Auditor Independence Essay Example
The regulatory framework in Australia over all publically listed companies require that all disclosing entities to prepare and audit financial reports in every financial year. The corporations act 2001 sect 301 specifically requires that the auditor provide an audit report subject to the requirements of the ACT. Further, there is established the auditing and assurance standards board auditing standards that guide the activities and scope of the auditing or any other services provided by the auditing firm. All accountants are bound by the code of ethics established by the accounting professional and ethical standards board. For further effectiveness in ensuring that the accounting and auditing officers comply with the given regulations and standard there is established the regulatory institutions such as the AUSTRALIAN Securities exchange, the institute of chartered accountants in Australia, CPA Australia, the A accounting professional and ethical standards board and the FRC. In spite of these regulations, audit forms usually find themselves to have contravened some of the requirements especially the lack of objectivity or independence in their reporting duties. These failures in the audit firms to comply with regulations have in the recent past cast doubt in their professional skills and knowledge of their undertakings.
Auditing issues: context
KPMG is widely considered to be one of the big four auditing firms in the world. This year (June 2017) KPMG is reported by the Financial Review (Han 2017) to be facing class action for giving misleading advice to the Discovery Metals in 2013. The advice was given during a joint takeover that the joint offer price of $1.70 was not reasonable given that the shares, in the opinion of the auditor, was worth between $1.74 and $2.22 while at that time the shares were selling at $1.65. Discovery metal used the advice given to caution the class action instituted by the former shareholders of the company. Therefore the class cation seeks to sue KPMG on the basis of the violation of sec 670A of the corporations act (Creagh 2017) as negligent and misleading actions from KPMG. For the mere fact that the recommendation was material in the decision of rejecting a takeover bid this represent a misstatement of material information within the meaning of ASA 720.
In March 2017, PwC was also named a defendant in class action against Vocation limited on the accusation of misleading and deceptive conduct in audit. The Australian financial review, (Tadros 2017), reports that PwC failed to take reasonable care and due diligence in carrying out its audit of the firm and specifically the role of their partner Steve Bourke. At the heart of the class action is the failure by PwC to raise alarm over the Victorian funding scheme for which the vocation training was party and inflating the revenues of the institute. The allegation throw doubt of the outcome of the audit report carried out during the 2014 financial year (Danckert 2017). The last time that PwC was involved in a class action was against the Centro shareholders in 2012.
In early 2016 Deloitte was accused or misleading and deceptive conduct as well as misrepresentation in the audit of Dick Smith’s financial reports. King (2016) reports that in 2014/2015 financial year, Deloitte reported that Dick Smith was financial stable while in less than 6 months; the company was put under receivership for having losses and cash problems. Deloitte is being accused of failure to identify such misstatement in prior years since it has been the auditor for the firm since 2013.
In principle, KPMG, PwC and Deloitte, in the named media articles are being accused of engaging in misstatements and misleading reports of their expected activities. Specifically, KPMG was in breach of the sect 670A of corporations act. All the audit firms together, are liable for failure to uphold the code of ethics standards of integrity, professional competence ad due diligence, and professional behaviour. In effect the misstatement of the audit and expert report imply that the auditor independence was not maintained and therefore affecting the audit quality.
The Auditing Standards Related To the Issues Raised
The auditing and assurance standard board requires that all audit firms need to comply with the auditing standards given therein. ASA 102 requires that all auditors should comply with the ethical requirements when performing the duty of audit, reviews or any other assurance engages. Sec 100.1 of APES 110 requires that all auditors act in the interest of the public and implicitly, the interest of the shareholders takes precedence over the interests of the managements. Moreover, all members are required to comply with the principles of integrity, objectivity, professional competence and due care, confidentiality, and professional behaviors (sec 100.5 APES 110). Sec 110 requires that all members to be honest in all professional an business relationships an specifically warns that no members shall not be associate (either in agreement or in preparing) with a report that (110.2 a) contains materially false or misleading information or omits or ensures information required to be included in the written failure to which makes the report misleading. This was evident the expert report provide by KPMG to discovery metal and the audit report provide by Deloitte on Dick Smiths financial health.
