Collusion In Auditing: Investigation And Recommendations

Methodology

Discuss about the Collusion in Auditing : Investigation and Recommendations.

The key motivating factor to drive this research was the intent to learn whether the corporate entities in Australia are following ethical practices in accounting. In the research, focus has been given to obtain information regarding the personnel responsible for the various accounting frauds pertaining to the corporate companies and the effects created on the various stakeholders (Onyebuchi, 2011). The research also intends to identify the different ways through which the managers and the auditors collude for failures in ethical audit practices (Pagano & Immordino, 2012).

Are managers and auditors colluding against the owner in Australian auditing practices?

The research methodology focuses on the manner of collecting the required information to gauge the intents of the study. In this research, secondary sources of data has been used to gather evidence from multiple case studies.

In the recent decade, many companies have been reported to suffer due to conspiracy of the managers and the auditors in Australia. Most of these reports were published in newspaper reviews and other online sites, which have been used as data sources for this study. A few of the recent examples of accounting scams witnessed in Australia include, the Dick Smith scam, Bankasia collapse and Westfarmer’s collapse (Keall, 2016; Mofatt, 2012; Parker, 2016). These examples have been used as case studies in this report, which also helped in drawing comparisons for analysis in this study.

The research is exploratory in nature that aims to obtain a clear understanding of the impacts of collusion between the managers and the auditors, which in turn inhibits the owners’ interests in the business, with due significance to the Australian market trends. The benefit of using secondary materials in this study is that only valid and reliable information about collusion between managers and auditors were examined within the Australian context, which has apparently stirred a debate in the society.

Moreover, the information available through these sources helped to decode the impacts of such collusions the economy and the investors at large. Collection of information through these secondary sources further contributes to the time as well as cost efficiency of the study, besides ensuring adequate flexible in the process (Wrenn, Loudin & Stevens, 2012). To incorporate the information in a systematic and objective oriented manner, the multiple case study method is a recognised way of drawing inferences through document analysis.

Theoretical Framework

This study utilises the behavioural agency theory to understand the collusion between the managers and the auditors within the Australian context and suggest remedies to the situation. The behavioural agency theory focuses on the need of following ethical practices on part of the executives, so that the interests of the shareholders are maintained. It can be performed by creating an intrinsic motivation in the executives, rather than focusing solely on extrinsic motivations (Pepper & Gore, 2012).

The  behavioural agency theory is commonly used to define the corporate governance principles of an organisation, in alignment with the roles and responsibilities bestowed on its leaders and managers ( Pepper & Gore, 2012). This theory pays highest attention towards the intrinsic motivation needs of the business leaders to take ethical decisions in the best of the interest of the company and all its stakeholders, which also includes its owners(Pepper & Gore, 2012). It plays a crucial role in determining the compensation for these decision makers to a business, which in turn may prove useful to restrict chances of collusion between the managers and auditors. It has certainly emerged as an issue in the modern business field, whereby this approach may contribute towards enriching the morale of the managers towards the business and the organisational stakeholders, which would in turn ensure the owners’ interests in the long run (Pepper & Gore, 2012).  

According to Fiocco & Gilli (2015), collusion between the business entities and the regulatory agencies is quite likely to result in reporting of false financial statements. Inefficiency on part of the auditors in detecting the flaws of financial statement is also responsible for accounting frauds. Pagano & Immordino (2012) asserted that the auditors often collude with the managers in order to simplify the auditing process, which increases chances of biases and misrepresentation of the financial reports. Baglioni & Colombo (2011) extended on the issue that the root causes of imperfections in the process of auditing are the mistakes encountered on part of the auditor or collusion between the auditors and the managers. The chances of collusion reduce if the managers intend to keep a watch on the efficiency of the audit process or if the responsibility of auditing is passed over to the external auditors. In this regard Burlando & Motta (2014) argued that collusions often occur on part of the auditor, which can create an effect on the costs of production and the policies of outsourcing used by a company, further affecting its profitability at large. Managers should be aware of their responsibilities towards the company owners and stakeholders, which would in turn depict their strong moral towards the organisation, minimising their involvement in a possible collusion to a substantial extent.

