HI6026 Audit Assurance And Compliance2 : Essay Fountain

Question:

When sub-standard audits are performed and reasonable assurance cannot be reliably ascertained, there are consequential risks for key stakeholders, including auditors. In light of this, perform the following key assignment tasks:

1. Perform a key stakeholder analysis for an ASX listed company. Explain how the key stakeholders would be affected if material misstatements are not properly identified, disclosed or adjusted for in the finalised financial statements. What are the key risks posed to each key stakeholder you have identified?

2. Consider the concepts of independence and “whistleblowing” in relation to auditors. How do these concepts relate to the public interest requirements mentioned in the APES 110 Code of Ethics for Professional Accountants document?

3. What lessons can auditors learn from the Enron scandal and in particular from the behaviour of Arthur Andersen?

4. With reference to the APES 110 Code of Ethics for Professional Accountants document and the ASIC website, research “audit quality” and discuss what auditors need to do to address the “warning” noted in the statement made by Greg Medcraft above.

 

Answer:

Introduction

Auditing can be considered as an important process of the companies as it helps in showing that whether the financial statements of the companies are free from material misstatements or not (Louwers et al., 2015). Auditing can be defined as the set of activities for on-site verification like the inspection and examination that the auditors conduct. It needs to be mentioned that there are certain objectives of this report (Knechel & Salterio, 2016). The present study will involve in the identification of the key stakeholders of Commonwealth Bank with the aim to explore the impacts of material misstatements on them. After that, this report also undertakes the analysis as well as evaluation of the public interest requirements of the auditors by discussing the matters like independence and whistleblowing. After that, this report considers the analysis of the major lessons that both the auditor and the other can obtain from the collapse of Enron. After that, this report stresses on the quality of the audit operations.

Effects of Material Misstatements on the Key Stakeholders

In this context, it needs to be mentioned that Commonwealth Bank has certain key stakeholders and some of them will be majorly affected in case there is major material misstatements in the bank’s financial statements. The following discussion shows the impact of material misstatements on these key stakeholders.

 

Investors Community

It can be seen from the appendix of this report that Commonwealth Bank considers the Investors Community as one of the major key stakeholders of their business and they are the institutes and individual having stake in the company (commbank.com.au, 2019). It is the responsibility of Commonwealth Bank to ensure the delivery of financial information of them through financial reporting, briefing and meetings. Now, in case the auditors of the bank flops in recognizing, disclosing and adjusting the material misstatements in the financial statements, the bank will end up providing these stakeholders with the incorrect financial information and this will affect the investment decision-making process of the shareholders (Lennox & Li, 2014).

Suppliers

It can be seen from the appendix of the report that Suppliers are another key stakeholder group of the bank and the bank includes the international, national and local suppliers. It can also be seen that the bank has certain strategies to engage to these stakeholders like suppliers meetings, risk assessment and others (commbank.com.au, 2019). The requirement for the suppliers is the assessment of the bank’s ability to repay the credits and debts. For this reason, it is needed for these stakeholders to assess the liquidity position of the company and they look into the financial information of the bank in the financial statements. In this position, the presence of material misstatements in the statements can affect the suppliers’ ability to assess the ability of the bank to repay the credits (Cao, Chychyla & Stewart, 2015).

Government and Regulators

It can also be seen from the appendix that Government and Regulators are another key group of stakeholders of Commonwealth Bank (commbank.com.au, 2019). It is needed for these stakeholders to assess the bank’s ability to ensure the payment of tax. In this position, the presence of material misstatements can affect the bank’s ability to make the taxation payments (Czerney, Schmidt & Thompson, 2014).

Employees

As per the appendix, Employees are one key stakeholder group of Commonwealth Bank and the career as well as earnings of these stakeholders large depends on the ability of the bank to continue as a going concern (commbank.com.au, 2019). The ability of the bank to continue as a going concern can be affected in the presence of material misstatements in the financial statements (Quadackers, Groot & Wright, 2014).

