Discuss the Value of Audit and Assurance Services

Discuss the value of audit and assurance services and whether you think they can achieve this vision

 

  

Introduction

            Audits are crucial in financial reporting in that they reinforce the public confidence and trust in financial reporting. In this way, audits improve the economic prosperity of a firm by expanding the number, value, and variety of transactions that individuals are ready to enter into. This is indicative of recognition of the expanding roles of auditing. Over the years, various experts have provided varied definitions of auditing. For example, Montgomery (as cited by Rachchh et al.) defines auditing as “a systematic examination of the books and records of a business or other organisation in order to ascertain or verify and to report upon, the facts regarding its financial operation and the result thereof”[1]. Elsewhere, Kumar and Sharma[2] have defined auditing as the practice of scrutinizing another person's accounting and issuing a report on it. In recent years, in view of a growing number of corporate scandals, it has become necessary to ensure improvements in audit quality. This has necessitated making of changes as a means of encouraging enhanced transparency in the accountability and audit in auditors. Through audits, firms can increase user assurance. By assurance, we mean the ability to increase user confidence in a certain information or subject matter. In this case, an auditor's report enhances users' confidence in a firm's financial statement[3]. This raises the question of how the issues of auditing and assurance can be addressed at the firm level. In trying to find answers to this question, it will be necessary to explore the value of assurance services and audit, and if they can realise this vision. 

Discuss the value of audit and assurance services

Audit and assurance helps to sustain the Agency Theory

Audits and assurance play a key role in enhancing trust and confidence in the financial statements of a firm[4]. The principle-agent conflict that is brought about by the agency theory is of significant importance in underlining the value of audits and assurance, and shedding light on how these two processes have developed over time[5]. Concerns regarding the reliability and trust of financial information could perhaps give an explanation as to why audit and assurance are regarded as valuable mechanisms to promote confidence in shareholders that the management is running the firm with the best interests of the shareholders at heart. The agency theory points towards a lack of trust by principals on their agents owing to self-interest and information asymmetries[6]. Consequently, principals fail to trust their agents and hence endeavour to find a solution to their concerns by installing mechanisms that will unite their interests with those of agents.  In addition, the principals also install such mechanisms with a view to minimising the extent of opportunistic behaviour and information asymmetries[7]. A firm's financial statements act as the basic mechanism for shareholders to assess how directors are performing. Nonetheless, owing to the separation of control and ownership, issues with varying motives and information asymmetries, there the shareholder-director relationship could be strained[8]. 

Shareholders are limited in terms of accessing information regarding the operation of a firm, and have a reason to believe that the directors are not giving them the information that they require to help in their decision-making process[9]. Owing to such lack of trust, an audit and assurance services are essential in reinforcing trust and maintaining shareholder confidence.

Ensuring to material errors

The auditor has a crucial responsibility to play in planning and executing the audit with the aim of securing satisfactory assurance that material misstatements, whether as a result of fraud or errors, are detected. Auditors have a responsibility to exercise their professional judgement in considering material errors. According to the FASB (Financial Accounting Standards Board), materiality can be defined as

"the magnitude of an omission or misstatement of accounting information that,

in the light of surrounding circumstances, makes it probable that the judgment

of a reasonable person relying on the information would have been changed or

influenced by the omission or misstatement"[10].

Misstatements could be due to fraud or errors, and could encompass (i) inaccuracy data gathering while preparing financial statements; (ii) variation in the classification, presentation, or amount of a reported financial statement account, item, or element, and the amount, presentation, or classifications that could have been reported using GAAPs (generally accepted accounting principles)[11]. A misstatement could also be in the form of the omission of a financial account, item, or element, or disclosure of a financial statement in a manner that contravenes the generally accepted accounting principles. While auditors lack the responsibility to organise and execute the audit with the goal of detecting immaterial misstatements, an auditor responds to misstatements caused by fraud different from those caused by error. In the event that there is evidence of a likely fraud, irrespective of its immateriality, the auditor ought to take into accounts the possible effects on the integrity of the firm's employees and management, as well as the likely impact on other components of the audit.