Literature Review

Luo & Zhu (2013) argued that collusion between the auditor and the manager takes place when the auditor realises that the benefit of the collusion is larger than the penalty. These types of collusion lead to distortion of the market price and the financial reports that in turn gives incorrect information about the company’s performance to the investors. However, collusion can be prevented if the auditing responsibility is passed over to the external auditors, which minimises the risks of biases in financial reporting to a certain extent. According to Kasim & Hogson (2012), the involvement of external auditors can help in mitigating and detecting the fraudulent practices within the organisation, which also involves the chances of collusion between the managers and the auditors. Guha (2012), on the other hand, argued that external auditors can also fall victim to the collusion chances that in turn indicates to the stronger need for a behavioural approach to define managers’ moral towards the organisation and its stakeholders. Chou, Xu, Anandarajan & Valenti (2012) were also of the view that the policies of the client company and the auditor are at times responsible for unethical auditing practices.

Contextually, Jo & Mallick (2011) observes that the auditors prepare the financial statements as per the requirement of the client that in turn affects the interest of the investors too, which are although expected to discourage such conducts, often fail owing to the greater compensation auditors and managers retain through collusion. According to Chan & Vasarheyli (2011), collusion can lead to omissions, frauds and material errors. Auditors often deviate from the principles of objectivity and independence while entering into collusion with the managers and are to be blamed to the absence of moral principles followed by both the auditors and the managers (Kung & Huang, 2013).

Extending further on the issue, Okolie (2014) stated that in the absence of auditor independence, the authenticity of the audited financial report reduces substantially, which in turn gives rise to the rates of fraudulences, litigations and business failures, with concerns regarding the quality of auditing. Rawasdeh (2013), in support of this view, observes the growing number of scandals being reported in the recent decade, which have increased doubts regarding the effectiveness of the auditing processes and principles, in determining the authenticity of the financial statements. According to Khalil, Lawaree & Scott (2015), instances of accounting frauds have increased the need of monitoring the tasks of auditing, while Momani & Obeidat (2013) argued that ethics act as the key driver to the aptness of the process altogether. Overall, as Carnegie & O’Connell (2014) purport, the recently observed scandals of accounting clearly underline the cases of failures in the auditing tasks. These scandals have caused immense losses to the investors, often leading to the forced liquidation down of many companies. The alternative for this is to make a change in the corporate governance strategies that can prevent misrepresentation in the financial statements (Gherai & Balaciu, 2011).

A recent case of accounting scandal witnessed in Australia was that of DickSmith. Investigations to the accounting scandal revealed that Delloite, a leading auditing company, had approved the DickSmith’s financial report as on 2014/15 to be free from manipulations, which was untrue and erroneous, thereby leading to auditing fraudulency. It was also alleged that Delloite was involved into the manipulation in the inventory records of the company, which in turn fuels doubts regarding a possible collusion between the auditors and managers in this case (Keall, 2016).

The company further affirmed that there was a need of reducing the amount of inventory by $60 million in November, 2015. However, there was no such evidence of reduction in the inventory abiding by the accounting policies as per AASB, which should have been recorded or investigated in the auditing process. This reflects the inefficiency of the auditors in detecting the correct amount of inventory of DickSmith and a certain occurrence of collusion between the managers and the auditors, which apparently affected the interests of the stakeholders to the company (The Conversation Media Group Ltd., 2016).

Wesfarmers

Another example of accounting scandal recorded in the recent decade is the criticisms witnessed by Wesfarmers. Contradictory to the case of DickSmith, this case implied a positive view towards the auditing practices. According to the case facts, the acquired subsidiary of Wesfarmers, i.e. Target, was accounted for recording an inflated amount of earnings in the mid year financial records as on 2015. It was later identified as a breach to the company’s financial reporting policies, subjected to judiciary actions to be taken against the responsible managers of the subsidiary (Smyth, 2016). This particular occurrence indicates to a good practice of auditing, wherein collusion between the auditors and the managers was absent, thus resulting in the appropriate conduct of financial reporting.

