Auditing has evolved from a routine checking of the books of account to a vital part of the governance process of companies. Factors such as the volume of transactions, information technology, globalization and the constant increase in the complexity and number of laws, regulations and standards governing entities and their auditors have all impacted drastically on the evolving role of the registered auditing profession. The corporate collapses, business failures and fraudulent financial reporting scandals of the late 1990s and early 2000s led to a very turbulent time and resulted in a credibility crisis for the auditing profession. One of the consequences of this was the demise of Arthur Andersen and the resultant decrease in the number of big audit firms from five to four. A further consequence was the drastic interventions by governments, regulators and the auditing profession itself, which have given rise to various and onerous new laws, regulations and standards that govern financial reporting and the auditing thereof.
The period 2000 through 2006 has been a very turbulent time for the auditing profession, a period that witnessed numerous scandals and their aftermath (Enron, WorldCom, Parmalat), strident calls for changes in the way that auditors practice their profession, and regulatory initiatives that significantly change the way the profession is governed. Long-held attitudes and customary practices have been challenged and found to be deficient by the media, the investing public, and those charged with regulating financial reporting and auditing. Issues of auditor independence, the role of corporate governance, the responsibilities of management, the appropriateness of consulting services, and the overall professional obligations of auditors have all been discussed and debated by a broad array of interested groups and individuals. The theme linking these debates has often been ‘what is wrong with the auditing profession?’ and its close relative ‘what can be done to improve the auditing profession?’ As a result, this period has probably resulted in more substantive changes to the auditing profession than any other period in modern day business history.
Challenges auditor and overall audit profession faces can be classified as in-house challenges and outdoor challenges. In house challenges are challenges internal to the auditors and the auditing profession whereas outdoor challenges comes from the external sources on which auditors and audit profession has no control over.
In house challenges are challenges internal to the auditors and the auditing profession. Some of these challenges can be controlled by the profession or the audit firm itself. Whereas there are some challenges those are internal to the profession but out of control. Those challenges are inherent challenges. Audit firms and profession frequently adopts different safeguards to overcome these challenges or to reduce them to an acceptable level. Most of the in-house challenges are described below:
Limited number of employees
Auditing firms are experiencing significant shortages of trainee accountants and qualified staff. Audit firms have the added challenge of transformation and targets to deal with. Accordingly, there is a high demand for staff amongst auditing firms, and especially as regards attracting and retaining skilled trainees and accountants. This shortage of auditing staff has driven up salary costs, and consequently audit costs and audit fees.
In past, number of professional degrees was not that rampant. Students who wished to pursue professional degrees used to join audit firms to achieve professional degrees on accounting and auditing. In that time, firms were unable to accommodate all willing students. However, with time and globalizations, people now have access to various professional degrees without undergoing hard training for years. Therefore, people are losing interest to peruse chartered accountancy and to join in audit firms. They have alternative route to become accounting professionals.
Furthermore, human resource costs are fixed costs. Audit firms have to pay them even if there is no revenue is earned. Audit firms are mainly dependent of providing client services but there are no guaranty, especially for the small audit firms, that client will be available round the year. Firms therefore try to maintain human resources to an acceptable level. For that reason firms faces shortage of staffs when client increases at a particular period in a year.
Lack of motivation in human resources
In audit firms, most of the activities are similar and repetitive. Auditors have to work in extreme pressure and meet the deadlines set by the client and partners of the firm. Furthermore, they have to adjust with different situations and conditions while performing audit field works. Sometimes auditors have to face bitter experience due to improper behaviors and accusation by the personnel from client management. However, being a client facing organization, auditors have to bear with it.
Again people in the audit firms don’t enjoy different types of leaves provided to the employees of companies. Compensation in the audit firms are significantly lower compared to the employee compensation paid to the employees of companies. For most of the audit firms there is no option for provident fund, gratuity fund, payment in exchange of leaves. However, they have to work round the year. Sometimes they have to work extra hours without any overtime bonus and in holidays.
Many firms do not provide any training to the audit staffs regarding current developments or new technical skills. Staff themselves has to develop expertise. And when staffs do something extraordinary, firms do not provide any appreciation to them. Overall situations causes de-motivation to the audit staffs and which ultimately negatively impacts the audit activities and quality of audit.
Lack of expertise in audit staffs
Audit firms normally recruits fresh graduates. They have the theoretical knowledge but lack the practical knowledge. They develop expertise by matching prior knowledge with on-job experience. However, most of the time there expertise are limited to their level of educational qualification.
An auditor needs to have diverse expertise other than expertise in accounting and audit. The skills requirement of auditors has also undergone significant changes over the last number of years. Nowadays auditing staff face many new challenges, and in order to overcome these they should be schooled and trained in techniques that surpass traditional accounting and auditing procedures. These include, inter alia, computer skills, communication and presentation skills and professional and business ethics.
Familiarity or self-interest threats
Most of the audit clients are obtained through references. Partners and senior audit staffs was connection with the senior personnel from the client management. Furthermore, junior auditors might have close family relationship or financial relationship with persons from the clients. This raises a risk of familiarity and self-interest threats.