Independence, Whistleblowing and Public Interest Requirements

When discussing about auditor indepdence, it needs to be regarded as the indepdence of the external auditors from the audit client. One can characterize the auditor independence with certain aspects like integrity and approach of objectivity while performing the audit procedures (Ojo, 2015). As per the main requirement of the auditor independence, there must not be any undue pressure or influence in the auditors while performing the audit operations and it is needed for them to ensure performing the audit operations in the most objective way (Amar, 2014).

It is the requirement for the auditors to take into account the aspect of whistleblowing in the audit process. While performing the audit, if the external auditors think that the fraudulent and unethical business activities are taking place within the organisation, they needs to report this aspect to the internal or external regulatory authorities (Wainberg & Perreault, 2015). This whole process is called as Whistleblowing and whistle blower is the person who reports this fraudulent or illegal activity to the regulators. One important aspect that needs to be mentioned in this aspect is that the whistle blowers are needed to acquire the needed evidence before reporting the unethical behaviour to the respective authorities (Alleyne, Haniffa & Hudaib, 2016).

When maintaining the aspects like whistleblowing as well as auditor indepdence, one major obligation on the auditors is to follow the principles as well as standards of APES 110 Code of Ethics for Professional Accountants (apesb.org.au, 2019). It is mentioned under Section AUST210.11.1 of APES 110 that the existing auditors of the companies have the information related to new audit nomination and they are needed to provide the same to the new auditor who is asked to replace the nomination (apesb.org.au, 2019). For this reason, the need for the potential auditor is to ask for the information to the auditor in the presence of the client’s permission. In the presence of the proper approval, it is needed for the new auditor to ask for the information to the existing through writing (apesb.org.au, 2019). The absence of the needed permission can lead to the cancellation of the audit nomination. These are the crucial standards that the auditors are needed to follow. After that, it is mentioned in Section 100.1 of APES 110 that this particular regulation has ban the auditors from taking into consideration the interest of only the audit clients and the audit employer (apesb.org.au, 2019). These are the essential regulations that the auditors are needed to follow under the public interest requirements.

 

Lessons from Enron Scandal and Arthur Andersen

Fraud in Accounting

One crucial aspect that the Enron Scandal has been able in highlighting that the involvement of the management of the company various types of accounting fraudulent activities; such as finance through off-balance sheet items, false value asset developments and the generation of false amount of gains; and the main reason behind the appointment of Arthur Andersen was the assistance of them in these total accounting frauds. This whole aspect indicates towards one crucial lesson for the auditors and it is that the government agencies must obtain the authority for conducting the audit operations for the companies instead of the private firms (da Silveira, 2013). At the same time, with the aim to reduce the self-interest threat of audit independence, the audit authorities need to ban the auditors from providing any kind of non-audit as well as consultancy services.

Audit and Accounting Standards

It needs to be mentioned in this context, the management of Enronalong with their audit partner, Arthur Andersen, did not have the needed compliance with the required auditing as well as accounting standards; and this aspect contributed towards the unethical activities in the accounting and auditing operations of the company. From this situation, one crucial lesson that can be obtained is that there is a greater need for the introduction as well as implementation of strict accounting as well as auditing regulations for stopping these unethical actions (DiStaso & Scandura, 2014).

Incentive for the Auditors

One specific aspect that the collapse of Enron has been able to convey is that the auditors of the companies become demotivated in the presence of severe penalties for them while the presence of incentives can work as a motivational factors for them. It also needs to be mentioned that the most of the auditors still have compliance with the principles and standards of objectivity as well as professional competence. In this process, the audit authorities can use auditor insight as a tool for increasing the audit overall audit quality (Nguyen, 2014).

Independent Oversight

The results of the scandal of Enron has shown the whole audit profession the fact that the auditors of the company failed in the application of auditor independent oversight in the audit, but the application of auditor independent oversight is a major component that needs to be there to ensure the overall good quality of the audit operations. However, it is not possible for the auditors to apply independent oversight when they do not have the needed skill, experience and knowledge to perform the audit procedures in the quality manner. In order to ensure the audit quality by the application of auditor independent oversight, there needs to be sufficient inspection programs that will ensure the examination of the judgments that the auditors have used for developing the audit opinion (Albeksh, 2016).

