Question:
Discuss About The United States And European Union Auditor?
The present report aims to present an analysis and evaluation of the key issues present in the case study entitled ‘Enron: Independence’. Enron, an American company involved in energy, commodities and Services Company was declared bankrupt in the year 2001. The company who was recognized to possess large asset base till the year 2000 suddenly was announced to bankrupt thereby causing the loss of many of its investors and creditors. The case has presented an analysis of the importance of maintaining auditor independence for disclosing the real financial position of a business entity. This is because, Arthur, Andersen, an auditing partner of Enron, has very close relationship with the company as reflected from the case study and therefore has hide the materialistic facts about its financial position from the end-users. This was mainly done for increasing the stock price of the company by the managers in order to realize huge profits. As such, the present report has discussed the importance of auditor’s independence and significance to the profession of auditing. In addition to this, it has illustrated the importance of maintain professional distance in the auditing profession by discussing the case of Enron and Arthur Independence.
The main purpose of auditing carried out by the firms is to provide expert suggestions regarding the effectiveness of their financial reporting systems. The financial reports must provide a true and fair view of the annual accounts of a firm in order to ensure the transparency of its operations in the eyes of its stakeholders. It is essential for the auditor’s to maintain an independent position so that actual financial condition of an enterprise is depicted to the end-users without concealment of any pertinent financial facts. The auditor’s independence refers to the autonomy of the auditing firm hired by the client for analyzing the transparency of its internal business operations. As per the AICPA’s professional ode of conduct an auditor is required to have intellectual honesty and judicial impartiality in order to effectively meet the liabilities of its clients and all of its stakeholders (Adelopo, 2016).
The absence of independency of the auditor results in restricting the honest and fair view regarding the integrity of a firm’s operations that can negatively impact the stakeholder’s interests. The independency in the accounting profession means that the opinion of the auditor is not impacted by any relationship between the company and auditing firm. This is essential so that auditors provide an unbiased opinion on the financial position of a firm for protecting the interests of all its stakeholders (Langendijk, Swagerman and Verhoog, 2003). The major threats for auditor independence are as follows:
Self-interest threat: The threat exists when an auditor has a financial dependence on the client such as that exists in the case of Enron and Andersen. The auditing firm, Anderson, was realizing millions of income from Enron and therefore has become financially dependent on it.
Trust Threat: The auditor has achieved a high level of trust among the company executives and management and thereby not carrying out his/her job role effectively.
Threat of Familiarity: The development of high level of friendship bond among the auditor and the management people of the client restricts the independency if auditor role. This is because auditors has to follow to the advice of management people and thereby cannot perform the job functions with freedom. The familiarity issue was also responsible in the case of Enron corporate scandal as there was familiar relation between the chief accounting officer of the company and the auditor. This lead to the occurrence of mis-representation of the financial figures by the auditor on the advice of the chief accounting officer (Gray and Manson, 2007).
Thus, as such it can be said that there exist a high need for independent of auditor’s to provide sufficient knowledge to the outside parties regarding a firm financial condition. The end-users of the financial reports have faith in the auditor’s report and it plays an important role in their investment decision-making process. Therefore, for maintaining the confidence of the general public in the business world the independency of auditor’s actions is very essential. In this context, the stakeholder theory states that a business entity needs to be morally and ethically responsible for protecting the interests of all its stakeholders by providing them realistic financial information. The financial information presented to the end-users must be free from error so that it can be used in decisions relating to the investment. Therefore, the firm must ensure that it carries out its auditing is carried out independently without the involvement of its management (Friedman and Miles, 2006). This will help in preventing the occurrence of any fraudulent accounting activities within the firm such as that occurred the Enron Corporation.
The analysis of the case study has shown that the major role played in the collapse of Enron in the year 2001 was the ineffectiveness of its auditing services. The Enron has become one of the largest clients of Arthur Andersen as it realizes million of profits every week from the company. Apart from the audit services, the Andersen also provides non-audit services to the Enron such as business consulting and tax work and realizes about $27 million for such services. The large amount of compensation provided to the Andersen has made it quite challenging for the auditing firm to question the Enron’s management team regarding its fraudulent business operations. These non-audit services provided by Andersen provide it an incentive to work as per the interests and goals of the management of Enron. As per the Sarbanes Oxley Act, it is illegal for a public accounting firm to provide any type of non-audit services to its clients. The non-audit services forms a large part of compensation provided to the Andersen and thus maintaining of high financial interest in the client can be said to be one of the major reason for impairment of auditor’s independence (Rantanen, 2007).
In addition to this, the presence of close friendly relations between the chief accounting officer of Enron and the auditing partner of Andersen lead to restriction in maintaining the auditor’s independency during the audit of Enron by Andersen. David Duncan, the Chief Accounting Officer of Enron and the Andersen engagement partner, Cuasey, knew each other from long time and they enjoy vacations together. The existence of long-standing relationship between the client and auditors becomes responsible for the larger role of auditor in the client management functions. This can be done for releasing high profits from the client as Anderson gains huge revenue from Enron. Therefore, the familiarity issues also resulted in impairing the auditor’s independency in the case of Enron (Rantanen, 2007).