Cost in excess of revenue
Auditors sometime have to charges fee even if the cost of the service is far greater than the fee of the audit. Sometimes these engagements are to maintain certain level of client portfolio, or to infiltrate new industry where the firm has not audited yet. Sometime due to close relationship with client, auditor is requested to provide assurance service at a significantly lower cost. Auditors have to honor the request for the sake of long term relationship and in expectation of future benefits.
Testing is used
A financial statement covers all the transactions occurred during the year. However, At the time of audit, auditors do not oversee the process of building the financial statements from start to finish. Assurance providers may sometime not test the entire item in the every subject matter. Auditors use different types of sampling techniques and use representative samples to test and provide opinion on the basis of the outcome of the tests.
The accounting systems on which assurance providers may place a degree of reliance also have inherent limitations. The nature of the assurance report might itself be limiting, as every judgment and conclusion the assurance provider has drawn cannot be included in it. For that reasons, assurance providers does not provide absolute assurance. Rather, auditors provide a reasonable level of assurance. In the field of audit, reasonable assurance is the highest level of assurance. Some users misinterpret the reasonable level of assurance with absolute level of assurance. This is called the expectation gap which has been covered in the outdoor challenges.
Persuasive audit evidence
Most audit evidence is persuasive rather than conclusive. That means audit evidences do not provide a clear cut conclusion about the financial statements. Rather, the evidences provides an indication or basic understanding a about the financial statements. Auditors have to use their own judgment to conclude the outcome of the audit and provide assurance on the basis of their judgment.
Audit costs and audit fees
The cost of performing audits has increased significantly over the past number of years. This is attributed to factors such as the drastic increase in staff salaries, professional indemnity insurance, increasing technology costs, as well as the impact of changing audit methodologies and new accounting standards, which are time consuming to understand and to audit. At the other end of the scale are the clients who are often reluctant to accept increases in audit fees in excess of inflation. These forces auditors to do extra work without being paid for it, this in the long run will affect the firm’s ability to retain such clients.
Efficiency is one thing, but audit fees have been so drastically reduced by factors such as bidding and price competition that firms have been forced to think of ways to reduce the time spent working on audits. Accountants are under pressure to fit the expenses of the job into the fees they can charge. Many of the firms involved in the continuing high-profile accounting scandals had their work papers done by firms that easily passed peer review. The auditors probably did their jobs efficiently, but didn’t have the luxury of thinking about what might be wrong. Auditing fees should be high enough so that auditors can think on the job instead of quickly and mindlessly doing paperwork that will pass inspection.
Subjective provision of assurance
Assurance provision can be subjective and professional judgments have to be made. For example, about what aspects of the subject matter are the most important, how much evidence to obtain etc. Some items in the subject matter may be estimates and are therefore uncertain. It is impossible to conclude absolutely that judgmental estimates are correct.
Auditor independence and the provision of non-audit services
The provision of non-audit services by auditors to audit clients has had a significant impact on auditors’ independence and the profitability of their firms. Usually these non-audit services are very profitable and sought after, with the resultant effect that in the past auditors were tempted to succumb to management pressures on external audit issues in order to retain the audit engagement, and so to provide the very profitable non-audit services. The various regulations issued and legislation passed since Enron, as well as the various corporate governance codes, now all include stringent rules that either prohibit, or strictly control, non-audit services rendered by auditors to their audit clients.
Fraudulent financial reporting and audit failures
Various corporate collapses occurred in the late 1990s and early 2000s many of which were the result of fraudulent financial reporting, and these resulted in significant losses for creditors and serious hardship for shareholders. Many of these business failures were also seen as audit failures, and the auditing profession stood accused of not performing its ‘watchdog function’ effectively and with objectivity. Questions were also asked about the auditing profession’s ability to self-regulate, and governments responded by issuing new laws to regulate the auditor’s work. The auditing profession also implemented vigorous self-regulatory processes such as practice review, as well as other forms of auditor control, as discussed below. Lastly in this regard it is interesting to note the cynical comment that is sometimes heard that the auditors, through failure to perform their responsibilities with diligence and care, actually created more work for themselves and benefited substantially from their clients’ demise.
According to an article in the Wall Street Journal, the Big Four accounting firms KPMG, PricewaterhouseCoopers (PwC), Deloitte & Touche and Ernst & Young (EY) are more powerful than ever. The scandal that brought down US-based accountancy firm Arthur Andersen, gave rise to an increase in work generated by the stricter accounting and auditing standards in the Sarbanes-Oxley Corporate Governance Act. The increase in work combined with limited resources in turn delivered greater leverage for demanding and winning higher fees at the Big Four. So great is the demand that they are turning away work especially when the risks seem to outweigh the potential rewards.
(to be continued in part 2)
N.B.: This post is part of the paper on “Methodology, Benefits and Challenges of Auditing in Bangladesh” written by same author. The Paper was prepared for academic purpose and submitted to Faculty of Business Studies of The University of Dhaka.