Buacc5935 | Auditing | A Assessment Answers

Introduction

The independent audit of companies relied on several types of key component for supporting capital markets and regulatory framework. The various types of concerns expressed by the regulators are often expressed by the regulators and observers with sufficient independence and competency as per the approved audited accounts. The restatement pertaining to Enron accounts and failure of Lehman Bros is seen to be an obstruction towards justice against a firm which may have devastating effect associated to loss of confidence and integrity of an audit firm. Despite of this loss, companies such as Enron, Worldcom and Lehman Bros have severely compromised with independence in appearance. The main incidents relate to failure of auditors to identify and report the nonfactual financial information which has a detrimental long-term impact on the value of the firm. In addition to this, failure by the auditors in identifying the report on misleading financial information have been expressed with serious concerns pertaining to the regulators who can also undermine the stability of the capital markets (Ackermann & Marx, 2016).

Defining Audit risk

Audit risk relates to any instance of projecting met really incorrect information even after having an audit opinion which states that financial information is free from any material statements. Due to the investors, stakeholders and creditors, audit risk may possess several instances of legal liability pertaining to perform audit work (Griffiths, 2016).

Undermining ideology for auditor independence

Based on the establishment of audit risk modelling as per SAS 300 is beneficial in recognizing overall risk of audit. This is considered as the inappropriateness of the audit opinion pertaining to financial statements. The three main risk in auditing is seen with inherent risk, control risk and detection risk. It needs to be understood that in and risk is defined as the condition of an account balance or a set of transactions which relates to material statement either when aggregated with misstatement or individually in other classes or balances irrespective of the associated internal controls (Smetanko, 2014). On the other hand, control risks are those risks which relate to misstatement is as and when they occur and cannot be prevented, corrected or detected in a certain time as per internal accounting control system. The detection risk is seen to be consisting of those risks which are having substantive procedure of detecting material statements (Borkowski & Gaffney, 2018). The control risk and inherent risks are referred to those which are already incumbent or present by default in a company. It needs to be also understood that detection risk lies within the auditors. The consideration of substantive testing preceded by the auditor is seen with the function of assessment associated to the level of control risk and inherent risk related to a particular company (Zamboni & Litschig, 2018).

In general, some of the audit forms have assessed risk by replacing the combination of control risk and inherent risk. On the other hand, the business risks are referred with those measures in which risk pertaining to the audit entity is not achieved according to its objectives. Therefore, business risks are closely related to objectives of the business rather than financial statement audit. The procedure of audit can be considered before cost on the risks relating to material statement in the financial statements as well. This approach is regarded as the main consideration for adding value to the auditors which may be conducive for improving the overall performance of the business and managing of the risks at the same time. There are several suggestions pertaining to the literature which have stated that big farms have been able to differentiate the value of auditing by adoption of several types of business risk assessment procedure which are closely aligned with the objectives of management along with consequent risk compromising with the independence of the auditors. However, there are several counterbalance measures which are acquired by the auditors for better knowledge and know-how of understanding the business (Chen et al., 2015). Several other arguments have suggested that there is much greater responsibility related to the compliance with several types of regulatory initiatives such as improvements in corporate governance requirements and understanding the risk management. In case the role of auditor involved with the design of compliance system within the company, then the independence from the company seen to be becoming more difficult to achieve. Such an issue raises several factors which are often criticized by the management (Chan & Vasarhelyi, 2018).

It needs to be also understood that independence of mind relates to that state of mind which allows provisioning of opinion without affecting our compromising with professional judgement and thereby permitting an individual to act according to objectivity, professionalism, skepticism and integrity. The independence as per appearance defined by IFAC needs to be understood as per the avoidance of circumstances and facts which have a significant and reasonable effect on the informed third-party along with several types of members of assurance team. Some of the well distinguished model of political cognition needs to be taken into consideration with the conventional, conventional and post-conventional. The pre-conventional concept relates to placing of self-interest above the interest of society. On the other hand, the conventional interest pertains to conformity of an individual to sensitive affiliation of attributes. The postconventional theory relates to the individual judgements in conformation with the ethical norms according to society’s rule (Cohen, Krishnamoorthy & Wright, 2017).