External Auditor and Audit Committee

Another major insight that can be gained from the Enron collapse is that there was not any initiative from the management of Enron to ensure the true and fair disclosure of their financial information due to the presence of several accounting manipulation. For the application of auditor independent oversight to retain the audit quality, the need for the companies is to ensure the true and fair disclosure of the financial information. It is possible to use auditor independent oversight to increase audit quality only when the companies ensure the true and fair disclosure of the financial information (Jones & Stanton, 2013).

Audit Internal Control

Ineffective internal control was another major reason for the collapse of Enron as the company did not ensure the presence of any mechanism to ensure the truthfulness and fairness of financial reporting. The lesson that can be obtained from this is that the companies are needed to ensure the presence of strong internal control for retaining the audit quality (Hosseini & Mahesh, 2016).

Behaviour of Arthur Andersen

At the time of performing the audit of Enron, Arthur Andersen was considered as the second oldest audit firm. The liability of the audit firm was to ensure the fairness and correctness of Enron’s financial statements along with the internal bookkeeping. On the basis of the audit report of Arthur Andersen, the investment decisions were taken by the company’s investors, since the presence of the assurance that the financial statements are free from material misstatements (McLean & Elkind, 2013). However, Arthur Andersen had business partner relation with Enron during the audit tenure that became obvious after Enron appointed some of the executives of Arthur Andersen. In the presence of this reason, Arthur Andersen did not feel the obligation to examine the partnership agreement through the analysis of the financial report of Enron. Moreover, the auditors were guilty in March 2002 due to the destruction of certain audit documents of the company. All these actions indicate towards the unprofessional as well as unethical behaviour of Arthur Andersen as they received huge money from Enron as audit fees (Markham, 2015).

 

Audit Quality and Audit Strategies to Address Warning

According to the international standpoint, the perfect definition of audit quality has not yet been developed. For ensuring the quality of the external auditors, the entire audit processes need to be accurate while ensuring the presence of professional scepticism to be performed in the presence of the adherence to the existing audit standards. However, the presence of certain other aspects endures the audit quality; they are knowledge of the industry, nature as well as extent of audit insight, observations developed from the audit processes and others.

According to the statement of Greg Medcraft, collapses like Enron may occur in Australia, unless the big four audit firms take inititiatives to improve their audit standards. For this reason, the accounting books of the top Australian corporations require correct auditing with the aim to avoid the next financial crisis (abc.net.au, 2019).

In case the auditors fail in effectively perform the audit works, possibility of the occurrence of the incidents like Enron increases. Thus, in order to assure effective audit works, the need for the auditors is to fulfil their duties in correct manner to gain the assurance that there is not any material misstatement in the financial statements of the audit client. As per the requirement of Section 2 of APES 110, there needs to have the auditor’s assurance on the fact that the disclosed financial information are true and fair and the financial statements are not materially misstated (apesb.org.au, 2019). Greg Medcraft identified the fact that one main reason for Enron scandal was audit failure and this contributed to the financial crisis (abc.net.au, 2019). For this reason, accountability must be there from the auditors’ side for providing correct financial information by performing the audit procedures thoroughly (Beattie, Fearnley & Hines, 2013).

It can be seen from the analysis of the news article that ASIC has gathered certain key audit samples of the big four audit firms that are PwC, Deloitte, KPMG and E&Y for 18 months until December 2016. After the analysis of these samples, ASIC detected wrongness in 23% of the cases where failure of the auditors was seen in disclosing the material impact of the significant events on the financial statements. This aspect indicates towards the absence of professional scepticism in these audit companies when they are facing any kind of challenging audit situations. It cannot be considered as favourable in the presence of the possibility that the situation can become worse (Byrnes et al., 2018).