 Auditing and assurance helps to detect and deter fraud

Advances in technology have made it increasingly hard to detect fraud, particularly if the fraud in question is conclusive in nature and the top management is involved. This is because the top management are highly capable of concealing fraud. Fraud detection is especially vital from the investor's point of view[12]. Basically, all investors wish to ensure that their investments are protected, and they also seek an assurance that the assets of a firm are not only safeguarded, but also correctly stated[13]. However, auditors contend that detecting fraud should not be their responsibility[14]. Nevertheless, the auditor has a role to play in detecting fraud by way of exercising their professional care and skills[15]. While it may be easy to define the role of an auditor in exposing material fraud[16], explaining and actualizing this role is more intricate and less obvious. This could be the case since fraud is a rare occurrence, the available internal accounting mechanism can effectively encourage an honest climate, or because most individuals tend to be honest[17]. Consequently, auditors may fail to identify sings of a fraud being committed, or they could be privy to the potential for fraud. So as to execute his role more effectively, the auditor ought to fully comprehend the nature of fraud, along with its implications on planning and executing the audit exercise (Guan et al. 2008). In this case, auditors need to exercise more vigilance in carrying out their duties by seeing to it that care and due diligence is foremost on their agenda in order to detect and expose fraud[18].

Helps the company to improve its internal control processes

In the fields of auditing and accounting, internal control describes the process for ascertaining the attainment of a firm's objectives in operational efficiency and effectiveness, conformance with existing laws, policies, and regulations, and reliable financial reporting.  Basically, the internal control of a firm encompasses virtually everything that has an effect on risks to a firm. Both the external and internal auditors play critical roles in assessing the effectiveness of a firm's internal controls. In this case, the auditor examines if the controls have been adequately developed and executed, and if they are working properly. Thereafter, the auditor is expected to provide recommendations on how the internal controls can be improved.

Moreover, an auditor could as well evaluate the firm's information technology controls, which are in turn associated with the firm's IT systems.  This is aimed at ascertaining that the information technology control conforms to the laws and regulations that govern them. Various jurisdictions have various regulations and laws on internal control with respect to financial reporting. In the United States for example, the 2002 Sarbanes-Oxley Act provide the current guidelines on internal control disclosure requirements while in the UK, the 1999 Turnbull guidance (later revised in 2004) and the Combined Code constitute part of the rules regarding internal control disclosures[19]. The external auditor has to ascertain the effectiveness of the financial reporting processes of a firm as a means of giving reasonable assurance on the same. In this case, the external auditor has to give their opinion on a firm's internal controls[20], and give a verdict on the reliability of the firm's financial reporting.

Improve the credibility of financial statements of the company

Audit quality is essential in upholding an efficient market environment. In this case an independent quality audit helps to promote confidence in the integrity and credibility of a firm's financial statements which is in turn crucial for improved financial performance and well functioning markets.  A key role of financial statements is to promote exchange of capital between firms and investors. The level to which investors have faith in information contained in financial statements is underpinned by how credible such financial statements may be. To ascertain the credibility of financial statements, firms enlist the services of an independent auditor whose role it is to ascertain the accuracy of such disclosures. Nonetheless, the implications of auditing on the credibility of financial statement hinges on auditor independence, as well as the accuracy involved in perform the audit. Improved reporting credibility could enhance the level to which investors have faith in information contained in financial statements such as information on the firm's performance and operations[21].

Consequently, improved reporting credibility could enhance the firm's access to external financing. This could in turn improve the ability of a company to invest in new projects. A firm with audited financial statements is also likely to secure finance at reduced costs. For instance, in a 2001 study conducted by the Booth School of Business affiliated to the University of Chicago, the findings revealed that companies that had their financial statements audited went on to secure bank loans at lower interest rates in comparison with companies whose financial statements were not audited[22]. Having audited financial statements while securing a bank loan gives banks and other lending companies reliable insights to your firm likely value.  Moreover, audited financial statements enable a firm to monitor its credit or loan facilities[23].

