Discuss about the Audit for Financial Accountability & Management.
An auditor is responsible for this duty not only to the client but also to the third parties related to the client. His engagement letter has enough scope for the client and the third parties to claim damages in case of negligence by the auditor. Unprofessionalism and negligence are both unacceptable. Mistakes can be overlooked but only to a certain level. Beyond the tolerance limit of the client, the auditor should not make errors in auditing. Fraud is any day out of tolerance (Fazal, 2013).
In the given case, King and Queen have been the auditor of Impulse since 2005. Since they have been the auditors of the company since its formation, they prepared an unqualified report for the company. The company was going through liquidity issues. Its debtors and inventories position was already not sound, and to top it all, based on the auditor’s clean reports, EFL granted a huge loan to Impulse. In short, there was a crunch in the situation that was overlooked by the auditors (Heeler, 2009).
Debtors and inventories are the two most important components of a company’s current assets. They determine how strong a company’s liquidity position is. It provides a general explanation as to whether the firm is in a strong position to meet the obligations. So when EFL granted the huge loan, they would have first checked the financial statements and the auditor’s report of the company to come to the conclusion that the company’s financial position is sound and the loan can be granted to them (Cappelleto, 2010).
Now that the company’s intention to take up the loan is bearing its immediate cash needs and also debt servicing to a certain extent as is evident by the scenario, the company’s cash position is hugely misbalanced. There is the likelihood that the loan granted by EFL becomes irrecoverable. Therefore, King and Queen are liable to EFL. The entire report was audited King and Queen and hence, are directly responsible to EFL because the loan was granted based on the audited report.
Arthur Anderson was the auditor of Enron Corporation. The company had to suffer is the hands of the auditor and as a result, both the auditor and the company has to close down business. The company was declared bankrupt. Because of this many third party companies were so affected that they too had to declare themselves insolvent (Hoffelder, 2012). As a result, a huge setback was faced by the US economy back then. There have been many instances where the fraud and deficiency on the part of the management led to the downfall and liquidation of the company.
There have been cases in the past when auditors had to suffer huge penalties on account of fraud and breach of duty as auditors. The Linter group had sued Pricewaterhouse Cooper and the case settles for a whopping $ 320 million. The Australian Securitie4s and Investments Commission, on behalf of Adelaide Steamship, had sued Deloitte for the improper conduct of the audit, and charged Deloitte of fraudulent activities with respect to an audit engagement. Deloitte had to foot damages of $ 340 million.
The responsibility of an auditor to be diligent in his duties is an implied duty. It holds well even if not spoken expressly. This means that the auditor must perform the duty with due diligence and take all the necessary steps to ensure that the law is being complied. Undertaking an audit engagement in itself implies that the auditor will be fair and diligent in his work and will be independent of all bias from the client or third party, or any external force (Baldwin, 2010). Here, King and Queen being an audit professional, have it in their code of professional ethics that they shall always be fair in any audit engagement that they undertake and that shall be independent in expressing views on the financials of a company. The auditor has to watch out for frauds that the employees or management of the company undertakes. If it instead practices the same and hides the irregularities of the company, the entire point of getting accounts audited fails. Auditors are considered professionals of high technical knowledge and accounting understanding. Their opinion is relied upon. Whatever the result is provided, it is considered that the report is prepared with due diligence and an independent decision is framed.
Many major decisions are based on the auditor’s report. Therefore, it is of utmost importance that the auditor must provide due emphasis to the report preparation otherwise, it might lead to potential errors. When a third party refers to a financial statement, it is implied that the auditor must have seen and noticed the irregularities and hence decisions are formed. Here it is important to mention that the third party should always conduct its share of the investigation but depend on the Auditor’s statement is also not incorrect. Had EFL specifically written to King and Queen that they are intending to make a loan to Impulse and that they would base their decision on King and Queen Audit report, the responsibilities of the auditor would have been increased all the more. The auditors are liable to civil as well as criminal liabilities for the incorrect audit report which they have signed on. As the audit was undertaken by the auditors they are entirely responsible for the act and hence action needs to be taken on them.
Nonetheless, this in no case will reduce the responsibility of King and Queen, if EFL had expressly written to them to make sure their decision on providing a loan to Impulse based on the financial report circulated by them. It would have then been not only professional but also moral and social responsibility of the auditor to make sure the transaction undertaken by EFL is not detrimental to its financial health. Hence, King and Queen should be held guilty, and apart from the penalty and legal proceedings, it also can be asked to pay damages to EFL up to the amount lost by them. The above case clearly reflects that King and Queen were guilty and that the report led to major jerks for the EFL. Hence, King and Queen should be held responsible.
An audit is generally conducted to present an opinion that is reliable and free from any partiality or biases in judgment so that others can effectively use it for making informed investment decisions or use it for any other regulatory purposes (Livne, 2015).
Auditor independence can be stated as a reference to the freedom of auditors (internal or external) from parties that are having an interest of financial standard in the business where audit needs to be dome. In this case auditor, internal auditor or the external auditor, who is preparing the audit, should be free of any financial, personal or other undue influence in the business to be independent (Gilbert et. al, 2005). The auditor should prepare the report freely maintaining integrity, honesty and approach towards objectivity and without making any compromise related to the judgment. This independence can be actual and perceived.
The fundamental principles related to audit independence are Integrity, Objectivity, Competence, Confidentiality and professional behavior. The above principles guide the independence of the auditor (Gilbert et. al, 2005).