Sec 130.1 of the code of ethics obliges any member to maintain professional competence and due care by imposing on each member the obligation of maintaining professional skills and knowledge, acting in diligence when providing their professional skills. Compliance to this standard requires that an audit firm be aware of all the developments taken place at the time of the audit process. Failure of PwC to know that the Victoria funding had been withdrawn at the time of the audit process, directly contravenes the professional care and due diligence. Deloitte, in its issue with dick Smiths show their inability maintain professional competence and the skill level required by the client. The practice of professional competence warrants that the auditing firm be have the ability to perceive, or be conscious of events that relate to the business environment of the reporting entity. Though it is impossible to capture all the possible events that could occur the compliance to sec 130.1 implies that the auditor is able to be aware of all the relevant factors that pose a threat to the independent of the firm (Jaber and Fadda 2016)
All members are also required by sec 150 of the code of ethics to maintain professional behaviour in their undertakings. Sec 150.1 imposes an obligation on all members to be in compliance with the relevant laws and obligations required of it and should avoid any omission that could discredit the profession. This standard is particularly contravened by KPMG by contravening Sect 670A of the Corporations Act 2001. Sec 670A states that a person shall not give an expert report (670 (1(k))) for which there is material omission from the material report required for use in takeover decisions.
The action carried out by PwC and its failure of to disclose the material misstate of the Vocational training earnings is in violation of ASA 720. Para.14 of ASA 720 requires that if an auditor becomes aware of an apparent material misstatement of fact, that the auditor should inform management of the same and recommend that a third party advice be sought. PwC was in clear contravention of this standard as it failed to raise the red flag on the inflated earning. The audit failure by Deloitte on Dick smith’s financial status was also flawed to this respect. Moreover Deloitte gave an audit opinion of the entity on a going concern basis despite the fact that the company was put into liquidation not long after the audit report (King 2016). Under ASA 570 (6) the auditor has the responsibility to obtain appropriate audit evidence about the appropriateness of the management’s use of the going concern basis though (7) recognizes the limitation of the auditor in assessing the future outcomes of the company.
Sec 320 of the code of ethics relate to the preparation and reporting of information and sec 320.3 specifically requires that a member shall make reasonable cause to ensure that information for which the member is responsible should be (a) a true representation of the facts and (c) represents the facts accurately and completely in all respect. The audit firm is bound by this regulation on the basis that it is responsible for the preparation of the audit report. Failure of PwC and Deloitte to prepare and report on the true nature of the respective business that were being audited accurately and timely is a clear contravention of this standard.
The contravention of the audit firms in the audit process and expert services compromises the auditor independence as require by sec 290 of APES 110. SEC 290.6 defines the independence of the mind as the state of the mind that permits the expression of a conclusion without being affected by influences that compromise professional judgment. The independence of the auditor in mind and appearance requires that the member uphold objectivity and professional skepticism in their judgment. Nelson (2009) describes the professional skepticism as indicated by the judgments and decisions that reflect assessments of the…risk that an assertion is incorrect, conditional to the information available to the auditor.
The failure in maintaining the audit independence ultimately affects the audit quality of the occlusion made therein. The relationship between the audit independence and quality is apparent in the threats arising from lack of independence: importance of the client, non-audit services, the number of years the auditor has been undertaking duties with the firm and the affiliation the firm has with the audit firms (Tepalagul and Lin 2015). These constitute some of the factors that could have considerably influenced the conclusions made by the audit firms in giving professional services to the individual firms. The more financial stable a company is the higher the incentive for the auditor to consider a compromise on its independence in its conclusion on grounds that the pay will be higher. Notable, the Australian financial review reports that Deloitte earnings from the services rendered to Dick Smith was close to $441,927 (King 2017).in support of this, Reynolds and Francis (2001) showed that the Big 5 audit firms( in which Deloitte is part) are more conservative and more likely to waiver their independence.
However a research by Craswell, Stokes and Laughton (2002) found that the auditor evidence is not compromised by the importance of the client. DeAngelo (1981) in a study of small audit firms showed that the size of the audit firm does not affect the quality of the audit process. Further section 340 of the code of ethics relates to the impact of financial incentives and compensation in promoting the self-interest of the auditing firm
The auditor tenure also impacts the audit quality of the auditor. The logic presented is that the longer the auditor has stayed with the reporting entity the more likely it is that the auditor will act in favor of the management irrespective of the public interest (Tepalagul and Lin 2015). It is for this reason that the auditor rotation was introductive to improve the audit process (Carey and Simnett 2006). The independence of Deloitte could have been further compromised by the fact that the firm had ha Deloitte audit it financial statements even when it was till part of the Woolworths Group for almost a decade (king 2017). An assessment of the impact of the audit partner tenure on audit quality in Australia revealed that firms with longer tenure are more likely to issue an audit on going concern basis for a distressed company, report abnormal earnings and though long tenure did not impact the abnormal working capital (Carey and Simnett 2006).