Auditing and assurance improves corporate governance

Auditors also play a key role in assessing and assisting to promote governance processes. Auditors are vital in regards to a firm's corporate governance given that whenever corporate abuse or fraud happens an auditor is usually the first person to locate it. While the auditor may not be directly involved in corporate governance activities within a firm, they nonetheless, provide checks and balances on the information components of corporate governance. An auditor is best placed to uncover misdeed in management and to also report on the firm in an objective manner. In particular, an independent auditor could fulfil this role very effectively while also upholding good governance. Auditors also facilitate in removing possible bias from a firm's financial reports. However, concerns have been raised to the effect that the monitoring role of an auditor is at variance with their consulting activities. In addition, the disciplinary mechanism available to auditors could be poor, and this could in turn dilute their independence. This can be improved by granting more independence to directors in the auditing committee.

Can they achieve the vision?

Auditors can achieve the vision by accomplishing one of two things. First, auditors must not only be independent in their responsibilities, but also seen to be independent. The auditor should also go about his work devoid of any bias towards the client as being biased would imply that he lacks the impartiality that the client requires to view his findings as being dependable[24]. In this case, independence refers to a judicial impartiality that acknowledges a duty to exercise fairness to owners and the management of a firm, and other stakeholders of the firm, such as creditors. In the absence of independence of an independent auditor, this is likely to impair public confidence in the auditor's findings[25]. An independent auditor is free from any interest or obligation to the management, or owners of a firm. For instance, an auditor must not have significant financial interest in the firm he is auditing as there is the likelihood that he could be biased in giving his opinion regarding the firm’s financial statements. This is likely to have the public view him as biased.

            It is also important that auditors abide by ethical guidelines as a means to avoiding threats likely to impact on their independence. Abiding by ethical guidelines enables auditors to steer clear of behaviour that might jeopardise their independence or objectivity.

Self-interest threat could happen in case an auditor has a certain beneficial interest in the performance of the firm owned by his client[26]. This could happen in a case where the auditor own shares in a firm owned by the client. It could also happen in a case where the auditing firm is over-reliant on a single client for a considerable portion of its income. Acceptance of hospitality and gifts also constitute self-interest threat.

Auditors must also avoid self-review threat. This happens in case an auditor prepared the financial statements of a firm and thereafter is required to audit these. In such a case, there is the danger that the auditor might fail to acknowledge any flaws in their won work out of fear of a possible reputational or financial penalty.

Advocacy threat could happen in case the auditor is requested to represent or promote their client in a certain way[27]. For instance, a client could request the auditor to represent them in court. This would demand that the auditor show preference for the client, and hence fails to be objective. 

Familiarity threat happens in case the auditor is too trusting or sympathetic to the client after a close relationship develops, usually after the auditor has worked closely with the client for a long time[28]. Again, this is likely to influence their independence negatively. 

On the other hand, intimidation threat could occur in case clients attempt to bully or harass auditors into providing a favourable report of their financial statements. Should this happen, the auditor must not yield to such intimidation and can even opt to resign.

Conclusion

Audits and assurance services are important in financial reporting as they have been shown to promote public confidence and study in financial reporting.  Audits and assurance services helps to reinforce trust between shareholders and the management of a firm, thereby restoring shareholder confidence. In planning and carrying out the audit, the auditor has a responsibility to ensure that they detect any material misstatements that could occur owing to fraud or errors.  Moreover, auditing and assurance enable auditors to not only detect fraud, but also deter it. However, auditors are of the view that detection of fraud is not their responsibility. Another crucial role of auditors is that they help firms to improve their internal control processes by ensuring that their objectives in operational efficiency and effectiveness are realised, and that they comply with the existing laws, polices, and regulations. This also includes promoting reliable reporting of financial statements. Auditors also help to improve the credibility of a firm's financial statements in the eyes of banks and other financial institutions. Consequently, a firm with audited financial statements can easily borrow money to financial its operations. Auditors are also crucial in assessing and assisting the firm to promote its corporate governance processes. This is crucial since in the event of a corporate fraud, auditors are almost always the firms to spot it. To realise these varies responsibilities, auditors need to be independent in their duties and also conform to the existing ethical guidelines. 

 

 

 

 

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