It is required to be noted that one major reason for the collapse of Enron was the accounting fraud in 2002 and this fall of Enron hugely contributed towards the downfall of Arthur Andersen as the audit firm provided major assistance in these accounting manipulations. In Australia, Seven Media and Nine Entertainment Company ensured the write down of their asset values identified by ASIC and raised concerns about the valuation f these assets (abc.net.au, 2019).

One particular aspect is evident from the statement of Greg Medcraft that ASIC performed 7000 surveillances and more than thousand of inspection; as a result, more than 600 firms were banned, 80 people were imprisoned and $1.3 billion was refunded to the investors in the past six years (abc.net.au, 2019). In addition, Greg Medcraft handed over his unfinished business’s list to the federal government. In addition, it became necessary for the enforcement of criminal charges in the place of civil charges; and this recommendation was identified from the enquiry of the government and the financial system (abc.net.au, 2019). Thus, with the aim to address the audit independence threat, the need is to maintain the audit quality and thus, safeguards need to be applied in the presence of proper auditing activities (Fiolleau et al., 2013).

As mentioned in Section 290.155 of APES 110, in case an organization has a handful of persons having the needed experience as well as competence for carrying out the audit responsibilities of the audit partner, it is not possible to apply the audit safeguard of audit partner rotation(apesb.org.au, 2019) . In case the company obtains exemption from the independent audit regulator on the rotation of the audit partner as per the jurisdiction, it is possible for the person to remain as an audit partner for more than seven years (apesb.org.au, 2019). However, it is needed to conduct independent external audit review as alternative safeguard (apesb.org.au, 2019).

As mentioned in Section 100.1 of APES 110, it is required for an auditor to act in the best interest of the public so that they can get the necessary assurance on the financial information disclosure (apesb.org.au, 2019). For this reason, an audit member needs to be responsible to meet the needs of the public and stakeholders. It is also mentioned in Section 100.2(c) of APES 110 that for the elimination of threats, it is important to apply the necessary safeguards. Apart from this, safeguards need to be applied when the audit threat crosses the safe level and there is not negotiation in the audit standards (apesb.org.au, 2019).

Hence, it can be seen from the remark of Greg Medcraft that the auditors in Australia need to be more professionally competent at the time to conduct the audit work to avoid the collapses like Enron in Australia (abc.net.au, 2019). For ensuring this, they must have the required knowledge, skills and experience for providing reasonable assurance on the accounting information of the companies. In addition, confidentiality needs to be maintained by the auditors as they cannot provide the business information of the audit clients to any third party and it is mentioned in Section 100.5(d) of APES 110. On the overall basis, the auditors are needed to comply with the necessary standards so that they can avoid the discredit of the profession (apesb.org.au, 2019).

 

Conclusion

After taking into consideration all the aspects of the above discussion, it can be said that Commonwealth Bank has different key stakeholders and it is evident from the above discussion that the presence of material misstatements in the financial statements can create major adverse impact on these key stakeholders. After that, the report also states that both the audit independence and audit whistleblowing play crucial part in uncovering the unethical as well as illegal activities within the business organizations. When considered the discussion on the lessons, it needs to be mentioned that each lesson is important for the auditors to increase the audit quality and to avoid the occurrence of the same kind of corporate collapses in the country. For this reason, Greg Medcraft has issued a warning to that big four audit firms that unless they improve the overall audit standards, it may happen that Australian witnesses the corporate collapses like Enron. For this reason, it is needed for the whole Australian auditor community to comply with the necessary regulations and standards of auditing to increase the audit quality.

 

References

Albeksh, H. M. A. (2016). The Crisis of the Ethics of Audit Profession: Collapse of Enron Company and the Lessons Learned. Open Access Library Journal, 3(11), 1.

Alleyne, P., Haniffa, R., & Hudaib, M. (2016). The Construction of a Whistle?Blowing Protocol for Audit Organisations: A Four?Stage Participatory Approach. International Journal of Auditing, 20(1), 72-86.