Also, Anderson had developed a promotional video for sharing the closeness of its relationship with Enron. There was large number of accountants hired by Andersen that were working at Enron and hold prominent positions in the management team of the company. Also, besides performing auditing of its internal operations, the auditing firm Andersen was also involved in external audit of its financial statements. As such, it was rather difficult for the auditing firm to carry the auditing of its own work resulting in impairment of auditor’s independency. In this context, the AICPA code of conduct states that individual involved in general public practices such as of auditing should provide unbiased services for maintaining the general public confidence (Edwards, 2003).
The case of Enron bankruptcy has emphasized on the need and importance of maintaining auditor independency through developing professional distances. The presence of nay type of personal bonds between the auditor and client can result in biasing the potential judgments of the financial statements. The presence of some sort of professional distance is essential in providing public contact services such as auditing for protecting the stakeholder interests. The client should not have nay personal relationship with the auditor so that he/she can perform the job role independently and provide unbiased statements with the financial audit (Strohm, 2007). The present case study has reflected the impact of presence of personal relationship between the auditor and the client on the auditing services. The audit firm is paid by the client and thus it has made rather difficult for the auditing firm in the present case to carry out an independent audit. The maintaining of independency is highly essential in the profession of auditing which can be impacted to a huge extent through the presence of bonds of personal relationship. The case of Enron has shown that both the auditing firm and the client should not be known to each other to work in independence. The professional distance will enable the auditor to complete the auditing work through greater proficiency and competency (Alipur, 2013).
The presence of close relations between the auditor and the client will have large impact on the professional competency of the auditor’s. The auditor’s owes an ethical obligation towards the clients, employers and other stakeholders and therefore should carry out their roles with utmost care and diligence. The many researchers in this context have demonstrated the negative relationship between the presence of personal bonds in auditing profession and the quality of auditing (Alipur, 2013). There are many issues present in the auditing quality and therefore many researchers have emphasized on the importance of professional distance in the accounting profession. The case of Enron has also shown that having more information about the client does not impact the ability of an auditor for identifying the auditing problem. There should be good communication between the auditor and the management of the client company for identifying and resolving the potential problems (Edwards, 2003).
However, this should only be maintained at professional level and there should not be nay personal ties between them. In this context, the agency theory of corporate governance has emphasized on the relationship between principal and agents in a business entity. The theory helps in resolving the issues related present between the management and its different level of stakeholders (Forbes-Pitt, 2011). The agency relationship is said to exist when the principal hires an agent for performing some duty in his behalf such as auditing firm being hired by a business entity for carry out auditing of its financial statements. As per the theory, in the case of auditor-client relationship, the agent (auditor) should present the best interest of the principal (client) without any personal interest in the principal actions (Bamberg and Spremann, 2012). Therefore, it can be said that accountancy profession is entrusted with high public interest role and therefore all professional accountants need to adhere to the standard code of conduct directed by the AICPA. The code of conduct has mandated the auditor’s to act in independency and restrict themselves from any type of relations with the client that can impact their professional capabilities. Therefore, any type of personal relationships between the auditor and the client can be regarded to be unethical as per the AICPA Code of Conduct (Strohm, 2007).
Conclusion
The discussion held in the report has helped in developing an understanding of the significance of independency in the auditing profession. The case of Enron has also helped in developing an insight regarding the negative impacts of having personal relationships with the auditing firm on the future sustainability of a business entity. The auditing profession holds high responsibility of maintaining the public confidence and trust. The report has also depicted the issues causing the impairment of auditor independency through the help of case study of Enron. The case study has shown that one of the major reasons for the loss of investor confidence during Enron collapse was ineffective audit services provided by its auditing partner, Arthur Andersen. The presence of close bonds between the auditing firm and the client has resulted in impairment of auditor’s professional competency and capability in the case of Enron. The auditors, as such, require carrying out their job duties with honesty and integrity to meet their ethical obligations towards their clients and its stakeholders
References
Adelopo, I. 2016. Auditor Independence: Auditing, Corporate Governance and Marketing Confidence. Routledge.
Alipur, R. 2013. The relationship between the spatial distance of auditors and clients, and the quality of auditing in accepted companies in Tehran stock exchange. Issues in Business Management and Economics1 (6), pp. 133-141.
Bamberg, G. and Spremann, K. 2012. Agency Theory, Information, and Incentives. Springer Science & Business Media.
Edwards, F. R. 2003. U.S. Corporate Governance: What Went Wrong and Can It Be Fixed? Federal Reserve Bank of Chicago conference.
Forbes-Pitt, K. 2011. The Assumption of Agency Theory. Taylor & Francis.
Friedman, A. and Miles, S. 2006. Stakeholders: Theory and Practice. OUP Oxford.
Gray, I. and Manson, S. 2007. The Audit Process: psychology, Practice and Cases. Cengage Learning EMEA.
Langendijk, H., Swagerman, D. and Verhoog, W. 2003. Is Fair Value Fair?: Financial Reporting from an International Perspective. John Wiley & Sons.
Rantanen, M. 2007. Reasons of Systemic Collapse in Enron: Systems Intelligence in Leadership and Everyday Life.
Strohm, C. 2007. United States and European Union Auditor Independence Regulation: Implications for Regulators and Auditing Practice. Springer Science & Business Media.
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