial statements, complex structure of
the company, low standard and unethical behaviour of top management. Lehman Bros provide
loan to the client without knowing the fact of repayments, so it leads to shortage of cash flow in
the company. Some of the other reason were, company balance sheet was not properly
maintained, and the company has no buyer.
There were many lessons from Lehman Bros collapse that have been learnt by the
accounting profession such as market condition must be clearly and carefully examine and studied,
auditor of company don't overdo the value of stock or any other investments. They should read and
understand trends of market and should invest in high quality stocks. They should understand the
importance of financial stock as they are cheaper for a reason and provide loan and other services
with proper documentation (Jones, 2017).
CONCLUSION
In this essay report it is concluded that auditing is important for every organisation in
order to grow. It the process of examining an organisation financial records to determine if they
are accurate or not. Threats and safeguard to auditor independence in fact which are relevant to
outcomes. Audit risk and auditor independence are discussed with a view to understand the
importance of key audit risk. There are number of threats to auditor independence such as
Familiarity or trust threat, Intimidation threat etc. There are number of audit failure cases which
help accounting profession to learn lesson some of those are failure of Enron, WorldCom and
Lehman Bros.
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REFERENCES
Books and Journal:
Fiolleau, K., and et. al ., 2013. How do regulatory reforms to enhance auditor independence work
in practice? Contemporary Accounting Research. 30(3). pp.864-890.
Greiner, A., Kohlbeck, M. and Smith, T., 2013. Do auditors perceive real earnings management
as a business risk?
Hicks, M. A., and Nielsen Co, 2012. Methods and apparatus for auditing signage. U.S. Patent
8,315,456.
Jones, P., 2017. Statistical sampling and risk analysis in auditing. Routledge.
Knechel, W. R. and Salterio, S. E., 2016. Auditing: Assurance and risk. Routledge.
Ng, T. H., Chong, L. L. and Ismail, H., 2012. Is the risk management committee only a
procedural compliance? An insight into managing risk taking among insurance
companies in Malaysia. The Journal of Risk Finance. 14(1). pp.71-86.
Nicolăescu, E., 2013. Understanding Risk Factors for Weaknesses in Internal Controls over
Financial Reporting. Journal of Self-Governance and Management Economics. 1(3).
pp.38-43.
Sarkar, J. and Sarkar, S., 2012. Auditor and audit committee independence in India.
Tepalagul, N. and Lin, L., 2015. Auditor independence and audit quality: A literature review.
Journal of Accounting, Auditing & Finance. 30(1). pp.101-121.
Online
what is auditing. 2017. [Online]: Available Through:
<https://www.accountingedu.org/what-is-auditing.html>
WorldCom. 2018. [Online]: Available Through:
<https://www.referenceforbusiness.com/history2/10/MCI-WorldCom-Inc.html>
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