Banksia

The third case that attracted critics from the global platform was that of the collapse of Banksia. Following an in-depth investigation, the auditors were held responsible by the Australian Securities and Investment Commission (ASIC) to fail to detect the actual conditions of the loan book of the client (Bankasia) that involved loan transactions amounting to $500 million (Australian Securities & Investment Commission, 2014). With the misrepresentation of the fact, the company was valued at a higher price than its actual worth, thereby misleading the investors. However, on the disclosure of this fraudulence, the company was led to its ultimate collapse in 2012, making its investors suffer a loss of $660 million. The ASIC further stated that most of the auditing tasks conducted for the company lacked proper evidence, which fuelled suspicion regarding a possible collusion between the managers and the auditors (Wilkins, 2014). This negligent attitude demanded the need of penalty to the auditors and the directors of Bankasia (ABC, 2016). The auditor was also held responsible for imperfect auditing in the subsidiaries of the Banksia group that included Securities Hodolco Limited and Cherry Fund Limited, as the auditing standards were not at par with the Corporations Act (2001) (Australian Securities & Investment Commission, 2014).

Discussion

As can be observed from the findings obtained through the case study reviews, it can be argued that in one of the two referred cases of accounting fraud, no collusion was observed between the managers and the auditors. It was in this case that the auditors had delivered authentic reports of financial misstatement and assist in taking judiciary measures against the guilty. While in the other two cases, the auditors and the managers were found to have deceitful intents and were colluded or were ignorant to their bestowed responsibilities. It directly implies that the moral concerns and responsible attitude of the auditors as well as that of the managers impose a crucial impact on the chances of accounting misstatements that in turn affects the interests of the owners to the company. It also implies that by encouraging moral behaviour amid the auditors and the managers, possibilities of financial misstatements owing to collusions between these two parties can be reduced to a more sustainable extent (Keall, 2016; The Conversation Media Group Ltd., 2016; Smyth, 2016; Wilkins, 2014; ABC, 2016; Australian Securities & Investment Commission, 2014).

It is in this context that the behavioural agency theory can be applied to the context, emphasising its notion of principle-agent relationship. With regards to the auditing process, the principle is referred to the owners and the agents are the auditors as well as the managers, who are bestowed with the responsibilities to perform on behalf of the owner (the principle). According to this notion, although a degree of decision making power is allowed to the agents, the major right is restricted among the owners, who can decide upon the compensations to be enjoyed by both the agents on performing their responsibilities in the best of the owners’ interests.

Trust is a vital factor in this regard, which is often deemed as defined by the compensation assured by the principles to the agents. Therefore, it is essential to understand the expectations and the motivation needs of the auditors as well as that of the managers, in order to ensure a higher degree of moral among them towards the owners, which in turn will inhibit their intentions to collude against the owners (Burns & Needles, 2014).

Conclusion

The findings and the discussion results, as presented in the above sections of the paper, depict that auditing practices in Australia are affected by the rising incidents of collusion between the auditors and the managers. Intentionally or unintentionally, it does affect the owners’ interests, financial fraudulences mostly lead to corporate wind-ups. In the entire context of auditing practices of Australia thus, auditing transparency and moral concerns of auditors as well as managers was found to hold substantial importance. Furthermore, to determine the ethical correctness of their actions, the compensation offered by the owners to the managers and the auditors to act as their agents was a key element. It can be argued accordingly that auditors and managers are more likely to collude when the compensation gained through financial fraudulency is higher than the amount committed by the owners. Application of the behavioural agency theory further revealed that trust acts as another determinant to the relationship between the owners (as principles) with the agents, which in turn can help in inhibiting possible chances of collusion. It is in this context that the Australian auditing practices should define the compensation payable to the agents in a concise and comprehensive manner, which would restrict the decision making rights of the agents towards the principle and likewise, reduce chances of their fallouts.

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