Research Paper: Audit Quality and Agency

Pages: 15 (4858 words)  ·  Bibliography Sources: 1+  ·  Level: Doctorate  ·  Topic: Accounting  ·  Buy This Paper

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[. . .] All of these play a major role in minimizing the chances of such occurrences of errors in the audit report. But sometimes these incidents do not only happen because of mistakes of the human nature. The auditors might provide such misleading information deliberately and knowingly. They can do this to avail benefits for themselves by colluding with the management, thus becoming involved in a fraud or scandal. This gives rise to the concern of improper auditor independence, the effects of these on the audit quality, and the issues of trust and confidence in the auditors by the shareholders.

The Enron and WorldCom Scandals

History has proved that this is not only a myth as there have been cases, most recently that is, that have witnessed such frauds being committed by companies and their auditors to work against the shareholders' interests to benefit themselves instead. One of such cases has been the history's biggest corporate collapse, the Enron scandal of 2001 in the U.S., followed by the demise of its auditors, Arthur Andersen (one of the big five audit firms then). This case jolted the roots of accountancy and audit in the business world, tarnishing the image and reputation of the accounting profession and its members worldwide as a whole, and questioning the adequacy of rules and regulations and laws in place at that time.

Enron was a company in the U.S. energy sector and was formed in 1985 by merger as a natural gas pipeline company based in Houston, Texas. Enron had become the 7th largest U.S. based company by early 2001 and was also seen as the largest seller and buyer of electricity and natural gas in the U.S. The business failure of the Enron was discovered in December 2001, when it filed for bankruptcy (BBC News World Edition, 2001). It was said to have been one of the biggest failures in business history that involved a staggering amount of 8.5 billion dollars in debt. This was eventually viewed by many as a result of failure of audit, questioning the audit quality directly.

The auditors of Arthur Andersen, the audit firm that provided audit services to Enron, were under the limelight, particularly their ability to investigate any signs of questionable accounting practices followed by Enron and failure to report to the shareholders. Investigating more in to the case by the authorities brought to attention that for almost 20 years, Arthur Andersen had been providing audit services to Enron. These services were not only external audit services, but also internal audit services to Enron. This clearly showed that Arthur Andersen had violated the U.S. Securities Exchange Commission's laid down principles for impairing independence that when provided to an audit client, internal audit services was one of the 'nine non-audit services' that could impair the auditor's independence, and thus could affect the audit quality of the assignment (U.S. Securities and Exchange Comission, 2003).

It was also reported that Arthur Andersen had received earnings of about 52 million dollars during the time as auditors of Enron, and it was further expected that the amount was to get doubled soon. It also came to the knowledge of everyone that Arthur Andersen had also stationed a permanent office space in the Enron's building. Additionally, many of the events organized by Enron's management were joined and attended by employees of Arthur Andersen as well. It became evident that Arthur Andersen's profitable role as the auditors of Enron that earned them a hefty fee and the close intimacy with the company had gravely affected the independence of the auditors of Arthur Andersen, which eventually resulted in overlooking of compliance issues with relevant policies and regulations and making sure proper and adequate accounting practices were in place. Auditors of Arthur Andersen had known all along that the financial position of the Enron was not good and had serious issues, but they signed off the financial statements regardless of that.

Another major case that occurred such as the Enron scandal was related to a company called the WorldCom. The WorldCom was also a U.S. based company in the telecommunications sector that was formed in 1983 with the name of 'Long Distance Discount Services (LDDS)'. It grew in to one of the largest companies of U.S. And a telecom giant by the year 2000, by going through a series of acquisitions since its advent. In 1995, it changed its name from LDDS to the WorldCom Inc. Eventually in July 2002, the WorldCom filed for bankruptcy. This bankruptcy was the largest in the U.S. history, beating the record that was set by the Enron in December 2001. The company admitted that it had falsely booked an amount of 3.85 billion dollars of expenses as capital expenditure to make the company look more profitable. After an internal investigation was carried out by WorldCom itself and its auditors, it was revealed that since 1999 WorldCom was involved with some improper accounting practices. The internal auditors also uncovered that other than the original amount, another 3.83 billion dollars were found to be wrongly dealt with, bringing the total errors since 1999 to the value of almost 7.70 billion dollars.

Here also the auditors of the WorldCom were from Arthur Andersen. For the audit related to the year 2001, Arthur Andersen had given an unqualified opinion on the WorldCom's financial statements. At a meeting with the Audit Committee of WorldCom in February 2002, among other things related to the end of year financial statements of 2001, Arthur Andersen presented that:

1) There were no significant or unusual transactions, or material transactions in controversial or emerging areas for which there was a lack of authoritative guidance or consensus.

2) Andersen has assessed the Company's key accounting practices to determine whether management had adequate controls to prevent a material error in the financial statements as s result of a failure to properly record data in the general ledger.

3) It was Andersen's assessment that the Company's processes for line cost accruals and for capitalization of assets in Plant, Property and Equipment accounts were effective.

4) It was Andersen's assessment that the Company's process for formulating judgments and estimates for accrued line costs was effective, noting that line costs as a percentage of revenue had remained flat at 41.9% on a YTD basis. During the meeting, Andersen advised in response to specific questions by the Committee hat Andersen had no disagreements with management and that there were no accounting positions taken by the Company with which Andersen was not comfortable. (Anderson, February,2002)

Since the Enron scandal, Arthur Andersen was already under fire and subsequently after the bankruptcy of WorldCom, a number of cases were lodged against Arthur Andersen, where it was accused of not being able to protect the shareholders. To save their selves, Arthur Andersen blamed the WorldCom's Chief Financial Officer Scott D. Sullivan for withholding information during the course of the audit. But as soon as they discovered that certain expenses were reported as capital expenditure, Arthur Andersen straight away announced that the audit report for the WorldCom's financial statements for 2001 should not be relied upon by all the stakeholders.

In light of such huge scandals and frauds, the auditors of the Big Five firms claimed that they had adhered to ethical standards and guidelines. But unluckily, most of the corporate failure cases involving large companies such as Enron, WorldCom, Parmalat and Xerox were closely related to audit failures that affected the audit quality, involving large audit firms. Therefore, it becomes clear that it is of grave importance that the audit quality is properly controlled and maintained so that a proper audit report can be presented.

Controls for Audit Quality

The audit quality control can be carried out and maintained at two levels; one being the audit firm level and the other being on the individual auditor level. The presence of international standards on quality control (ISQC) and international financial reporting standards (IFRSs) helps audit firms to establish quality standards for their businesses and provide them a general quality control framework within which audits should be conducted. Firms are required to ensure that the appropriate training is provided to ensure there is complete understanding of the procedures and objectives. It is also essential for a firm to implement policies, such as the internal culture of the firm, where quality is considered essential. Such a culture must be inspired by the leaders of the firm, who must sell this culture in their actions and messages. The firms may appoint individuals with sufficient and appropriate experience and necessary authority to oversee the quality in the firm and its audit work.

The firms' overriding desire for quality will necessitate policies and procedures on ensuring excellence of its staff, through continuing professional development, education, work experience and coaching by more experienced staff, to provide the firm with 'reasonable assurance that it has sufficient personnel with the capabilities, competence and commitment to ethical principles necessary to perform its… [END OF PREVIEW]

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Audit Quality and Agency.  (2012, March 12).  Retrieved March 18, 2019, from https://www.essaytown.com/subjects/paper/audit-quality-agency/1710109

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"Audit Quality and Agency."  Essaytown.com.  March 12, 2012.  Accessed March 18, 2019.
https://www.essaytown.com/subjects/paper/audit-quality-agency/1710109.