Value of auditing Essay
Value of auditing
Would you obtain an audit for this company? Explain the reasons for your decision. Yes, audits exist because of regulatory mandate (required by government). There are three theories which propose reasons why demand for audits might exist without regulatory mandate:
1. Agency theory
(The focus of the agency demand for auditing is more related to the stewardship role of accounting- which is more an examination of what has happened.) The separation of ownership and control of organizations has resulted in an information asymmetry problem for the owners of the organization- -agency problem. The owners entrust managers to run the company so they could control the business to make any decision about the business. However, the managers do not necessarily have the same incentives as the owners of the company and will probably be trying to maximize their own resource consumption. It may be that they may enjoy first-class travel, dining and accommodation which may be more than is necessary for the company. Most importantly, they might manipulate earnings in the short term to earn bonuses, which would not be in the long-term interest of the company.
The agency problem is why managers produce financial reports for shareholders to try to alleviate their concerns. However, there is still a risk that this information may be biased. For this reason, it is in the best interest of both parties to obtain the services of an independent auditor to check the financial statements prepared by management and provide reasonable assurance that it is true and fair to the users of the financial statements. An audit by someone independent of the manager reduces the incentive problems that arise when the firm manager does not own all of the residual claims on the firm (Jensen and Mackling). So, an audit is a monitoring activity that will increase the value of the firm when there are agency problem. Following these arguments, regulation would not appear to be appearing to be necessary to observe audits occurring.
2. Information hypothesis
(Information hypotheses is more towards the decision usefulness role of accounting) The audit improves the quality of information, which provides benefits through the reduction of risk, improvements of decisions, and the increase in profits. And investors will demand this information because it is useful for decision making and will assist them in assessing the risks and returns associated with their investments. There will also be value within the firm to assist in improving financial data for internal decision making; it can detect errors and motivate employees to exercise more care in preparing records in anticipation of an audit.
3. Insurance hypothesis.
Firstly, The related to investors and creditors who might demand an audit to show that they are being prudent to insure against losses which is to create additional demand for auditing so that insurance can be prudent against loss. Secondly, a major reason for a demand in audition in Australia is due to the significant changes in the legal environment, which have reduced the legal exposure for auditors considerably.
The first one will be investors, who might demand an audit to show that they are being prudent to insure against loss.
Discuss the views of the audit partner. This case said users of audit want all fraud found, and a guarantee that will continue forever which quite unreasonable and not the value of audit create to do. Moreover, audit can do more issue, nut it charge more money. This situation exists because of the expectation gap. The expectation gap comprises the difference between what financial statement users believe the audit provides and what and audit actually does provide.
1. A gap between what society expects auditors to achieve and what they can be reasonably expected to accomplish (reasonableness gap) When there is a difference between what this company expects auditors to achieve and what auditors can reasonably achieve, the gap will be created.
2. A gap between society can reasonably expect auditors to accomplish and what they are perceived to achieve (performance gap) In this case, the expectations may be reasonable, but other factors such as deficient performance and standards will cause the gap.
1.28 Independence and reliability
Based on the series of accounting crises and corporate collapses in the early 2000s, discuss the importance of maintaining independence (and reliability) by an auditor. What do you think of the above comment?
The audit quality states that the market-assessed joint probability that a given auditor will both a) Discover the breach in the client’s accounting system, and b) Report the breach.
It requires that auditors have the ability to pick up errors or irregularities and then they have the independence to do something about it.
1. Non-audit services
Non-audit services have meant that the amount of these services purchased by companies has dropped off significantly. Non-audit services are defined as any service provided by the External Auditor under engagement with the group outside the scope of the external audit. The external auditor should not provide services that have the potential to impair or appear to impair the independence of their audit role. The concepts of independence and integrity are more a state of mind and as such are not conducive to prescription by detailed rules. However, the following activities are examples of services that should not be provided by the external auditor: book-keeping, presentation of, and other services in relation to, accounting records and financial statements; the design and implementation of financial information systems or financial controls;
2. Audit partner rotation
If an audit partner stays with the client for a long period of time, they will become too familiar with the client and it will impair independence. So, there required that the audit firm rotate. A person who plays a significant role in an audit in 5 or 7 years must rotate.
3. Auditor working for the client
A mumber of an audit firm, or director of an audit company who was a professional member of an audit team, from becoming an officer of an audit client until two years from the date of ceasing with the audit firm. In the case, independence important because can avoid company and auditor too close (they may have same objective or own interest), so need rotation auditor In addition, auditors not just have independence, also need concern the public interest.
2.22 audit committees
Discuss the work of the audit committee in enhancing corporate governance. Refer to specific examples-choose some large companies and access information from their websites. There are some recommendations which advice the company to establish the audit committee; the reason is that the audit committee can enhance corporate governance through following elements. 1.To assist the directors to take their responsibilities with due care, diligence and skill 2.To improve the credibility and objectivity of the accountability process 3.To improve the effectiveness of the internal and external audit functions and providing an objective forum for improving communication between the board and the internal and external auditor 4.To facilitate the independence of the internal and external auditors 5.To strengthen the role and influence of the non-executive directors 6.To foster an ethical culture throughout the organization
Qantas audit committee
1.The objectives of the Qantas Audit Committee are to assist the Board in fulfilling its corporate governance responsibilities in regard to financial reporting, audit and risk management. 2.The Committee is responsible for the review and monitoring of financial reporting, audit and risk management strategies, systems, policies and processes implemented. 3.The Committee will review the draft half yearly and annual financial statements of Qantas and the Qantas Group prior to consideration by the Board, to assess whether they represent a true and fair view of Qantas and the entities consolidated for reporting purposes, financial position and performance. 4.The Committee will consider the adequacy and effectiveness of the Qantas Group’s internal control and risk management framework by reviewing reports from Qantas Management and the internal and external auditors, and by monitoring Qantas Management responses and actions to correct any noted deficiencies.
2.24 Madoff’s scheme
Evaluate the case from an audit point of view, highlighting possible risks for an investor and a fund manager who might be attracted to such a scheme.
According to the case, Madoff was operating a Ponzi scheme to cheat investors. In this case, the returns generated by most Ponzi schemes on paper looks good which attracted unprofessional investors to invest the money in it. In other words, the information provided to the investors in this case is misstatement. Therefore, there is a risk for investors and fund managers to make wrong decisions. Financial statements will need to be audited so that information is reliable for investors to overlook. This is because auditors are independent persons who are out of company’s business, and they can achieve enhanced credibility of information disclosed to increase reliability of the financial statements.
Investors and fund managers should find some companies that have an audit committee to invest to avoid losing money easily, and should not trust other’s oral statement that is unreliable.
Investors and fund managers should invest some companies that have an internal auditing and not trust oral statement, which can avoid losing money.