Therefore, auditor’s independence is considered as the independence of the internal auditor and external auditor from parties who have financial interest in a business which is being audited. The independence factor needs to be accessed with integrity and objectivity approach. This concept is required with the auditors in carrying out their duties with the objective and free manner. The independence of the internal auditor related to the independence from the parties who might be interested in harming the results of an audit report. Similarly, the specific functions of internal management issues are considered with inadequate risk management programs, poor governance and internal controls (Sakr et al., 2017). The independence of the external auditor is discerned with the various types of Independence factors from the parties were having an interest in results disclosed in the financial reports of the company. This is depicted in support of audit committee pertaining to the client company and contractual reference code is generally provides the independence relating to management and code of ethics (Rakhmanova, Nagumanova & Naumova, 2016).

Reviewing the literature of Failure of Enron, Worldcom and Lehman Bros

The collapse of Lehman Brothers in 2008 is identified as one of the largest instances of bankruptcy in the history of the United States. However, such a failure is identified as only the beginning of series of events which has rippled through the market. The failure of the company cannot be seen with a single cause. Some of the well noted reasons leading to the failure of the bank can be identified with the debt load of American households, action by the feds, the regulation of the economy, traders of Wall Street and rating agencies. The aforementioned factors are some of the reasons which are responsible for credit crisis at Lehman Bros. The bank was accused of selling CDO to its clients and taking short positions which have eroded the value of the securities. Goldman Sachs catalysed the process by shortening the mortgage bond market which triggered a plunge in the sub-prime market (Parwada et al., 2015).

Enron was formed in 1985 followed by a merger among Houston Natural Gas Co. and Omaha-based InterNorth Inc. The company’s failure was triggered in 2000 after CEO Jeffrey Skilling found a way of hiding the financial losses pertaining to trading and other operations. This act was known as market to market accounting which involved measuring of value of the security as per present market value rather than book value (Chernov & Sornette, 2016). In terms of auditing this is seen as a breach of audit fraud and failure to comply with relevant audit obligations. The collapse of Enron Corporation led to affect thousands of employees of Wall Street to its core. The approach of market to market practice made the company appear more profitable than it was in real. In order to accommodate the mounting pressure of liabilities it further adopted to several unscrupulous auditing measures which led to use of off-balance-sheet special-purpose vehicles to conceal the toxic and debt assets related to creditors and investors. The primary reason of these SPVs where focused with accounting of realities than operating results (Gambacorta & Mistrulli, 2014).

WorldCom started its business in 1983 with set to create its long-distance telephone service provider plan as its initiation. Due to questionable accounting practices and misrepresentation of $ 3.8 billion in capital expenditure, thousands of employees and shareholders were affected. Despite of increasing cash flow is and profit over four quarters for misrepresentation of capital expenditure, the firm’s net actual loss was revealed in the long term. The company revealed its expenses by reducing the overall book value of the assets which required simultaneous increase of value of goodwill. In addition to this, the internal investigations revealed that investors were unaware of alleged fraud which pushed its stock price to $ 64 for each share (Dibra, 2016).

Lessons drawn by the accounting profession from these collapses

The lessons drawn from the failure of Lehman Bros in accounting profession needs to be understood with avoiding unachievable business strategy. Lehman made a deliberate decision for fastening the growth strategy. In doing so, they switch to a low-risk brokerage model to a high-risk capital-intensive model which needed them to buy assets and store them in opposing to acquiring the assets and primarily moving them to a third party. There had been several instances of mismatch in the illiquid investments required, short-term and long-term debt which raised the audit risk. Therefore, in general companies needs to adopt a capital-intensive model if the benefits outweigh the costs (Ahluwalia et al., 2018).

The lessons drawn from the collapse of Enron have conformed some notable improvements for treatments associated to off-balance-sheet dodges. The American accounting standards have aimed to improve their standards to impose more rigorous principles which relates to adoption of a more rigid audit program. In addition to this, the effort made by the company to ensure realignment of the audit procedure is focused on increasing interest of shareholders. Several other companies are seen with the need of maintaining stronger non-executive directors’ attention towards devoting more time for better audit plan. The American audit standard have also taken several actions for avoiding an instance of market to market accounting which involved measuring of value of the security as per present market value rather than book value.