Another school of thought, with support evidence from empirical findings, show that the longer the tenure the more likely the auditor is to understand the business of the firm and hence notice the errors more quickly than a newly appointed auditor (Tepalagul and Lin 2015).
Tepalagul and Lin (2015) noted that the audit firm independence and be threatened by the kind of relationship the firm has with the reporting entity. The nature of non-audit services rendered by the audit firm influences the audit independence. However there was not found empirical evidence that show such services and relationship materially affect the outcome of the audit process.
It is evident that the failure of three of the BIG five audit firms in their audit practice has resulted in the questioning of the professionalism, skill and knowledge of the firma and their partners in fulfilling their duties. The primary issue of concern that has risen is the impact of the auditor independence on the audit quality. The independence of the auditor is threatened by the failure of the firms to adhere to APES 110 on code of ethics and breaching some of the auditing standards on quality control and independence. Empirical research has shown that the independence of the auditor is largely determined by the size of the company to be audited hence the remuneration on the auditing services; the auditor tenure with the client firms; the non-auditing services provided by the auditor; the relationship between the auditing firm and the reporting entity. The impact of long tenure on auditor independence is reduced by the auditor rotation arrangement, evidenced by the empirical findings of Wang and Tuttle 2009 as in Tepalagul and Lin 2015). However, these threats can and should be eliminated as per the requirements of the auditing standard to enable improve the audit quality.
Carey P and Simnett R 2006 Audit Partner Tenure and Audit Quality the accounting review May 2006 vol 81(3) pp 653-676
APES 110 Code of Ethics for Professional Accountants APESB
Corporations Act 2001 (Cth) [online] available from: www.austlii.edu.au/legis/cth/consol_act/a2001172
Craswell A, Stokes D and Laughton J 2002 Auditor independence and fee dependence journal of accounting and economics vol 33 pp 235-275
Creagh B JUNE 2017 disgruntled former discovery metals shareholders propose class action Australian mining [online] available from: www.australianmining.com.au/news/disgruntled-dformer-discovery-metals-shareholders-propose-class-action/
Danckert S May 2017 PricewaterhouseCoopers accused misleading vocation investors the Sydney Morning Herald [online] available from: www.smh.au/business/markets/pricewaterhousecoopers-accused-of-misleading-vocation-investors-20170329-gv8ywo.html
DeAngelo L M 1981 auditor size and audit quality journal of Accounting and Economics vol 3(3) pp 183-199
Han M June 2017 KPMG faces class action over ‘misleading’ advice to Discovery Metals Australian Financial Review [online] available from: www.afr.com/business/accounting/kpmg-faces-class-action-over-misleading-advice-to-discovery-metals-20170615-gws88n
Jaber J R and Fadda M 2016 Awareness level of Professional Independence Requirements, through Assimilation of Fundamental Principles of Professional Ethics, by Jordanian CPA Auditors, in Auditing Process: Field Study international journal of economics and Finance vol 8(9) pp
King A January 2016 Deloitte ‘in firing line’ after Dick Smith failure Australian Financial Review [online] available from: www.afr.com/business/accounting/deloitte-in-firing-line-after-dick-smith-failure-20160104-glzefd
Nelson M W 2009 A models and Literature Review of Professional Skepticism in Auditing Auditing: a journal of practice &theory vol 28(2) pp1-34
Reynolds J and Francis R 2001 do size matter? The influence of large clients on office level auditor reporting decisions journal of accounting &economics vol 30 pp 375-400
Tadros E march 2017 PwC drawn into Vocation Class action: report [online] available from www.afr.com/business/accounting/pwc-drawn-into-vocation-class-action-report-20170329-gv9hys#
Tepalagul N an Lin L 2015 Auditor Independence an Audit quality: a literature review journal of accounting, auditing and finance 2015 vol 30(1) pp 101-121
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