Actual independence is very straightforward and considers accounts only. This provides a general idea that the main focus is on the accounts and not related to other factors. This actual independence is hampered when there is any notable financial transaction other than required fees paid for audit services or any connection of personal relationship (Tepalagul & Lin, 2015).
Perceived independence looks into the relationship between auditor and the client and tends to investigate whether the auditor doing the audit is independent. This has a direct bearing with the other factors and the link between the auditor and the client bring emphasis. As per “APES 110 Code of Ethics for Professional Accountants,” it is said “When evaluating materiality, a member present in public practice or a firm stress on the qualitative and quantitative feature of the matter that is considered to have an adverse impact on the firm’s objectivity (Holland & Lane, 2012).
Here Bob who is an audit assistant of Club Casino, uses financial information of Club Casino while auditing the books of Club Casino. In this case, Confidential Client Information Rule under Section 1.700.001 of AICPA Code of Professional conduct is breached by disclosing information without authority which is specific. In this case, the audit assistant should have taken the consent of client to disclose client’s information. Client might not expect the member to use his information elsewhere without his knowledge and due permission; even if information is used in such a way that client cannot be identified. “Confidential Client Information Rule limits when and how the information may be disclosed. Furthermore, if the client information is considered confidential, the member would be in violation of the rule unless the client specifically consented, preferably in writing, to the disclosure or use of the information (Lapsley, 2012). The consent should specify the nature of the information that may be disclosed, the type of the third party to whom it may be disclosed, and its intended use”. So Clients consent as stated above is a must in order to discharge his professional responsibilities properly and in an effective manner (Mintz, 2014).
As per the given conditions of the present case study, Wendy has been the engagement partner on the Ace Limited audit for a number of years, performed the company secretarial duties for six months as entrusted upon him by the comp any management due to the retirement of Ace’s long-standing company secretary. As per “Guidance on the provision of non-audit services by the auditor of a company in terms of section 90(2) of the Companies Act, 2008 and in addition to the prohibition contemplated in section 84(5),” an appointed auditor must not perform related secretarial work for the company (Cameran et. al, 2016).
As per the present case study the question arises whether Leo who is assigned to the audit of Precision Machinery for testing the internal controls of the cash payments system, is in the place of making impartial opinion regarding testing the internal controls of the cash payments system as he is the eldest son of the factory foreman of the client. This is the case of Audit independence (Cameran et. al, 2016). At the same time, it attracts as per “Guidance on the provision of non-audit services by the auditor of a company in terms of section 90(2)” that an auditor must not be a person related to a person who is an employee of the company. Self-review and familiarity threat may arise in this case and re-evaluation may be conducted on the part of auditor due to the close relationship between them or removing the staff from audit assignment (Wright & Charles, 2012). Hence, when an auditor has an interest with the external parties it affects the decision-making process and this leads to tampering of the independent decision. Hence, it is advisable that the auditor should not have any financial pecuniary with the company or any external party.
Here professional ethics related to auditor’s independence is concerned. In this case there may be self-interest threat on the part of auditors of Chan & Associates accepting Furniture of Classic Reproductions Pvt. Limited, a large furniture wholesaler that is currently experiencing financial difficulties. Chan & Associates was also offered 25% shareholding in an unrelated listed company as “thank you” present as the furniture was only worth 50% of the balance. It should be maintained that the settlement of audit fees should be at par with the actual audit fee and not more than that. Area of risk, in this case, is financial interests which may affect audit opinion (Cameran et. al, 2016). The auditor should not have any financial interest as it destroys the independent decision and leads to big errors.
References
Baldwin, S 2010, Doing a content audit or inventory, Pearson Press.
Cameran, M., Prencipe, A. & Trombetta, M., 2016, ‘Mandatory audit firm rotation and audit quality’, European accounting review, vol. 25, no. 1, pp.35-58.
Cappelleto, G. 2010, Challenges Facing Accounting Education in Australia, AFAANZ, Melbourne
Fazal, H 2013, ‘What is Intimidation threat in auditing?’ viewed 2 December 2016, https://pakaccountants.com/what-is-intimidation-threat-in-auditing/.
Gilbert, W. Joseph J & Terry J. E 2005, ‘The Use of Control Self-Assessment by Independent Auditors’, The CPA Journal, vol.3, pp. 66-92
Heeler, D 2009, Audit Principles, Risk Assessment & Effective Reporting, Pearson Press
Hoffelder, K 2012, New Audit Standard Encourages More Talking, Harvard Press.
Holland, K. & Lane, J 2012, ‘Perceived auditor independence and audit firm fees’, Accounting and Business Research, vol. 42, no. 2, pp. pp.115-141.
Lapsley, I. 2012, Commentary: Financial Accountability & Management, Qualitative Research in Accounting & Management, vol. 9, no. 3, pp. 291-292.
Livne, G 2015, Threats to Auditor Independence and Possible Remedies, viewed 2 December 2016, https://www.financepractitioner.com/auditing-best-practice/threats-to-auditor-independence-and-possible-remedies?full.
Tepalagul, N. & Lin, L 2015, ‘Auditor Independence and Audit Quality A Literature Review’, Journal of Accounting, Auditing & Finance, vol. 30, no. 1, pp.101-121.
Wright, M.K. & Charles, J 2012, ‘Auditor independence and internal information systems audit quality’, Business Studies Journal, vol. 4, no. 2, pp.63-84.
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