The aftermath of WorldCom collapse has focused on preventing companies in ambitious investments and availing of easy credit options which may violate the debt equity ratio of the company. The important measures taken by the companies after failure of WorldCom was identified with focusing on core competencies rather than short-term growth. By 2000, the telecom industry identified that WorldCom was covering up for its losses by inflating the total assets by up to $ 11 billion. This made the company the largest contributor to the fraud in US history. As a result of such a breach of corporate culture, the newer accounting practices have ensured strengthening the leadership aspect to avoid such instances (Chernov & Sornette, 2016).

Conclusion

The learnings from the auditor risk is identified with condition of an account balance or a set of transactions which relates to material statement either when aggregated with misstatement or individually in other classes or balances irrespective of the associated internal controls. On the other hand, control risks are those risks which relate to misstatement is as and when they occur and cannot be prevented, corrected or detected in a certain time as per internal accounting control system. The independence as per appearance defined by IFAC needs to be understood as per the avoidance of circumstances and facts which have a significant and reasonable effect on the informed third-party along with several types of members of assurance team. The important lessons drawn from the collapse of Lehman Bros, Enron and WorldCom needs to be understood with avoiding unachievable business strategy.

References

Ackermann, C., & Marx, B. (2016). Internal Audit Risk Management in Metropolitan Municipalities.

Ahluwalia, S., Ferrell, O. C., Ferrell, L., & Rittenburg, T. L. (2018). Sarbanes–Oxley Section 406 Code of Ethics for Senior Financial Officers and Firm Behavior. Journal of Business Ethics, 151(3), 693-705.

Borkowski, S. C., & Gaffney, M. A. (2018). Transfer Pricing and FIN 48: How Managers Attempt to Mitigate Audit Risk. Management Accounting Quarterly, 19(2).

Chan, D. Y., & Vasarhelyi, M. A. (2018). Innovation and practice of continuous auditing. In Continuous Auditing: Theory and Application (pp. 271-283). Emerald Publishing Limited.

Chen, Y., Gul, F. A., Veeraraghavan, M., & Zolotoy, L. (2015). Executive equity risk-taking incentives and audit pricing. The Accounting Review, 90(6), 2205-2234.

Chernov, D., & Sornette, D. (2016). Dynamics of information flow before major crises: lessons from the collapse of Enron, the subprime mortgage crisis and other high impact disasters in the industrial sector. In Disaster Forensics (pp. 175-221). Springer, Cham.

Chernov, D., & Sornette, D. (2016). Dynamics of information flow before major crises: lessons from the collapse of Enron, the subprime mortgage crisis and other high impact disasters in the industrial sector. In Disaster Forensics (pp. 175-221). Springer, Cham.

Cohen, J., Krishnamoorthy, G., & Wright, A. (2017). Enterprise Risk Management and the Financial Reporting Process: The Experiences of Audit Committee Members, CFO s, and External Auditors. Contemporary Accounting Research, 34(2), 1178-1209.

Dibra, R. (2016). Corporate Governance failure: the case of Enron and Parmalat. European Scientific Journal, ESJ, 12(16).

Gambacorta, L., & Mistrulli, P. E. (2014). Bank heterogeneity and interest rate setting: what lessons have we learned since Lehman Brothers?. Journal of Money, Credit and Banking, 46(4), 753-778.

Griffiths, P. (2016). Risk-based auditing. Routledge.

Parwada, J. T., Shen, J., Siaw, K., & Tan, E. K. (2015). The Value of Institutional Brokerage Relationships: Evidence From The Collapse of Lehman Brothers.

Rakhmanova, I. I., Nagumanova, R. V., & Naumova, N. A. (2016). Application of Fuzzy Sets Theory to Assessment of Audit Risk in a Tax Audit. International Business Management, 10(27), 6149-6152.

Sakr, Y., Rubatto Birri, P. N., Kotfis, K., Nanchal, R., Shah, B., Kluge, S., ... & Vincent, J. L. (2017). Higher fluid balance increases the risk of death from sepsis: results from a large international audit. Critical care medicine, 45(3), 386-394.

Smetanko, O. (2014). Improvement of Internal Audit Planning Method through Application of Risk Card by the Indices of Value-Based Management System of Joint-Stock Company. Accounting and Finance, (2), 144-154.

Zamboni, Y., & Litschig, S. (2018). Audit risk and rent extraction: Evidence from a randomized evaluation in Brazil. Journal of Development Economics, 134, 133-149.