Amar, A. B. (2014). The effect of independence audit committee on earnings management: The case in French. International Journal of Academic Research in Accounting, Finance and Management Sciences, 4(1), 96-102.

Apesb.org.au. (2019). APES 110 Code of Ethics for Professional Accountants. Retrieved 26 January 2019, from https://www.apesb.org.au/uploads/standards/apesb_standards/standard1.pdf

Beattie, V., Fearnley, S., & Hines, T. (2013). Perceptions of factors affecting audit quality in the post-SOX UK regulatory environment. Accounting and Business Research, 43(1), 56-81.

Byrnes, P. E., Al-Awadhi, A., Gullvist, B., Brown-Liburd, H., Teeter, R., Warren Jr, J. D., & Vasarhelyi, M. (2018). Evolution of Auditing: From the Traditional Approach to the Future Audit 1. In Continuous Auditing: Theory and Application (pp. 285-297). Emerald Publishing Limited.

Cao, M., Chychyla, R., & Stewart, T. (2015). Big Data analytics in financial statement audits. Accounting Horizons, 29(2), 423-429.

Commbank.com.au.  (2019).  Stakeholder Engagement Approach. Retrieved 26 January 2019, from https://www.commbank.com.au/content/dam/commbank/assets/about/opportunity-initiatives/Stakeholder-Engagement-Approach.pdf

Czerney, K., Schmidt, J. J., & Thompson, A. M. (2014). Does auditor explanatory language in unqualified audit reports indicate increased financial misstatement risk?. The Accounting Review, 89(6), 2115-2149.

da Silveira, A. D. M. (2013). The Enron scandal a decade later: lessons learned?.

DiStaso, M. W., & Scandura, T. A. (2014). Organizational legitimacy: Lessons learned from financial scandals. In An integrated approach to communication theory and research(pp. 420-431). Routledge.

Fiolleau, K., Hoang, K., Jamal, K., & Sunder, S. (2013). How do regulatory reforms to enhance auditor independence work in practice?. Contemporary Accounting Research, 30(3), 864-890.

Hosseini, S. B., & Mahesh, R. (2016). THE LESSON FROM ENRON CASE. Journal of Current Research, 8(08), 37451-37460.

Jones, M. J., & Stanton, P. (2013, July). Enron Cartoons: Accounting in the Spotlight. In Seventh Asia Pacific Interdisciplinary Research in Accounting Conference (p. 136). Kobe: The APIRA Conference Committee.

Knechel, W. R., & Salterio, S. E. (2016). Auditing: Assurance and risk. Routledge.

Lennox, C., & Li, B. (2014). Accounting misstatements following lawsuits against auditors. Journal of Accounting and Economics, 57(1), 58-75.

Louwers, T. J., Ramsay, R. J., Sinason, D. H., Strawser, J. R., & Thibodeau, J. C. (2015). Auditing & assurance services. McGraw-Hill Education.

Markham, J. W. (2015). A financial history of modern US corporate scandals: From Enron to reform. Routledge.

McLean, B., & Elkind, P. (2013). The smartest guys in the room: The amazing rise and scandalous fall of Enron. Penguin.

Nguyen, T. N. (2014). A different approach to information management by exceptions (toward the prevention of another Enron). Information & Management, 51(1), 165-176.

Ojo, M. (2015). Audits, audit quality and signalling mechanisms: concentrated ownership structures. American Research Journal of Humanities and Social Sciences, 1(2).

Poor auditing could be ‘canary in the coal mine’ for financial crisis: ASIC. (2017). ABC News. Retrieved 26 January 2019, from https://www.abc.net.au/news/2017-11-03/asic-boss-concerned-over-poor-auditing/9114490

Quadackers, L., Groot, T., & Wright, A. (2014). Auditors’ professional skepticism: Neutrality versus presumptive doubt. Contemporary accounting research, 31(3), 639-657.

Wainberg, J., & Perreault, S. (2015). Whistleblowing in audit firms: Do explicit protections from retaliation activate implicit threats of reprisal?. Behavioral Research in Accounting, 28(1), 83-93.

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